The Mr Price Group has shown spectacular growth over the past decade, dwarfing its competitors. Its success led to overly optimistic investor expectations, and when these expectations were not met, the share price declined. This created an excellent opportunity to buy a high-quality business at a reasonable price – with very promising long-term return prospects.
Investors in Mr Price have enjoyed exceptional returns over the past five years
Mr Price is a leading South African retailer that sells apparel and homeware aimed at the middle-to high-income consumer. It is listed on the JSE with a current market capitalisation of R54 billion – a decrease of about 30% from its peak valuation of R75 billion in April 2015. Nevertheless, Mr Price shareholders have been rewarded with a handsome 26% compounded annual return over the past five years.
The group has experienced significant growth since the first store opened in 1987
Mr Price Group’s roots go back to the first John Orrs store established in 1885. In 1986, the Mr Price founders, together with BoE, acquired a major stake in John Orrs, which had been listed on the JSE since 1952. The founders used the entity to roll out Mr Price stores and buy franchised Mr Price stores. The early Mr Price apparel stores were franchised due to a lack of funds.
Mr Price initially traded as a factory shop, selling quality clothing at very low prices. From early on the founders’ vision was three-fold: to offer the lowest prices, to have attractive store interiors, and to have merchandise that appeals to potential customers. It’s been nearly 30 years since the first Mr Price store opened and the group has stuck to its strategy of offering quality products at a reasonable price.
Mr Price Group experienced incredible growth in the 1990s and 2000s. Today, the Group trades in five different formats with more than 1,150 stores. The offering has been expanded to include homeware, which currently accounts for more than 38% of the group’s store base and 26% of group revenue, as can be seen in Figure 1.
Consumers have become a lot more demanding when it comes fashion
Consumers today are more fashion-conscious due to an increase in media usage and in the coverage of fashion and trends across different media channels. As a result, consumers have a constant awareness and need for new products and the latest fashion trends. Clothing retailers therefore have to be able to deliver what their customers expect more rapidly than ever before.
“Fast fashion” retailers are highly responsive to changing consumer needs
Over the last decade, a new concept called “fast fashion” became a key factor for retailers looking to respond to these changes in consumer behaviour. [ds_popup_explanation data=’Fast Fashion: Business Model Overview and Research Opportunities, Felipe Caro and Victor Martinez-de-Albenizy, 24 January 2014 ‘]Fast fashion [/ds_popup_explanation]is a business model that offers fashionable clothing at affordable prices targeted at consumers under the age of forty. It is characterised by constant replenishment of merchandise to give consumers greater choice. The challenge is to get the latest market trend at the right time and at the right price. As a result, fast fashion retailers have to reconfigure their supply chain to cater to the demands of their customers. They require a highly responsive supply chain as well as very short product cycles. Retailers that have been able to adapt their supply chain to meet the demands of consumers have gained a competitive edge and have outperformed their peers. Global examples of fast fashion retailers include ZARA and H&M.
Mr Price is a focused fast fashion retailer with a competitive edge
Mr Price is able to introduce new trends into its stores ahead of competitors, which is essential since it caters to a younger, more fashion-conscious demographic. It also offers lower price points that attract consumers to its stores. As a result, it is difficult for competitors who don’t have a fast fashion strategy to replicate Mr Price’s advantage as these retailers’ customers have varying price points and fashion preferences, resulting in less frequent purchases and therefore fewer unit sales. The fact that most of Mr Price’s customers buy with cash as opposed to credit (because the products are relatively affordable) holds the added benefit that Mr Price is far less exposed to the vagaries of the consumer credit cycle than its South African peers.
The group’s spectacular sales growth has enabled it to increase its operating margin
As a result of this competitive edge, Mr Price’s same store sales growth figures since 2007 are nearly double those of its major competitors. It has surpassed Woolworths and The Foschini Group in terms of market share. The benefits of this growth in the scale of the business are evident – the company has reported profit growth that is far ahead of its competitors. Simply put, Mr Price has been able to sell more merchandise through its existing store base; and, as a result, revenue has grown more than costs, enabling the group to expand its profitability.
Figure 2 illustrates the Mr Price strategy at work. Since 2007, revenue increased by 15% per year while costs grew by 13% per year. As a result, net income grew by 22% per year as operating margins expanded from 10% in 2007 to 18% in 2016.
Mr Price shareholders have reaped the benefits of the strategy. Today the company generates shareholder returns that far exceed those of its competitors, as shown in Figure 3.
Overly optimistic investor expectations created a buying opportunity
Due to its success in generating value for shareholders, Mr Price has been highly valued. Last year investors were willing to pay 27 times the expected earnings per share. Earning a good return on a company is dependent on paying a reasonable price. On a price to earnings ratio of 27X, the company would have to continue to grow earnings at over 20% per year for the next five years for investors to earn a reasonable return. The expectations implied by the share price had become overly optimistic, resulting in an inflated assessment of fair value.
When Mr Price posted revenue growth of 9% and earnings growth of 15% in 2016, investors who were expecting more sold their shares. This resulted in a 30% fall in the share price, which created a great buying opportunity.
We bought Mr Price at the right price and are confident about the long-term prospects
At Denker Capital, we aim to invest in high-quality businesses. However, we also recognise that it is difficult to earn a reasonable return for our clients if we overpay for a business. We are therefore happy to wait patiently for a rational entry point. We were fortunate earlier this year when we had the opportunity to buy Mr Price in our clients’ portfolios following the decline in the share price. Since then the price has appreciated by about 25%, which is much quicker than we had anticipated. We continue to hold the stock as we believe that we have bought an outstanding business at an attractive price that will continue to reward our clients with favourable returns for many years to come.
By Khuthadzo Masindi