OPINION: This could be an opportunity to accumulate Truworths shares

By Amelia Morgenrood Time of article published Jul 8, 2019

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Last week, the (very short) list of companies with proper offshore success lost Truworths.

On Tuesday morning, the Truworths share price fell 6.50percent, after an announcement that they are investigating a company voluntary arrangement (CVA) for its Office division caught the market by surprise.

Although the group has previously indicated that they were focused on closing under-performing stores, the CVA proposal was unexpected and involved the possible closure of about 100 of its 152 stores.

In December 2015, Truworths bought 88.90 percent of the Office division for £256 million (R4.5billion) cash, and £86m in term loans and revolving-credit facilities).

However, Office has been under pressure due to the collapse of the department store House of Fraser, where it had a few concessions. It is currently unclear if the CVA will affect stores in Ireland, Germany or South Africa.

The group indicated that the discussions with lenders and the debt restructuring should not have a material impact on its African operations.

In the UK, trading is tough due to the complications surrounding Brexit. Retail profitability is challenged by increased costs and channel shifts, causing downwards pressure on margins and weak retail sales. Moreover, changing trends in consumer and occupational markets such as omni-channel retailing, as well as digital technology are leading to financial under-performance.

The Office group contributes 27 percent to the Truworths group revenue and 10.6 percent to the overall operating profit before tax.

However, the Office e-commerce operation continued to show strong performance as online retail sales grew 7.2 percent, and comprise about 33 percent of retail sales.

As at December 31, 2018 the group was in a net positive position of R1.08bn with a debt to equity ratio of negative 9.57 percent, and Office had a debt to equity ratio of 1 percent. Office has about £45m debt of which “a significant portion” should be settled through a lump-sum payment that will mature in December 2020.

With the potential closure of the stores, there is enough headroom that the attractive dividend yield of 6.17 percent should not be significantly affected. Historically, the group has shown strong cash generation. As at December 31, 2018 Truworths generated R2.61bn cash from operations which enabled the funding of dividend payments, loan repayments, and capital expenditure.

Furthermore, Truworths is a quality retailer with a very high return on equity (ROE) of about 25 percent. ROE has been under pressure due to top-line growth being muted, given the challenging macro-environment. Stronger top-line growth remains the group’s most significant challenge as it is primarily influenced by economic activity and merchandise inflation.

In the short-term, the retail picture seems unlikely to improve significantly due to high personal debt levels, a complicated regulatory environment, and slow economic growth; but merchandise inflation should benefit from a weaker exchange rate.

All these concerns seem to be somewhat reflected in the current valuation multiples. With the forward price/earnings ratio now at 11 times, it might be an opportunity to accumulate shares. Hopefully, the results due in mid-August will hold no nasty surprises.

Amelia Morgenrood is a PSG Wealth financial adviser based in Pretoria. Views are of the author and not necessarily the general view of the entire PSG entity. Shares are held in her own capacity and on behalf of clients.


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