When it rains, it pours for Spar

So, it turns out it can get worse for Spar, South Africa’s second-largest grocery retailer after Shoprite. 

Fresh from the unexpected resignation of CEO Angelo Swartz on Friday, citing an inability to haul the group back onto the right path quickly enough, a horror trading update on Monday saw Spar’s share price tumble to new lows.

Sadly, the market wasn’t persuaded by its efforts to convince investors all was under control, as the price plunged to R75.35 – a fall of 10% on Monday alone, and 16% since Swartz announced he was quitting. Over one year, Spar has lost nearly half its value. 

During a presentation after a trading update for the 18 weeks to January 30, it was hard to shake the impression you were listening to the corporate equivalent of President Cyril Ramaphosa’s state of the nation address (Sona). There was a keenness to believe all the plans to lift sales and margins were working – there just wasn’t a lot of evidence that they are.

Wholesale turnover from continuing operations for those 18 weeks grew by a slight 2.1% year on year. And it would have been considerably worse had it not been for a strong contribution from Ireland, where turnover grew 6.1% in rands. In South Africa, sales growth was a miserable 0.9%, which was underpinned by a 2.9% rise in liquor sales.

If you’re looking for a silver lining, it is that trading momentum in Southern Africa improved in the later weeks, with sales growing 2.3% in November and January.

Squeezed profit margins

There’s no doubt Spar has a lot to contend with. It is operating in a hugely competitive market with low food inflation and deflation in several key categories. 

That’s the same for all the grocery retailers, of course. But Spar differs in that it has less scope than its rivals to push sales at the expense of margins because its business model relies on supplying independent retailers. 

During the 18 weeks, Spar said it “deliberately intensified promotional activity to support retailers, protect volumes and reinforce its value proposition” in response to the tough trading conditions.

In some areas, it was worse than others. In KwaZulu-Natal (KZN), which is still suffering from the mangled rollout of the SAP software system in 2023, it chalked up an “underperformance” rating for the 18 weeks.  

Reeza Isaacs, the current finance director who will take over as CEO from March, told analysts that there were two main reasons for the underperformance. First, there was a “volume-led overshoot”, which compressed margins; second, and more worryingly, given that this is Ground Zero of the SAP problems, “logistics and warehousing inefficiencies”.

It seems that what happened is that Spar redirected a huge volume of products to KZN in the hope that it would encourage retailers back into the fold. The province’s “loyalty rate” is said to be 71% which, if true, is considerably below the group’s average of just above 80%. 

In the end, it turned out, the take-up wasn’t as enthusiastic as it hoped, which squeezed profit margins. As for the logistics and warehouse problems, a thorough review was done “to unpack” the underlying problems and now a “120-day stabilisation plan” has been implemented.

That squeeze on margins came on top of an unfavourable sales mix, as well as promotions around Black Friday. 

A brave show

Still, much of this emerges in the narrative, since the update provided no specific margin numbers – it just said “gross profit margins in Southern Africa declined relative to the comparable prior period”.

Despite, or perhaps because of, the worse-than-expected sales and Swartz’s premature departure, Isaacs put on a brave show – and (Sona-style) he tried to assure investors all was good. 

Isaacs said Spar’s strategic framework is unchanged: strengthening Southern African performance; improving margin resilience; maintaining disciplined capital allocation and advancing balance sheet resilience. 

The difference will be speed of execution. “What changes now is execution intensity,” said Isaacs. To this end, within the next two months a dedicated MD will be appointed for the “grocery and liquor” division.

And, to “reinforce delivery”, Spar will also appoint a chief marketing officer.

Apparently, the grocery and liquor MD will be based in Pinetown, KZN, and so the incoming CEO assumes it will be okay for him (Isaacs) to remain in Cape Town. Not many analysts agreed with that assumption.

As Spar’s share price began to slide on Monday morning, it was evident that investors weren’t persuaded by the upbeat tone. 

Nor did many of them know what to make of Spar’s reference to a possible share repurchase, for which the board would seek approval at the upcoming AGM. 

But why, asked a few analysts; surely Spar’s priority should be to pay down debt and cut its interest cost on loans, before buying back shares?

Isaacs acknowledged that this was a fair point. But, he argued, “we’ve demonstrated we can generate cash and deleverage”.

Spar is targeting a gearing level of 1.5 times and, “once we’re within that, we can buy back shares”.

Isaacs said this is a good way to generate returns for shareholders “without compromising our balance sheet”.

This suggests Spar’s board believes the share price is close to the bottom. The question is, how much lower can it still go?

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