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Truworths UK woes show dangers facing corporate South Africa abroad
Buy in haste, repent at leisure. The refinancing of Truworths Office shoe retailing operation in the UK announced in late September highlights the dangers for South Africa companies desperate to break out into foreign growth markets.
Standard Bank is providing £32.5m of funding for Office, with a guarantee on Truworths operations in South Africa. Truworths entered Europe for the first time when it bought Office in 2015 for £256m. The depressed UK retail environment, Brexit and the trend to online shopping meant that Truworth already had to write down the value of Office assets by £97m.
Alec Abraham, senior equity analyst at Sasfin in Johannesburg, argues that Truworths shouldn’t be faulted for looking for growth overseas in the context of a South African retail outlook that remains “very poor.” But Abraham suspects that Truworths looked at what was for sale, rather than at what could provide a genuine growth engine.
Truworths management, Abraham argues, has yet to demonstrate that it’s capable of turning around a foreign retail operation that’s having difficulties. He “wouldn’t like to hazard a guess,” as to whether they will succeed.
- A much lower-risk strategy, Abraham says, would be to look abroad for businesses that are doing well.
- Abraham gives Foschini as an example of a South African retailer that has expanded abroad by buying businesses that didn’t need to be turned around.
Damon Buss, equity analyst at Electus in Cape Town, says that Office operated in the fashion sneakers category where Truworth lacked a skill set.
- “Expanding into a new market is always a risk, and doing so with a different business model/category significantly increases the risk,” he says.
- Truworths credit offering has been a key driver of their success in South Africa, but in the UK people do not buy clothes on credit, Buss says.
- Shoe retailing is also notoriously competitive, resulting in lowers margin than apparel, he says.
Buss says that Truworths has little choice but to stick with Office. In the context of uncertainty over Brexit, Buss says that Truworths would have to sell Office at a substantial discount to its current, post-writedown value. Buss expects Truworths to exit Office in the medium term when it can achieve a better sale value.
The Brexit process may hurt Office in the meantime:
- Most of Office’s products are imported, Buss says, so Brexit could mean longer lead times for products, requiring higher inventory and higher working capital.
- In addition, Buss says, products could become more expensive depending on the terms of any new trade deal.
Truworths chief executive officer Michael Mark has said that up to 15 Office stores in the UK will close in the next two years, which will help to lower costs.
The company’s expertise in cost control and inventory management should enable Office to deliver satisfactory results from here, Buss says. Overall, Buss argues, Truworths offers value at the current share price and Electus holds it in some of its funds.
- But Truworths shareholders won’t see any decent return on the Office investment, Buss says.
Bottom Line: South African companies must not be panicked by domestic gloom into attempting foreign turnarounds in businesses they don’t fully understand.