I wanted to get back to the basics for my search. Ultimately, the value of a stock comes down to how much money the company can earn. In the long-term, a stock tends to move along with its earnings. In the short-term there can be disconnect between the earnings of a company and the price of its stock. One company I want to discuss is Shoprite Holdings Ltd (SRGHY). I had to look outside of the United States to find some of these bargains. Shoprite is headquartered in South Africa and trades on the Johannesburg Stock Exchange. It trades over-the-counter in the United States. I found the company by using the GuruFocus All-In-One Screener to find stocks trading at a large discount to its discounted earnings. The trouble is that many of the companies are trading at discounts to their earnings because earnings growth is slowing. I further narrowed my search to find companies that also have earnings and revenue growth.
Company Background
Shoprite is the largest retailer in Africa. It started in 1979 as a chain of eight supermarket stores in Cape Town. It is now a nearly $8 billion dollar company with 1902 stores in 15 African countries and the island country of Mauritius in the Indian Ocean. The holding company has supermarkets as its cornerstone, but also has a fast food chain, furniture stores, pharmacies, and liquor stores. There are brands serving all income levels.
| Store Portfolio as Dec 2013 | |
| Segment | # of Stores |
| Supermarkets - S. Africa | 848 |
| Supermarkets - Non S. Africa | 163 |
| Hungry Lion (Fast Food) | 164 |
| Furniture | 350 |
| OK Franchise | 377 |
| Total Stores | 1902 |
| Pharmacies | 150 |
| Liquor Stores | 220 |
The OK Franchise division enabled the group to gain a foothold in a diverse range of mostly smaller, convenience oriented markets situated in rural towns, suburbs, and neighborhoods. The stores offer a wide range of fresh and non-perishable food items, as well as general merchandise. The pharmacy and liquor stores are located within other stores. That is why they are not included within the store count.
Financial Strength
The company receives high scores in all categories, 4/5 for Business Predictability, 7/10 for Financial Strength, and 7/10 for Profitability & Growth. The company is solid financially with its $732 million in cash compared to its $366 million in long-term debt. The debt was nearly non-existent until 2012 when it jumped to $378 million. The debt was an issuance of convertible bonds with an interest rate of 6.5 percent maturing in 2017. So far the funds have been used to open new stores, align long-term investments with long-term capital, and improve liquidity. In the future, the capital will be used further fund its growth through opening more new stores and for possible acquisitions.
Revenue and earnings have been steadily growing over the past ten years. Revenue has increased at an annual rate of 15.8 percent, and earnings have increased at an annual rate of 24 percent for the past ten years.
The economy has been struggling lately in Shoprite’s largest market, South Africa and is currently in a recession. The sluggish economy is largely blamed on industrial unrest and a reduction in foreign direct investments. Local news outlets suggest that it is also due to a credit bubble, excessive government spending, and corruption. Even with the slowing economy, Shoprite has been able to grow its earnings and revenue at 11.1 percent and 8.3 percent over the past twelve months.
The largest segment of the company, South African supermarkets, grew revenues at a rate of 7.6 percent over the past year. Their fastest growing segment has been non-South African supermarkets growing revenues at a rate of 28.1 percent. Shoprite is planning on opening 13-14 percent more supermarkets in and outside of South Africa for the year. Outside of the country, growth will be focused on the west coast of Africa, mainly Nigeria and Angola. As of the latest investor presentation, Shoprite has 7 supermarkets in Nigeria and 17 in Angola.
On top of the expansion by opening new stores, Shoprite has been expanding its margins as well. Net margins have been increasing at a rate of 3.47 percent annually over the past 5 years. The latest net margin was at 3.57 percent while their Wal-Mart (WMT) majority owned competitor, Massmart (MMRTY), has seen decreasing net margins at a rate of -12.21 percent over the past five years. Massmart’s latest net margin was at 1.78 percent.
The higher margins of Shoprite can be attributed to their competitive advantage in their supply chain management. It has 28 distribution facilities spread throughout Africa and a delivery fleet of more than 1,000 vehicles. The biggest challenges to the company have been navigating through the bureaucratic red tape involved in African inter-country trade and the lack of infrastructure. Africa has 54 countries and every single one of them impose trade barriers on its neighbors. Even with these challenges, Shoprite has been successful at growing their margins due to its superior supply chain management.
Management
Chairman Christo Wiese and CEO Whitey Basson have been leading Shoprite from the start in 1979. Wiese has an estimated net worth of about $4 billion and Basson is a top earning executive in South Africa. They bought the chain of 8 supermarkets in Cape Town for 1 million Rand, or $94,000 at today’s rates. The two together were able to turn a small $100 thousand dollar chain of supermarkets into an $8 billion company with 35.5 percent South African market share. They have obviously done an excellent job, but they are getting up there in age. Wiese is 72 and Basson is 68 years old. In 2012 Wiese said that he is not prepared to step aside anytime soon and believes that he is good for another five to seven years according to an interview with South Africa’s Moneyweb. He says that Shoprite is a family business. It is likely that his son, Jacob Wiese, will take over for Christo when he retires. Jacob is currently a non-executive alternate director, serves on the boards of various listed companies, and is an Advocate of the High Court of South Africa. Whitey Basson expects to be in the CEO role for at least another five years, but will be delegating more responsibilities. He says that there are several inline for the job and the company has firm succession plans.
Valuation
Shoprite is currently trading at a P/E of 22.8. On a comparative basis, it is about the same as Massmart’s P/E of 22.70. The difference is that Shoprite is growing at a faster rate and should be trading at a higher P/E. The GuruFocus DCF Calculator gives a fair value of $18.08 per share, giving it a 20 percent margin of safety. The stock closed at $14.58 today, June 26, 2014. The default earnings on the calculator needed to be cut in half due to the stock split in December. The chart was not adjusted for the 2 for 1 split, and that is why there was a large drop.
Risks
Chairman Wiese has said that trading in Africa has not become any easier over the years. They have just learned to deal with many of the restrictions that apply and learned how to be self-sufficient in an environment in which there is virtually no infrastructure. The many trade restrictions and lack of infrastructure can slow down the growth of Shoprite. It has not yet, but the political environment can be unstable. There is also a risk that the South African economy can take longer to recover from its recent downturn. Even though Shoprite is expanding throughout Africa, a majority of their stores are in South Africa.
Another risk is that the people responsible for leading the company for past 35 years are very likely to retire within the next ten years. CEO Whitey Basson says that there is a firm succession plan, but the company will have to go forward without Basson and Christo Wiese. The company can still thrive with the correct planning. Wal-Mart grew from a $45 billion to its current $241.8 billion market cap after Sam Walton passed away in 1992. Sam’s son, Rob, took the lead of the company, just like Christo Wiese’s son, Jacob, is likely to take the lead of Shoprite.
Conclusion
Shoprite is a well established company that has been consistently growing under strong leadership. Africa is a difficult market due to all of the regulatory red tape, but the company has continued to thrive. It is the largest retailer in Africa and has a 33.5 percent market share in its home country of South Africa.
The company is also a very strong brand. Wal-Mart has entered the African market with buying a majority stake in Massmart, but they have not been able to compete with Shoprite. Shoprite is a larger company and continues to grow at a faster rate. They have been able to grow revenues and margins while their competitors have seen slowing revenue growth and decreasing margins. Shoprite is further strengthening its African roots by working to reduce their dependence on international suppliers and to source, procure and employ locally and from within Africa where possible. The benefits the company directly by the way of better quality local goods and labor supply, resulting in operational efficiencies, reduced supply chain risk and ultimately lower prices for its customers.
The sweet spot for Shoprite is the expected population growth in Africa. The United Nations Population Division projects that Africa will grow at an unprecedented level throughout the rest of the century. A majority of the growth is projected to be in Sub-Saharan Africa with the possibly of Nigeria having nearly a billion people by the year 2100. That is exactly where Shoprite has focused its growth for outside of South Africa. With that kind of growth, the largest, most established supermarket chain will soar making Shoprite the stock to hold onto for the rest of the century.
