Spar: Buy high, sell low

One of Spar’s greatest strengths is its network of independent retailers. In large part these are hardworking, driven and entrepreneurial individuals who have invested considerable amounts of their own financial resources in the hope of building a wealth-creating business. 

While Spar’s model isn’t exactly flexible, as one analyst tells Currency, it’s very likely the commitment of these individuals that has kept Spar producing profits during the past four, remarkably tough, years. 

Spar’s ills are well-known: it’s been dogged by the consequences of controversies around the treatment of some of its independent retailers, as well as the botched implementation of an SAP contract entered into under dubious circumstances. And latterly, the steady implosion of a hugely expensive, ill-considered European acquisition strategy.  

Things are moving, slowly, in the right direction, but few analysts are excited about the near- to medium-term prospects for this troubled wholesaler. 

This week it released its results for the six months to end March. They weren’t pretty; they weren’t too ugly, either. But the barely discernible top-line increase suggests Spar’s retailers are taking strain. In Southern Africa revenue was up a nominal 1.7%, which means a volume decline, and in Ireland, revenue was down 0.6% in local currency. (Following the abrupt dumping of Switzerland and the UK into the “discontinued” basket, Ireland and Southern Africa are now Spar’s core businesses.) 

Management said the weak sales increase “reflected the ongoing pressure on consumer spending, compounded by low food inflation and the timing of Easter” (late Easter meant it fell in the second half of the financial year).

No doubt these were factors, but then you have to wonder, as Sasfin’s Alec Abraham does, how come Shoprite, Woolworths Food and Boxer did so well – increasing like-for-like sales 6%, 7% and 5% respectively. 

Despite this sluggish performance South Africa did manage to squeeze operating margins up to 2% from 1.9%. Sadly, Ireland didn’t do so well, with its operating margin moving in the reverse direction – down to 2.8% from 2.9% at the 2024 interim.  

A few store closures in both regions didn’t help, but given the franchise system underpinning Spar’s business model it’s tempting to wonder if the sales numbers weren’t damped by head office’s aggressive chase for margin. By pumping up what it charges its independent retailers, Spar can lift its margins, but at a cost to the independent retailers. 

As Protea Capital Management’s Jean Pierre Verster points out: “With this sort of model it’s crucial to divvy up the total margin carefully, it’s important to ensure the retail operator is getting a fair share.” 

Of course, as Verster says, pumping up the wholesale margin is not a sustainable strategy. It reduces the competitiveness of the retailers and also encourages them to source product elsewhere. 

Discontinued operations

The good news on the sales front is that things picked up after end-March, with the first few weeks of the second half of the year lifted by Easter spending. 

But the big news was released with the trading update a week before the results. The businesses in Switzerland and in the UK have been placed in suspended animation, and as far as Spar is concerned they are now “discontinued” operations.  

This doesn’t actually change the reality of the situation, except perhaps to speed up a disposal process. But it involves a hefty pre-tax loss of R4.4bn, largely made up of R4.2bn of impairments. If you can ignore that, it does help with the optics of the “continuing” business. 

Taking Switzerland and the UK out of the picture means the removal of two largeish chunks of debt with little profit. In fact, the more remarkable features of the results were the R200m combined losses notched up by the two entities, which had previously never made losses. 

For many investors the galling thing was the size of yet another impairment. At R4.2bn it is remarkably close to what the Polish venture has cost shareholders. Understandably, Element Investment Managers’ Keith McLachlan is a little frustrated that management is describing this latest leg of their long-term strategy as a “value-unlock”.  

“Spar is going through the classic ‘post-foreign-acquisition-spree dissonance’,” he says, which is essentially all about spending a fortune buying foreign assets, managing them badly, then limping home with hefty bills to pay. Not much “value-unlock” there, says McLachlan. 

In each case foreign assets are bought high and sold low. And debt repayments are at increasing levels of interest rates.  

McLachlan says at its core Spar is resilient, but it is battling to deal with some major own goals. It’s not just the ill-considered foreign acquisitions; the SAP implementation was a nightmare that is only now settling down.  

The botched implementation, which caused significant disruptions to the group’s supply chains, cost Spar R1.6bn in 2023. During the results presentation CEO Angelo Swartz told analysts that without the SAP problems South Africa’s operating margins would have been 2.2% (instead of 2%). He said the KwaZulu-Natal distribution centre – SAP’s ground zero – was now profitable, but only at 65%-75% of its normalised profit.  

Sasfin’s Abraham reckons there’s a lot more work to do to get it to 100%. It’s inevitable Spar still has to iron out a lot of problems and clean up the data, so it’s aligned with the SAP system. 

We may not know until next January if the system has settled. That’s when the next rollout is planned. It will be at Spar’s Build It distribution centre, which happens to be the group’s smallest. Understandably, the group is taking no chances. Swartz told BusinessLive the distribution centre only accounts for 1% of total sales, so the risk can be contained.  

While talk of renewing dividend payments in 18 months or so is encouraging, McLachlan fears the recovery process might be more protracted than management suggests. “They’ve got to exit Europe, de-gear the balance sheet and implement SAP effectively and meanwhile the whole retail landscape is changing around them.”  

The Irish question

Abraham says there’s no denying the current management team is working extremely hard, mainly to undo the damage caused by the previous management team, most of whom have exited the group over the past three years. (Max Oliva, CEO of Spar Southern Africa announced his resignation on the day of the results presentation.) 

But they have a lot of balls in the air right now and, reckons Abraham, there’s considerable execution risk. 

He is one of a growing number of analysts who reckon Swartz and his team should also put Ireland in the “discontinuing operations bucket”. It is a drain on management time which, given all the balls they’re currently juggling and the formidable challenge of winning back market share in their core, domestic market, seems pointless.

Abraham believes Spar has lost its historic comparative competitive advantage from the best neighbourhood locations to the palm of people’s hands … running the Sixty60 app. 

Yet during the presentation, Swartz tagged Ireland as part of Spar’s core long-term business. 

No doubt over the years Ireland has provided bulk to the accounts. But not much else. “After interest payments, there hasn’t been much return,” says Abraham. 

Protea Capital Management’s Verster says there’s no strategic rationale or synergy for operating in two entirely different regions. He wonders whether the group’s recently appointed CFO Reeza Isaacs won’t in time be able to persuade his colleagues of this reality. Isaacs was CFO to Woolworths’ Ian Moir when that group struggled in vain to justify Woolworths’ hefty investment in Australian retailer David Jones. 

Spar’s shares have lost almost 25% year to date, outpacing the losses seen in Shoprite (down 4.7%) and Pick n Pay (down 15%). Boxer stock has inched up almost 1% over the same period.