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By Marlo Scholtz, 13 August 2013
The business has its roots in SA but today also trades in Namibia, Botswana, Zambia, Mozambique, Mauritius, Swaziland, Lesotho and in Zimbabwe under the TM Supermarkets brand. The stock has gone from being the darling of the market in the late nineties and early two thousands to the black sheep of the sector due to poor execution and sub-par performance in recent years. What we like Pick n Pay is still one of the most recognisable and loved brands in SA. It has some of the best retail sites in the country and, as the second biggest food retailer in SA, still has a lot of sway over suppliers.
It has lagged competitors in terms of moving to central distribution and into the faster growing middle to bottom end of the market. The company has, however, seen the error of its ways and is in the process of rectifying both these issues. It is also addressing the poor availability of products in Pick n Pay stores, which we believe has been its Achilles heel over the last few years and a key reason for its underperformance.
Most of the problems in Pick n Pay are operational and can be fixed by better execution at store level. It still has the second highest trading density per square meter in the listed food retail space, implying that on a turnover-per-store basis it generates just as much – or more – revenue out of the same size stores as most of its competitors but at substantially lower margin (see graphs). This is indicative of a business that has not lost its appeal with its customers but is just poorly run.
New CEO Richard Brasher has the right pedigree and experience to address these issues. He is focusing on the right areas in the business and has the added benefit of not being involved in the historic decision making, which allows him to view the problems in the business impartially.
The market has lost faith in the business, with the price of the share implying that the status quo will persist indefinitely. This has, in our view, created a buying opportunity as the business model in Pick n Pay is still largely intact and all of the operational issues in the business are being addressed.
Execution risk in this business remains high. When a business is undergoing as much change as Pick n Pay, the potential to drop the ball in some areas of the business intensifies. This risk is exacerbated by aggressive space growth.
Although Richard Brasher has the right experience in the functional areas of Pick n Pay that are undergoing the most change, he does not have South African retail market experience. Fortunately there are a number of senior executives at Pick n Pay who should be able to guide him around the nuances of the domestic retail environment.
There is a risk that things could get even worse before they get better and that the execution of the strategy takes longer to implement than we expect. Pick n Pay’s competitors are not going to stand still while it is playing catch up and the risk is that once Pick n Pay catches up to their current level of expertise, competitors have improved even further. The current price implies that Pick n Pay will never even come close to its competitors’ current level of expertise, which we believe is unrealistic.
Pick n Pay is currently undervalued by the market because investors are not able to separate the current operational performance with the normalised potential of the business. We see the issues in the business as operational and not structural and believe this can be addressed through management intervention.