Read the full podcast transcript

DS: David Smith

TS: Tim Spira

• Introduction

  DS: The bigger question in my mind is what does the SA consumer look like when we get out of this? So, my number one concern right now is that we are going to have a hangover for the next 18 months and that's what keeps me up at night because you're not quite sure how that hangover looks. 

   

  TS: Hello, I’m Tim Spira, head of content at Investec, and today I’m speaking to my colleague David Smith, a research analyst and one of the foremost experts on the South African retail sector. It’s a sector that’s arguably been hit harder than any other by the Covid-19 crisis and the measures that we’ve been compelled to adopt in containing it. David, let’s kick off with an introduction. For the benefit of our listeners, who are you and what do you do for a living?

   

  DS:  My name is David Smith I sit within the equities cluster at Investec. My job is to analyse companies and provide investors with advice on them. So I cover a couple of companies or sectors the first being the SA retailers which is why we're chatting today and then as part of my sins my wingman and I Thapelo, who's not on the chat today, cover the media sector as well, which is Naspers, Multichoice.  We provide some fairly interesting insights into consumer behaviour as well.

• 1:20: Retailers in survival mode

  TS:  So, David, retail being your big focus area I assume you've been pretty busy with everything that's going on right now in the retail environment with the impacts of the Coronavirus and the lockdowns that we've seen all over the world.

   

  DS:  Absolutely, so everyone’s scrambling at the moment as you would imagine. This is pretty much uncharted territory for everybody. So, I suppose the focus right now is merely on survivable, making sure that you can get through this patch as unbruised as possible. So, when things normalise, whenever that might be, you are in a position to take advantage and you're still around, and you as a company are not massively impaired in the long-term view.

   

  I suppose that's the major worry for a lot of people that what you thought these companies were able to generate from sale or from revenue might not be the same on the other side of this.

• 2:14: The impact on retailers selling discretionary items

  TS:  Now obviously not all retailers are being affected equally. Could you perhaps just talk a little bit about the different tiers and categories of retailers and how each of these is going to be affected?

   

  DS: Where we are in South Africa now is probably, we have the single most concentrated or one of the most concentrated retail markets in the world. The big guys are just really big versus everyone else. If you go into a mall, more than 85% of the space is let out to big South African corporates who dominate the SA retail landscape.  So that is a backdrop now. 

   

  This little lockdown period is interesting because it's forcing certain behaviour types. Behaviour type number one is of course restaurant sales and anything discretionary is getting absolutely smashed. So, people's propensity and desire for things that you don't actually need right now is way down the list, and things like food, you saw a huge amount of stockpiling but that's probably fairly temporary in nature.   

   

  The real question on our minds though is what happens in three to six months’ time when we go back to some sort of level of normalcy.  It's going to be tough, very tough for people who are relying on discretionary income for a while.

   

  So, my biggest concern by a country mile is, outside of ‘does the corporate survive’ - and I think all the big retailers in South Africa do survive. They might have to get a helping hand from banks into giving them very lenient credit terms and covenant terms and might have to go to shareholders for some more capital, but they're all fundamentally decent businesses.

   

  The bigger question in my mind is what does the SA consumer look like when we get out of this? So, my number one concern right now is that we are going to have a hangover for the next 18 months and that's what keeps me up at night because you're not quite sure how that hangover looks. 

   

  So, it's very clear that food is going to be okay through this period.  Everyone still needs to eat.  The basic parts of the drug retailers, pharmacy retailers are going to be fine. They still have a market share dynamic, but the discretionary parts of those businesses are concerning, even in the pharmacy retailers, things like USN, or any sort of vitamin product, or the high-end health food stuff. Those are a concern.

   

  So if we think about secular shifts, what you're likely to see for a while, while people remain cautious about going out, is that you'll have more people like us, working from home, which means that the food spend you used to do outside of home is going to come inside the home.

   

  The question mark there is going to be if you go and buy a sandwich at the restaurant down the road from you or the canteen, it costs a lot more than making a sandwich in your own kitchen. So, the uplift in sales for the food retailers is likely to be lower than the loss in sales for restaurants, one; and two, even these businesses have a fair amount of discretionary spend. 

   

  You think about Pick n Pay clothing, or House and Home, or Shoprite or the African business for Shoprite, or Build It for Spar.  They're not immune and then it's the apparel players and the guys who are selling very discretionary things. 

   

  When you are feeling tough and under pressure and you're working from home, the likelihood of you going out and buying a suit, is close to zero, so businesses that are selling high end discretionary products on a fair amount of scale are going to be in trouble, or are at least are going to suffer on their top line for months and hopefully not years to come.

• 6:08: Tough times ahead for SMMEs

  TS:  So that's also interesting because the big players that you're saying will likely survive in the food and grocery segment, that's all very well. But the smaller guys, and I'm thinking about SMMEs like your corner spaza stores, one wonders whether this crisis is going to accelerate the demise of those smaller players?

   

  DS:  Absolutely, so I'm less worried about a spaza shop because people are still buying food, but your point is absolutely the right one. When I think about the other categories, whether it's the small boutique apparel shop, or a furniture shop, or somebody who is trying out their own restaurant, those players have the potential to be into lots of trouble, and it's not clear how it plays out in the near term, but the problem is you can appreciate how everyone has bonds to pay and wages to pay, and everyone owes somebody else money when you earn money at the start of the month. So those are the players I worry about. 

   

  So, in the South African context, we're really so consolidated, there are only such big players and so few smaller players and almost every facet of South African corporate society. I worry that this might accelerate that, and we end up in an even more consolidated position. 

   

  If you only had big players around, it limits people's ability to create new enterprises and compete effectively because you're competing with somebody who's got more cash and more scale and has ability to leverage online data or online delivery platforms, which is quite difficult for smaller players to do. I suppose the plus side to that is if there's ever a gap and the big players aren't nimble enough, there's always space for the smaller players, but it's going to be very, very tough for the small guys for some time.

• 7:54: What happens to the employees of retailers?

  TS:  And retail’s also a very big employer, right? And you referenced, for example, some of the measures that landlords are taking around things like rent holidays and just making it a little bit easier for retailers to survive this period.  But what was quite interesting in the Property Owners proposal that recently came out is that a lot of these measures were only open to retailers who undertook not to retrench any staff. But I'd imagine that there are going to be retailers who just have no choice and they're going to have to retrench, right?

   

  DS:  I tend to agree with you, and it might not be caged under the auspices of retrenchment, it might be forced long leave and when things normalise you come back.  The problem that everyone is facing whether it be politicians or you and I sitting in our studies trying to do work, is you don't know how this plays out. 

   

  My biggest concern if you've been following any of the epidemiologists is that, until you have a vaccine or effective treatment or people have been tested so you have some sort of level of herd immunity, which may or may not work, it's difficult to see the world going back to normal. 

   

  In that environment, if people continue... either because they just so stretched themselves because they haven't been earning money and they are not going out and spending money as a result on fine apparel etcetera, if people withhold spending in key areas which hire lots of people, so think about tourism and hotels, think about retailers and apparel retailers, think about restaurants, at some point those players genuinely have no choice but to let people go themselves, which unfortunately is this rippling effect, right, so it's fewer people jobs and they spend less and it hurts. So, you only really get back to things as normal when as many people are working as possible because that drives growth and GDP and productivity.

   

  It's going to be tough for a while and I would agree with you, I think if you are not a food retailer, maybe a pharmacy slash drug retailer. I think that some level of pay constraint whether it comes through limited hours, it comes from forced leave, is absolutely going to happen even amongst the big players and there's a near certainty amongst the small players.

   

  You just have to watch what's happened with the US and their unemployment numbers and the initial jobless claims. It's a multiple of almost 10 times in any given week what we have seen before.  I struggle to see why we would be immune to the exact same trend.

• 10:34: How retailers and consumers are adapting to the “new normal”

  TS:  Yes, we've seen moves like that already by big retailers, Woolworths being one that springs to mind where execs have taken cut in pay. Have you come across other innovative approaches to protecting or even generating cashflow? And I'm not just referring to pay cuts by management or employees, but also other innovative ways that retailers are trying to respond to a changed world. One of the examples again anecdotally that I've come across is Cape Union Mart that recently announced that they're working with some of their suppliers to start producing things like masks and other protective gear.

   

  DS:  Yes Tim, you're spot on - everyone is doing two things right now: Panicking and scrambling as hard as they can to survive and get through this as unbattered as possible; and two, looking if there's an opportunity and how they can shift their business to cater to the new demand. 

   

  Another example to your Cape Union Mart is Net Florist are now are doing food deliveries because there's a whole bunch of people that don't want to go out and are struggling to get spots on a typical Woolworths or Pick n Pay or 60/60 app because either their area's not serviced, or they are so busy, that they're not getting slots anytime soon.

   

  So those trends are likely to happen. I mean, it's not often being a tech media analyst is useful in a retail context, but a shift from offline to online is going to get accelerated.

   

  You are seeing some of the gaming companies or Netflix or if you have a look at Verizon in the US, the kind of data that they showing in terms of people shifting their spend where you would have potentially have gone out and spent something at a restaurant, you're now spending on a sandwich at home and then buying online goods to entertain yourself.  That's going to happen.

   

  The retailers are going to have to respond. So, you've seen Pick n Pay for example tying up with Bottles, which is an app which historically delivered booze and obviously can't do business in this environment that are now trying to deliver groceries to you.  Those sorts of things are likely to be accelerated.

   

  What you tend to find is that one of the biggest delays in people shifting online initially, is just you haven't done it before.  You're comfortable with going to the grocery store that you go to every week and you have done for the last several years. Consumers are beings of habit, and now this has just shifted those habits somewhere else and suddenly you’re starting to try new things. Actually, I can get everything I want online.

   

  My expectation is when we leave this patch of forced lockdown and maybe self-imposed lock down for some, you will end up by shifting consumer habits quite aggressively and I think the retail world will be the same, it's going to drive to people's needs and wants, is always going to be there. But the way that you service those is going to be different and I think convenience, in particular, is going to be front of mind for many. 

   

  And then I suppose the slightly darker side is that my concerns around health of the consumer. I do think that price sensitivity for the next year or two is going to be as acute as we have seen in our adult lives.

• 13:49: Covid-19 - a game changer for retail

  TS:  So that's fascinating because the shifts that you're talking about, these are not temporary shifts. These are potentially long-term shifts in the structure of the retail environment.

   

  I just read this a couple of days ago that Amazon is apparently looking to create an additional hundred thousand jobs in their warehouses to meet expected demand – that wouldn’t be the case if it was just a temporary measure? And you mentioned Alibaba earlier in the aftermath of the SARS crisis coming into its own. So clearly you're seeing this crisis as possibly being a permanent game changer for the retail segment?

   

  DS:  Yes, we're still a couple of years behind the rest of the world, I mean that's unequivocal, that shouldn't surprise anybody listening to this.  The company who had expected the fastest trend to moving online for apparel has actually been TFG. They have operations in both Australia and the UK, and they made a very interesting observation that there is no unique market. There might be some nuances that are different for South Africans versus Brazilians or Brits, but consumer wants and needs tend to align and people seem to respond in the long term in the same way.

   

  We have not encountered a market yet where people start to use online that go back to traditional retail. Once you find the convenience your patterns don't change, and you see it with actually almost any type of online transition. 

• 15:20: Who’s leading the online charge in SA?

  TS:  So, who are the South African players that are best placed for this future? Takealot obviously comes to mind, which is a Naspers business, but there must be a lot of other retailers that are that are comparatively well-positioned for an online future?

   

  DS:  That is a very good question. I had a very interesting chat with one of the founders of Yuppie Chef, and he made a very interesting observation, which I think is spot-on is that outside of Takealot which has been an amalgamation of a whole bunch of things and has the support of this behemoth of Naspers behind it, there is almost no other major online player, or solely online players in the South African context. 

   

  We really have got an unbelievably concentrated online player now and then the rest are hybrid, but all the South African traditional retailers, which you'd find in malls, less than two percent of their sales currently is online and most of them didn't expect it to be more than five percent in the next three maybe five years, that's probably wrong.

   

  In that world you’ve seen a couple of interesting things happen. So, you need to separate the different players.  In a food retail space, you had early movers of Woolworths and Pick n Pay doing delivery slots. You could pick a slot in a day or maybe an afternoon if you're lucky, not particularly easy to plan your life around it.

   

  And then very recently you had Shoprite come out with its app for Checkers, the 60/60 app. It's only in nine stores, but it's been a phenomenal driver of traffic and it's basically the Uber of food and you can buy anything in that store, and it will get delivered to your door in 60 minutes. And that's pretty phenomenal. And what you find is they will charge ahead with this and you'll tend to find that other players will come along and try catch up.

   

  In the apparel space you've had once again, Woolworths to an extent, you have Mr. Price who got a particularly good online store with an app functionality that works incredibly well, so they were ahead of the curve.

   

  But once again you’re bumping into the Takealot brands of Spree or Superbalist which have merged, but they probably are a net beneficiary and takes shares from everyone else online.

   

  And then far more recently while everyone is building out some sort of online functionality and that trend is absolutely going to accelerate, you have the likes of TFG who've spent a lot of money fixing their systems and positioning themselves where they can to be very well placed with dealing with customers either online or offline.

• 18:00: The challenge of price discoverability online

  TS: Now obviously the dynamics of an online space are different from those if bricks and mortar. One of the issues is that price discoverability is so much easier at the click of a button, you can very quickly compare prices between various online shopping options.  Is that going to put pressure on retailers’ margins? 

   

  DS: Absolutely. There's no doubt it's going to result in much higher pressure going forward and it's true across almost any category where the purchase item is relatively big for a consumer. So if you are buying a chocolate, the fact that one chocolate in one store is R2 difference in price, it matters, but it matters less. 

   

  When you're talking about a TV, when you’re talking about R2,000 price difference between the two, you can see where this tension comes between how a retailer tries to eek out margins on certain products, that wanes significantly. 

   

  As a consequence, consumers’ ability to go online and check pricing, A) going online normally tends to benefit new players relative to old players, old players tend to have systems in place and biases in their staff that make them not very well adapted to shifting online, whereas the new player doesn't have all the legacy issues and normally does incredibly well. 

   

  On top of that, you have a situation where that price discoverability lowers margins generally.  Now, it's more complex than that in a South African context but the entire retail sector, you look at the return on capital just over a decade ago, if you look post the GFC which we got through relatively well.  One of the biggest arguments why foreign investors wanted to play with South African retailers, is we made incredible return on capital.

   

  We're talking the sector made north of the thirty percent return on equity which is just mind blowing for the international stage. But that return on equity has been coming down steadily and partly it’s because we are more competitive, partly that's because consumers have been under particular pressure in the last while but the counter to that as well has been that online consumerism makes people far more savvy and you are unable to charge what you used to historically, because there’s just much more competition for you and that's not going away, that trend is going to continue.

   

  So, retail’s always tough, but it gets tougher and if you don't have the right investment - historically it would have been investment in stock and investment in where your stores were was incredibly important - increasingly that investment is ‘have you spent money on the right systems and data insights into your customers?’.  Those sorts of decisions probably determine who wins and loses over the next decade, or two.

• 20:57: Solving online shopping for the lower end of the economy

  TS:  You mentioned earlier that there are no unique markets, which was an interesting comment, because I think we often tend to think of South Africa as being perhaps more unique than it actually is, because we have this two-tier economy.

   

  We’re not alone here; a lot of emerging markets look like this, but when you look at trends like online retail, it's tended to take off at the upper end of that two-tier economy. What about the lower end, are we likely to see big shifts there away from bricks and mortar and who are some of the more innovative movers in that space?  

   

  DS: When I say there are no unique markets, of course they are, but what I'm trying to illustrate is that the trends you see in one market nearly always follow and conjure other markets.

   

  To the lower end question, there is no doubt in my mind that the team, the management team in place that is most forward thinking about solving for that issue of how you provide proper online capabilities at the low end at scale is the Pepkor group. So Pep, Ackerman's, they own some other brands as well, but those are the two big ones, and their management team impresses me continually, because they have thought about what are the key components that make an online business work and thrive, and it's some of the stuff we've talked about.

   

  It's solving for delivery. How do you get product to somebody who may not have a formal address? So, what happens in that scenario, is that you probably have to get it to a store that’s close to them, probably on a route back from home to work or vice versa or close to a taxi rank. So, they have a phenomenal store presence, so they're solved for that.

   

  They’ve thought about the systems issue. They have systems in place, which allow them to solve for this. They have systems in place where they can collect cash, not just online where a lot of people for the first while are quite nervous about putting card details in and certainly don't want you to have access to their bank account.

   

  You can solve for that by making them go in to the till points. And they solve for that by being able to go to spaza shops and they put a product called Flash that you are able to pay the spaza shop and get a slip and a voucher and then you can use that voucher to collect things.

   

  So they apply their minds a lot and their most recent addition to that process about being able to solve for an online business at the lower end is how do you get product from DC [distribution centre] to store, to ultimately the consumer, and they relatively recently launched a product called PAXI, it is a competitor to the post office and allows you to send a parcel from one Pep or Ackerman’s store to any of their branches around the country at a fraction of the price, often on what you'd get in a post office with far more reliability and you can track it the whole way. 

   

  So, they have built foundations of how to move online incredibly well.  There's just no need for them yet to pull the trigger. So, I suppose it's a bit of a chicken and egg scenario. Do you want to invest lots of money now when customers aren't showing the need, or do you wait for the customers to start wanting that, have that need and then supply the systems?  So, they've kind of positioned themselves for it, but haven't actually provided that functionality fully across their platforms.  They are going to increasingly do that.

   

  TS:  And presumably the lockdown and the Covid crisis that we're currently experiencing could again be an accelerating factor there?

   

  DS:  It could be. The interactions I've seen tend to suggest that the middle classes are far more likely to use online in the early days. Right? Just because if you think about the kinds of things that you normally buy online and the cost of delivery, those are really big sticking points for people who are struggling to buy food for the month.

   

  So, there's no doubt it's important, I'm just not sure we're going to see a major shift online at the lower end anytime soon. I think it's likely to remain a purview of the middle class consumer on average for a while and that the lower end because a matter of consumers likely, probably be five years away until it becomes relatively common with somebody in your direct family group to have shopped online within the last month.

• 25:35: Conclusion

  TS:  David great. Thank you so much for joining us and thanks to everyone listening in. If you’ve enjoyed today’s podcast, please take a moment to rate us and to subscribe to Investec Focus Radio wherever you get your podcasts.
  

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