Pepkor is back on the JSE as Steinhoff Africa Retail (Star). In this article, we explain the history of prolific corporate actions that led to the recent independent listing of what is essentially Pepkor as Star, and their new option to obtain a stake in Shoprite. When this happens, Steinhoff will become one of the 15 largest retailers in the world. It’s therefore worthwhile understanding the competitive traits that provide ‘moats’ or barriers to entry that both Star and Shoprite share.
Pepkor has returned to the JSE as Steinhoff Africa Retail (Star).
Pepkor has a colourful history.
As shown in Figure 1, it was a listed entity from 1972 to 2004 and then formed part of listed entities Brait and then Steinhoff since 2011. On 20 September 2017, the business came full circle, listing again (in its own right) as Steinhoff Africa Retail (Star) – essentially Pepkor’s African business. In the diagram, we have not included Pepkor’s acquisitions in the UK and Australia over the years, or its launch and the spectacular success of Pepco in Poland. Apart from these international assets, which have remained in Steinhoff, the pillars of the Pepkor group have always been Pep and Ackermans. These companies now fall under Star together with the rest of Steinhoff’s African retail business.
The business has maintained a close relationship with Shoprite.
It is striking how these assets have been moved over the years between listed and unlisted entities. It is also interesting to note the close history that Pepkor has had with Shoprite through all these years. In fact, until only a few years ago, some Pepkor employees may still have carried Shoprite store cards.
Figure 1: Highlights of Pepkor’s African business history
Source: Denker Capital research
With this history of corporate actions, it isn’t surprising that there are more to come.
Star has secured an option to acquire an effective controlling stake in Shoprite.
This is likely to be exercised quite soon. The transaction will give Star a 23% economic interest in Shoprite. Figure 2 shows the make-up of Star after the option.
Figure 2: Star after the option – Shoprite will represent 31% of Star*
Source: Denker Capital research
*Based on enterprise value before debt.
The possibility of lower product prices may enhance Star’s competitive positioning.
In the retail sector, scale matters – especially in the discount and value space. While Pep offers discount and Ackermans offers value, Shoprite offers both through its different brands. This therefore raises the question whether the combined size of Star and Shoprite can lead to lower product prices, enhancing Star’s competitive positioning. The Star and Shoprite management teams have been cautious about placing too much emphasis on this potential. We agree with this caution because they have very little overlap in products in their traditional markets. There could be some scale benefits in homeware. However, the goods and services that are likely to benefit from cooperation between Star and Shoprite are cell phones, airtime and financial services. It’s also possible that Shoprite’s furniture business could eventually be sold to Star.
Both Star and Shoprite share strong competitive traits.
As Warren Buffett would say, these provide ‘deep moats’ or barriers to entry.
- They offer attractive value and discount offerings that have translated into impressive sales growth
Star has shown that sales growth in the discount sector of the market in South Africa has compounded by 15% per year over the past ten years, significantly faster than the overall market.
- They have extremely focused and competent management teams
This is reflected in consistent market share gains over a long period of time by both companies. We believe gains in market share will continue as Shoprite out-competes its peers, and as Star potentially gains more traction in rural areas with the Ackermans brand.
- They leverage their retail presence, with additional services generating revenue in stores
Shoprite has been extremely successful with innovative financial services and offerings like Computicket, while Pepkor has become one of the biggest cell phone and airtime distributors in the country. These offerings are all profitable and improve foot traffic.
- They have achieved success in the rest of Africa
Both have rolled out an extensive and profitable store network. This is exceptional relative to other South African retailers.
The investment case for Star and Shoprite.
We continue to value Shoprite above its current market price and expect both Star and Shoprite to perform well.
At a listing price of R20.50 per share, the Star valuation is in line with our EV/EBITDA multiple of 11x that we use in our Steinhoff valuation. Given our sizable position in Steinhoff, the 20% that Star will make up of Steinhoff’s valuation leaves us with a fair indirect exposure. Adjusting for Star at the listing price, the rest of Steinhoff is valued at an EV/EBITDA multiple of 8.4x, which we believe is very attractive. In the current economic climate, we think Star and Shoprite will both perform well, especially relative to other consumer-focused companies. But we continue to see more value in parent company, Steinhoff.
Once Star obtains a stake in Shoprite, Steinhoff will become the 15th largest retailer in the world.
After the option is exercised, Steinhoff will own a 12% economic interest in Shoprite.
This economic interest and additional voting rights will give Steinhoff majority voting rights of 50.7% and, effectively, control of the African food retailing champion. The numbers will be complex and analysts will have their work cut out for them. Following the option, Shoprite may be consolidated into Star and, because Star is consolidated into Steinhoff, Steinhoff’s turnover and profit lines will include those of Shoprite. At the outset, the turnover line in Steinhoff will be boosted by about R141 billion (or around $11 billion). At just short of $35 billion in turnover, Steinhoff will become one of the largest retailers in the world. In fact, it will be 15th on Stores’ 2017 list of top retailers, ahead of Aldi and Macy’s, and just behind Apple Stores/iTunes and McDonalds.
The market is watching Star and Shoprite to see what lies ahead – there appear to be many roads to Rome.
Shoprite shareholders approved the buyback of former Shoprite Group chief executive Whitey Basson’s 8.7 million shares in early September 2017. This buyback took shares off the market and effectively gave Steinhoff’s chairman and largest shareholder, Christo Wiese, control over Shoprite. When Star exercise the option explained above, they will acquire these shares from Wiese and give Steinhoff control over Shoprite. Market participants are therefore keen to see what lies ahead for Wiese. After the failed previous attempts to combine Steinhoff and Shoprite, there are clearly many roads to Rome.
Portfolio manager: Denker SCI Flexible Fund
Co- portfolio manager: Denker SCI Balanced Fund and Denker SCI Stable Fund
Note: SCI stands for Sanlam Collective Investments
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