Pick n Pay’s great results in South Africa but weak international expansion

Pick n Pay’s FY2019 results confirm CEO Richard Brasher’s impressive turnaround job. Like for like turnover up 4.8% in a tough market. Profit margin up from 2.4% to 2.8%. Profit before tax up 17.1% from R1,768.1m ($121.9m) to R2,073.2m ($143.0). Pick n Pay’s share price has gained 50% since February 2013.

Almost any way you look at, it Pick n Pay’s FY2019 results are a dramatic turnaround – one that will be making its main domestic competitors Shoprite, Spar and Woolworths take note. 52 week turnover rose by 7.2% from R80.2bn ($5.53bn) to R86.3bn ($5.95bn). The key takeaway is that Pick an Pay has achieved volume growth without sacrificing margin – a real achievement in what is still a soft, depressed consumer spending environment in South Africa. The South African division that constitutes most of Pick n Pay’s business saw profit before tax rise 23.8%. Pick n Pay’s pricing strategy has been underpinned by fewer and deeper promotions but lower everyday prices. Behind the scenes the main difference has come from better cost discipline and operating efficiency. Over the financial year, Pick n Pay has opened 130 new stores and closed 20 stores – i.e. a net increase of 110 stores. 62 of these were franchise stores, 42 were company owned Pick n Pay stores and 26 were its Boxer discounter stores.

Within South Africa, Pick n Pay launched Fresh Promise, its quality guarantee on fresh produce, butchery and bakery products, part of a defined strategy to attack Shoprite on its quality credentials and emphasise Pick n Pay as the best compromise between Shoprite pricing and Woolworths quality. The retailer has also invested in 500 private label SKUs although private label penetration among consumers is still low and offers strong room for growth.

Another highlight was online, where Pick n Pay delivered 25% growth in online sales, albeit from a low base. notably, click and collect sales more than doubled, and account for nearly 10% of order volume.

There are negatives. Earnings from the rest of Africa fell 16.2%, reflecting what the retailer called “difficult economic conditions in Zambia and the once-off impact of currency devaluation in Zimbabwe.” The fact that in constant currency terms, revenue grew 5.3% is little comfort, as Shoprite has found to its cost in Angola.

Trading in Zambia is likely to be improved by what many commodities analysts see as an upcoming copper supply shortage, which will drive up prices for Zambia’s core export. The situation in Zimbabwe, where there is a full blown currency crisis, is unlikely to improve soon. Pick n Pay is heavily invested in Zimbabwe, where it has a 49% stake in TM Supermarkets. For now, Pick n Pay is saying there is no impairment charge to TM Supermarkets’ book value.

Outside South Africa Pick n Pay opened just 6 new stores: 3 in Eswatini (Swaziland) and 3 in Zambia. It closed 2 stores in Namibia. Here, Pick n Pay is considerably weaker than Shoprite. We already knew Pick n Pay was hunting for store locations in Lagos but it has now confirmed it won’t open its first store until 2020, with just two further planned. Shoprite has 24 stores in 12 cities and is set to open more. Pick n Pay has also stopped talking about plans to enter Ghana, were it was slated to open several mall-based stores.

Analysts have also raised the question of Pick n Pay’s trading margin, which has risen from 1% in the dark days of 2013 but still lags Shoprite’s 4.4% by a distance. CEO Brasher is dismissive of calls to aim to high on margins too quickly and he has a point. Pick n Pay can still improve its operational efficiency and improve margins to 3-3.5%.

Pick n Pay is trusted by consumers on product quality and there is little value in cutting back on product quality to keep shareholders happy. Actually, we think this is one of the most valuable lessons Brasher took from his time at Tesco. As with Tesco, Pick n Pay’s strength – being a quality-led middle ground supermarket chain can quickly return to being a weakness: weak quality credentials and being unable to compete with Shoprite on price leave it in no man’s land.

One factor Pick n Pay didn’t mention because it’s entirely speculative but we think interesting: Carrefour’s partner Majid Al Futtaim is on the hunt for an acquisition in South Africa. For several reasons – not least that Pick n Pay was modelled on Carrefour – the two companies are a good strategic fit. Geographically there is no overlap between Majid Al Futtaim and Pick n Pay and if the two businesses were to combine they would be capable of exerting considerable pressure on Shoprite in several markets. An interesting possibility to consider.