Spar Research Report

Spar Group Ltd

Is it good for you?

Rob Enslin

2/28/2013

http://www.google.co.za/url?sa=i&rct=j&q=spar+group&source=images&cd=&cad=rja&docid=6YbDTnm8fnosDM&tbnid=kXtanqTlEXp_eM:&ved=0CAUQjRw&url=http://africanbrains.net/2012/09/26/spar-group-subsidiary-announces-3-5-million-contract-with-fortune-500-consumer-goods-company-in-south-africa/&ei=Vz4vUe2JOKf80QWf9YHoDw&bvm=bv.43148975,d.d2k&psig=AFQjCNELw0Xih34hL_98XezKzZLLeEb5qQ&ust=1362137033313112

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1 INTRODUCTION ..................................................................................................................................... 2

1.1 IDEA GENERATION: ............................................................................................................................... 2 1.2 QUALITY ASSESSMENT: CONCLUSION .............................................................................................................. 2

2 COMPANY OVERVIEW .............................................................................................................................. 3

2.1 BUSINESS DESCRIPTION ........................................................................................................................... 3 2.2 HISTORY ......................................................................................................................................... 5 2.3 BUSINESS DIVISIONS .............................................................................................................................. 5

2.3.1 Overview ................................................................................................................................. 5 2.3.2 Contribution to revenue & profit .................................................................................................... 7

2.4 GEOGRAPHIC BREAKDOWN ........................................................................................................................ 8 2.4.1 Overview ................................................................................................................................. 8 2.4.2 Contribution to revenue ............................................................................................................. 10

3 QUALITY ANALYSIS ............................................................................................................................... 10

3.1 MARKET POSITIONING .......................................................................................................................... 10 3.1.1 Qualitative Score ..................................................................................................................... 10

3.1.1.1 Economic Moat ..................................................................................................................... 10 3.1.1.2 Market Share Analysis ............................................................................................................. 11 3.1.1.3 Financial Comparison .............................................................................................................. 11 3.1.1.4 Conclusion .......................................................................................................................... 12

3.2 BUSINESS MODEL ............................................................................................................................... 13 3.2.1 Qualitative Score ..................................................................................................................... 13

3.2.1.1 Centralised/Decentralised Business Model ..................................................................................... 13 3.2.1.2 Ease of understanding ............................................................................................................. 13 3.2.1.3 Forward looking strategy ......................................................................................................... 13 3.2.1.4 Vertical integration of the value chain ......................................................................................... 13 3.2.1.5 Conclusion .......................................................................................................................... 13

3.3 MANAGEMENT .................................................................................................................................. 14 3.3.1.1 Corporate Governance ............................................................................................................ 14 3.3.1.2 Ownership Structure ............................................................................................................... 15 3.3.1.3 Track-record ........................................................................................................................ 15 3.3.1.4 Management’s Experience ........................................................................................................ 15 3.3.1.5 Conclusion .......................................................................................................................... 20

3.4 FINANCIAL STRENGTH .......................................................................................................................... 21 3.4.1.1 Revenue growth .................................................................................................................... 21 3.4.1.2 Margin analysis ..................................................................................................................... 21 3.4.1.3 Financial Leverage ................................................................................................................. 21 3.4.1.4 Ratio Analysis ....................................................................................................................... 22 3.4.1.5 Competitor Analysis ............................................................................................................... 23 3.4.1.6 Conclusion .......................................................................................................................... 24

4 SWOT ANALYSIS .................................................................................................................................. 24

5 INDUSTRY OUTLOOK ............................................................................................................................. 25

BUSINESS DRIVERS ................................................................................................................................... 25

6 OVERALL QUALITY CONCLUSION .............................................................................................................. 25

7 VALUATION ........................................................................................................................................ 27

8 SOURCES ........................................................................................................................................... 27

9 APPENDIX .......................................................................................................................................... 28

9.1 FINANCIAL STATEMENTS .................................................................................................................. 28 9.1.1 Income Statement .................................................................................................................... 28 9.1.2 Balance Sheet ......................................................................................................................... 29 9.1.3 Cash Flow Statement ................................................................................................................. 30 9.1.4 Ratios ................................................................................................................................... 30

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1 Introduction

1.1 Idea Generation:

Screening Tool Theme Other

1.2 Quality Assessment: Conclusion

Spar Group was identified on an ad hoc basis after considering a random selection of SA retail company valuation multiples post the “SA retail companies sell-off” in January 2013. The company screened relatively cheaper compared to its peers and its own history. A Quality Assessment Report was run and the following aspects were identified. Spar Group scored highly on quality with a score of 12/159. It also scored well on the screening tool at 14/159.

Source: Efficient Select

It’s historical depiction of quality-to-valaution also presents an attractive picture.


x

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The picture below of earnings relative to price over time is supportive of a potential investment opportunitiy with price recently “dipping” below earnings.


Spar’s fundamental scorecard was less impressive, scoring 331/422 overall. It scored weakly on market positioning and financial strength. Intial perceptions are that it’s franchise model resulting in lower margins may explain this. A more in-depth assessment will provide us with more information.

Source: Efficient Select An analysis of risk and liquity indicate a maximum drawdown of 11.61% (suggesting that it is defensive in nature) and a 30 day value traded percentage of 122.75% relative to Efficient Select’s AUM representing a pass on liquidity. Finally, based on 5 year historic data and an equal weighting towards PE, DY, PS, PB and PCF metrics, fair value was estimated at 110.45 1/8 analysts had it on a buy rating, 5/8 on a hold rating and 2/8 on a sell rating.

2 Company Overview

2.1 Business Description

Spar Group Ltd. is a wholesaler and distributor of goods and services to SPAR grocery stores, Build It builders merchandise outlets, and TOPS and SPAR liquor stores. The company operates seven main distribution centers which are located close to the major metropolitan areas. These distribution centers service SPAR stores, Build It outlets and TOPS and SPAR stores across South Africa and neighbouring countries. Spar’s Business Model SPAR operates under licence agreement with SPAR International in Amsterdam. This licence agreement covers South Africa, Botswana, Namibia, Swaziland and Mozambique. Independent retailers who elect to be part of the SPAR family sign a membership agreement with the Guild which provides them with:

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Consolidated deliveries from distribution centres

Improved buying

Volume discounts

Store development advice

Retail consultancy service

Comprehensive computer services

International brand

Strong house brand

Regular promotions

Media exposure

Category management advice

Training

In turn the independent retailers undertake to adhere to certain standards and procedures as laid out in the membership agreement.

Source: Spar Group

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Warehouse and Distribution The group despatched 195.1 million cases through the seven SPAR distribution centres which reflected a healthy 6.4% increase on the volumes handled last year. Over the last five years volumes through our facilities have increased by over 50%. The rising fuel price has resulted in a renewed focus on more effective route management systems, improving truck turnaround times, the increased use of bio-diesels, reviewing truck specifications and driver training in an effort to further improve transport costs. SaveMor Store Format SaveMor is a new small store format to address the needs in the less populated rural towns and central business districts in larger towns, where we cannot justify the cost of setting up a SPAR store. We now have 17 stores and expect to open another 12 stores during 2013. Pharmacy at SPAR We continue to fine-tune this offering and, despite licencing challenges, opened 16 stores during the year. We plan to open another 12 stores next year. Corporate retail stores Stores owned by the franchise are insignificant at 11 (out of a total of 1725). They are generally also only a result of strategic reasons or distressed stores. In 2012, this part of the business made an operating loss of R28m. The company's three friendly store formats, which are SPAR for neighbourhood shopping, SUPERSPAR for one-stop, bulk shopping and KWIKSPAR for every day convenience, cater for all shopping preferences. It was founded in 1963 and is headquartered in Pinetown, South Africa. The company was unbundled from Tiger Brands and listed on the Johannesburg Stock Exchange in 2004.

2.2 History

Back in 1932 in the Netherlands, a wholesaler named Adriaan van Well, started his organisation DESPAR. The idea was simple: unite the efforts of both the independent wholesaler and retailer in order to mitigate the effects of grocery chains which were fast taking over the market. The name of the organisation has changed slightly and it has spread into 35 countries and 5 continents.

In South Africa, at the beginning of the 1960s, eight wholesalers got together and decided to introduce the SPAR concept into the country. In 1963 it was launched to service some 500 small retailers and now, 46 years later, the SPAR Group Ltd. operates out of seven modern distribution centres and services over 800 SPAR stores across southern Africa.

2.3 Business Divisions

2.3.1 Overview

The SPAR Group operates 6 distribution centres and 1 Build it distribution centre. The distribution centres supply and service independently owned SPAR, TOPS, Build it and Pharmacy at SPAR stores in southern Africa. Goods are distributed to the stores by a fleet of trucks and trailers, which are owned by the SPAR group.

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Distribution Centres DC 1

DC 2

DC 3

DC 4

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DC 5

DC 6

DC 7

Source: Spar Group

The Group owns three key retail brands that all operate in different spheres, namely SPAR, BUILD IT and TOPS.

2.3.2 Contribution to revenue & profit

The SPAR Group Limited acts as a wholesaler and distributor of goods and services to SPAR supermarkets, Build it building materials outlets, and TOPS at SPAR liquor stores. It’s franchise model means that 100% of revenues are derived from their distribution centre.

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Distribution

Centre

(100.00%)

Source: FactSet Fundamentals

Revenue by Business Segment

Spar Group Ltd. (SPP-ZA)

Distribution Centre (100.00%)

2.4 Geographic Breakdown

2.4.1 Overview

It is important to note that the Spar brand originates outside of South Africa (from the Netherlands). In the 1960’s eight wholesalers got together and decided to introduce the SPAR concept into the country. In 1963 it was launched to service some 500 small retailers.

Today, Spar International is represented in 35 countries and 5 continents around the world. Spar South Africa services Swaziland, Botswana, Mozambique, Namibia, Zimbabwe and Zambia through its distribution centres in South Africa.

- As mentioned, the geographic split is based on where the DC is situated. Below is how management reports geographic segmentation.

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Source: Spar Group

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2.4.2 Contribution to revenue

South Africa

(100.00%)


Revenue by Geographic Segment

Spar Group Ltd. (SPP-ZA)

South Africa (100.00%)

3 Quality Analysis

3.1 Market Positioning

3.1.1 Qualitative Score

3.1.1.1 Economic Moat

3.1.1.1.1 Supplier Power

Supplier power with suppliers is average to above average. Being a large established retailer, it is in the suppliers’ best interests to maintain a good working relationship with Spar. There is however demand from Spar’s competitors and therefore not complete bargaining power with suppliers.

3.1.1.1.2 Buyer Power

Bargaining power by buyers is high. Cost conscious consumers are sensitive to price changes and have the ability to shop at Spar’s competitors with relative ease. Buyer bargaining power is therefore high.

3.1.1.1.3 Degree of Rivalry

Degree of rivalry amongst Spar’s competitors is fierce. Primary competitors include: Shoprite, Pick n Pay, Woolworths,Game, Ultra Liquor, Cashbuild and Solly Kramer.

3.1.1.1.4 Threat of new entrants

Threat of new entrants is moderate. Competitors are likely to arise from developed market players seeking new avenues of growth, similar to what we saw with Walmart-Massmart. Supply-side economies of scale and access to

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supplies products along with large capital requirements in setting up the distribution channels protect Spar marginally.

3.1.1.1.5 Threat of substitutes The most likely substitute is online shopping. Whilst the concept has been around for some time, the number of people switching over to online shopping has started to increase. Technology, including smart phone and tablet devices, have assisted this change. Spar’s current structure is however easily adaptive to online sales as it relies on a centralised distribution model.

3.1.1.1.6 Overall pricing power

Overall, Spar has a low degree of pricing power. Due to the generic product (i.e. foods) that Spar sells, its pricing power ability is limited.

3.1.1.2 Market Share Analysis

3.1.1.2.1 5 year change in market share

Whilst the calculation below is incomplete in that it does not include all competitors, including Spar’s main competitors, calulating market share based on revenue shows a healthy pattern for Spar. A similar pattern exists for Shoprite at the expense of Pick n Pay.

Revenue 2012 2011 2010 2009 2008

Spar 43557 20.7% 38814 20.6% 34844 19.3% 31962 19.7% 26742 19.1%

Shoprite 82731 39.4% 72298 38.3% 67402 37.4% 59319 36.5% 47652 34.1%

Pick n Pay 55331 26.3% 51946 27.5% 54735 30.3% 49862 30.7% 45381 32.5%

Woolworths 28604 13.6% 25582 13.6% 23393 13.0% 21175 13.0% 20065 14.3%

210223 100.0% 188640 100.0% 180374 100.0% 162318 100.0% 139840 100.0%


3.1.1.2.2 Market Concentration

The food retail market in South Africa is concentrated. According to a Thomas White Global Investing Survey in July 2011, Shoprite, Pick n Pay, Spar, Massmart and Metcash constitute 80% of retail sales.

3.1.1.3 Financial Comparison

3.1.1.3.1 5 Year Margin Analysis

Operating margins have improved over the past 5 years whilst net profit margin has been flat/marginally weaker. This a positive signal as Spar has also been able to grow market share over the period.

5 Yr. Av. Sep '12 Sep '11 Sep '10 Sep '09 Sep '08

Gross Margin (%) 8.30 8.52 8.96 7.92 8.04 8.08

Operating Margin (%) 3.01 3.46 3.60 2.84 2.46 2.70

Pretax Margin (%) 3.63 3.48 3.62 3.75 3.59 3.73

Net Margin (%) 2.48 2.43 2.45 2.63 2.33 2.55


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3.1.1.3.2 5 Year Average ROE

Return on equity (ROE) over the past 5 years has been strong, averaging 40.33%. Net income has grown slower relative to equity, indicating that Spar’s high ROE is not a function of gearing with debt.

5 Yr. Av. Sept '12 Sept' 11 Sept '10 Sept' 09 Sept '08

Net Income 1058.9 952.6 915.8 745.2 681.6

% growth 9.21% 11.16% 4.02% 22.89% 9.33%

Equity 2838 2490 2187 1940 1488

% growth 13.78% 13.98% 13.85% 12.73% 30.38%

ROE 40.33% 37.31% 38.26% 41.87% 38.41% 45.81%


3.1.1.3.3 5 Year Average ROA

Return on assets (ROA) has been stable over the past 5 years with assets growing at an average pace of 11.48% compared to net income growth of 9.21%.

5 Yr. Av. Sept '12 Sept' 11 Sept '10 Sept' 09 Sept '08

Net Income 1058.9 952.6 915.8 745.2 681.6

% growth 9.21% 11.16% 4.02% 22.89% 9.33%

Assets 9895 8302 7529 6540 5834

% growth 11.14% 19.19% 10.27% 15.12% 12.10%

ROA 11.48% 10.70% 11.47% 12.16% 11.39% 11.68%


3.1.1.3.4 5 Year Average EPS growth

Five year earnings growth has been good. Diluted EPS has grown at a 5 year average growth rate of 16.7%. What is also impressive is that earnings growth has been positive for all 5 years even during the financial crisis, reflecting its defensive characteristics.

5 Yr. Av. Sep '12 Sep '11 Sep '10 Sep '09 Sep '08 Sep '07

EPS (diluted) 5.71 5.21 5.06 4.26 3.91 2.99

EPS (diluted) Growth (%) 16.67 9.44 3.00 18.83 9.09 30.60 29.05

EPS (basic) 6.16 5.56 5.36 4.39 4.07 3.13

EPS (basic) Growth (%) 17.43 10.82 3.66 21.98 8.09 29.87 30.15


3.1.1.4 Conclusion

Evidence above suggests good market positioning. On all factors analysed above, Spar measures satisifactory to well.

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3.2 Business Model


3.2.1.1 Centralised/Decentralised Business Model

Spar makes use of a decentralised distribution model. As mentioned above, Spar operates seven main distribution centres which are located close to the major metropolitan areas.

3.2.1.2 Ease of understanding

Spar Group has a very understandable business model. It can be discribed as a whole distribution business with 7 distribution centres. Its stores are franchised out. This has allowed the Group to achieve scale as well as owner managed businesses therefore the incentive and “customisation” of each owner is high.

3.2.1.3 Forward looking strategy

The group’s six strategic outcomes include: • A world-class replenishment system for retailers • Competitive pricing of products • Provide a comprehensive product range • Build world-class brands • Develop the best retailers • Realise new business growth

The strategic imperatives which will enable the achievement of the outcomes include: • Delivering excellence in fresh food departments • Optimising their supply chain from supplier through to the retailer • Providing expert retail leadership and support to their retailers • Being leaders in their retail communities • Creating a competitive price perception with consumers • Sustaining SPAR’s future growth through identifying and realising new business opportunities

3.2.1.4 Vertical integration of the value chain

Yes – through its distribution system, in-store restuarants and recently added Tops bottle stores and Build-it stores.

3.2.1.5 Conclusion Spar’s business model can be summarised as effective and well structured for fast expansion if applied outside of RSA. Its owner managed businesses model acts as an inherant quality control. It is less profitable than owning the stores 100% but benefits as a differenciated product offering (i.e. each Spar store is unique and suited to the region).

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3.3 Management


3.3.1.1 Corporate Governance

CEO and Chairman different Yes: The roles of the Chairman and the Chief Executive Officer are separated and a clear division of authority exists between these roles. Chairman is an independent non-executive director Yes Majority of directors are non-executives (i.e. greater than 50%) Yes: The current percentage of non-executive directors is 73% Corporation seen as a responsible corporate citizen Yes: Spar has established a clear social and ethics responsibility strategy for their business. Audit Committee only consists of independent non-executives and Chairman is not included Yes with explanation: Management has attended audit committee meetings but only by invitation. This is acceptable with best practice. Secondly, the Chairman, Mr. MJ Hankinson up until recently served on the audit committee. He resigned from the audit committee in August 2012. Remuneration Committee - salaries are in line with shareholder's interests Not sure: Spar has stated that they do not disclose the remuneration of the three highest paid executives who are not directors as they believe this would reveal sensitive information to competitors.

Source: Spar Group

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3.3.1.2 Ownership Structure

3.3.1.3 Track-record

Management has created shareholder wealth Yes: Spar’s share price has appreciated by 129.45% over the past 5 years; CAGR: 18.1% (427.5% over the past 10 years). Management has delivered on expectations Yes: Management has produced EPS growth of 17% p.a. over the past 5 years, strong ROE and ROA and have executed on their Tops and Build-it store layouts.

3.3.1.4 Management’s Experience

The Spar’s management is the executive committee of Spar responsible for ensuring the development, implementation and execution of Group strategy. The SMB meets 3 times a year.

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3.3.1.5 Conclusion Spar Group meets the requirements of the new Companies Act and have applied the principles contained in the King Report (King III). The structuring of the board and committees are all also within reason. The only aspect of the management and the board of directors is surrounding remuneration, where there is less transparency.

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3.4 Financial Strength


3.4.1.1 Revenue growth

CAGR since 2003 has been 15.7%


3.4.1.2 Margin analysis

Margins have remained relatively stable over the past 5 years, with its operating margin improving. Notice the colour chart regarding direction: FYE 2011 was the peak. Margins overall are “thin” typical of a food retail business, high volumes, small margins.


3.4.1.3 Financial Leverage

Below are the 5 year average numbers used as inputs to calculate operating leverage, financial leverage and subsquently, total leverage. Total leverage of the income statement is low at 1.02. Financial leverage is low. As a cross-check, Spar has a 5 yr Avg Debt/Assets ratio of 3.8%.

Degree of Operating Leverage = % change in operating income

% change in sales

= 162.12%

100.69%

= 1.61

Degree of Financial Leverage = % change in EPS

% change in EBIT

= 102.47

162.12

Sep '12 Sep '11 Sep '10 Sep '09 Sep '08 Sep '07 Sep '06 Sep '05 Sep '04 Sep '03

Sales/Revenue 43 557.40 38 814.00 34 844.20 31 962.10 26 742.20 21 704.00 17 009.60 13 598.96 11 985.15 10 121.05

12.2% 11.4% 9.0% 19.5% 23.2% 27.6% 25.1% 13.5% 18.4%

5 Yr AVG Sep '12 Sep '11 Sep '10 Sep '09 Sep '08 Sep '07

Profitability

Gross Margin (%) 8.30 8.52 8.96 7.92 8.04 8.08 8.19

Operating Margin (%) 3.01 3.46 3.60 2.84 2.46 2.70 2.65

Pretax Margin (%) 3.63 3.48 3.62 3.75 3.59 3.73 3.66

Net Margin (%) 2.48 2.43 2.45 2.63 2.33 2.55 2.41

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= 0.63

Degree of Total Leverage = % change in EPS

% change in sales

= 102.47%

100.69%

= 1.02

3.4.1.4 Ratio Analysis

3.4.1.4.1 Du Pont Analysis

Net profit margin: stable

Asset turnover: improving

Equity leverage: mixed

Overall: ROE is strong and improving, attributed to asset turnover increasing. This is an indication of more efficient use of company assets. It is important to point out that Spar has very little debt, therefore its high ROE is not a result of gearing.

Net Income x

Sales x

Assets = ROE

Sales Assets Equity

2008 2.5 x 4.40 x 3.49 = 38.4

2009 2.3 x 4.68 x 3.33 = 35.8

2010 2.6 x 4.63 x 3.44 = 41.4

2011 2.5 x 4.89 x 3.37 = 41.2

2012 2.4 x 4.58 x 3.92 = 43.1

5 Yr. Av. 2.46 X 4.64 X 3.51 = 39.99


3.4.1.4.2 Profitability Analysis

Overall assessment of figures below are good with the caveat that margins are thin. ROA, ROE and ROC are impressive.


Gross Margin (%) 8.30 8.52 8.96 7.92 8.04 8.08 8.19

Operating Margin (%) 3.01 3.46 3.60 2.84 2.46 2.70 2.65

Pretax Margin (%) 3.63 3.48 3.62 3.75 3.59 3.73 3.66

Net Margin (%) 2.48 2.43 2.45 2.63 2.33 2.55 2.41

Return on Assets (%) 12.25 11.64 12.03 13.02 12.04 12.52 12.17

Return on Equity (%) 44.17 39.76 40.74 44.38 43.48 52.48 52.25

Return on Total Capital (%) 38.53 38.92 35.79 36.56 36.45 44.93 47.21

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3.4.1.4.3 Solvency Analysis

Solvency ratios vary by industry, however a solvency ratio above 20.0% is considered financially sound. Spar’s solvency ratio of 17.95% is therefore on the threshold of what is considered acceptable.

5 year Average Solvency Ratio = After Tax Net Profit + Depreciation

Total Liabilities

= 975.11

5431.6

= 17.95%

3.4.1.4.4 Liquidity Analysis

Days of sales outstanding: marginally weakening but nothing alarming

Days inventory on hand: marginally decreasing, again – nothing alarming

Days of payables outstanding: payables negatively shorted during 09’ and ’10 but has steadily increased again.

Cash Conversion Cycle: difficult to summarise due to the number being a little volatile but overall improving

Current ratio: improving but still below acceptable 2:1, it is something to highlight

Cash ratio: improving but below the 0.5:1 acceptable level, therefore it is a flag. Overall, liquidity and solvency ratios have been on the threshold of acceptable and worthy of keeping an eye on. Industry charateristics are partly justifiable for lower readings.


Days of Sales Outstanding 42.46 43.15 44.06 42.87 40.61 41.61 41.12

Days of Inventory on Hand 10.67 11.68 10.82 10.31 10.24 10.32 9.56

Days of Payables Outstanding 40.45 44.67 40.16 37.45 37.01 42.93 48.88

Cash Conversion Cycle (Days) 12.69 10.16 14.71 15.73 13.83 9.00 1.80

Current Ratio 1.08 1.12 1.10 1.08 1.07 1.02 1.01

Quick Ratio 0.88 0.92 0.90 0.89 0.87 0.83 0.85

Cash Ratio 0.04 0.12 0.02 0.02 0.02 0.01 0.12


3.4.1.5 Competitor Analysis

5yr Av. Growth Gross Margin Operating Margin Debt/Assets ROE ROA ROIC EPS Growth

Spar 8.3 3.01 3.82 44.17 12.25 43.72 13.8

Shoprite 17.08 2.85 5.98 37.97 12.43 36.76 23.7

Pick n Pay 9.2 1.72 9.93 58.88 9.79 40.17 -0.2

Woolworths 28.86 5.83 13.69 39.76 14.93 31.69 14.8

Massmart 9.89 3.92 7.05 39.08 8.65 34.89 0.7

Cashbuild 21.76 5.01 0.12 30.22 10.73 30.11 18.6

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Relative to its competitors, Spar scores well on most metrics. Its gross margin is lower compared to peers due to its franchise model, however operating margin quickly improves. All other metrics are scored on the upper end of favourable compared to peers.

3.4.1.6 Conclusion

Spar’s financial position is good. It scores well compared to its peers. One exception to highlight is solvency and liquidity metrics scoring just below what is considered acceptable. It is important to highlight though that limits vary from industry to industry.

4 SWOT ANALYSIS

4.1 Strengths

Spar has been able to maintain food market share and grow already-dominant shares in liquor and building

materials.

Group’s warehouse capacities are more than strong enough to support future growth.

Due to the company’s owner managed format, unions have found it harder to unionise Spar’s staff.

More customised store offering based on demographics of store location.

4.2 Weaknesses

Spar, along with other food retailers, is subject to food inflation which can be volatile.

Spar’s wholesale distributor model should struggle to be as cheap on price of its goods as its competitors in

theory.

4.3 Opportunities

Spar holds rights to operate in Mozambique – with developments taking place in Mozambique and Spar’s

Nelspruit warehouse well positioned to distribute into the country, there is an opportunity for growth.

Spar also operates in Namibia, Botswana and Zimbabwe.

Higher food inflation positively impacts revenues and ultimately profits.

4.4 Threats

A marked decline in food inflation negative to profits.

Developed world competitors taking away market share.

A turnaround in Pick n Pay.

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5 INDUSTRY OUTLOOK

5.1 Industry life-cycle classification

Spar is considered to be in the mature stage of the industry life-cycle. The most obvious second wave of growth will come from expansion into surrounding African countries.

5.2 Stock classification

Spar can be considered to be a Stalwart business.

5.3 Stock market cycle analysis

Two major inputs affecting Spar are positive food inflation and the interest rate cycle affecting disposable income trends. Spar therefore performs well during the later stages of a recession into an early bullmarket.

BUSINESS DRIVERS

Positive food inflation

Disposable income trends

African expansion

6 OVERALL QUALITY CONCLUSION

The overall assesment of Spar is in support of an above average quality business. Spar scores well on market positioning, good on business model, satisfactory on management and good on financial strength.

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1 2 3 4 5 Score

Bargaining power with Suppliers poor below average average above average excellent 4

Bargaining power of Buyers poor below average average above average excellent 2

Degree of Competion high fairly high moderate fairly low low 1

Threat of new entrants high fairly high moderate fairly low low 3

Threat of Substitutes high fairly high moderate fairly low low 4

5 year change in Market Share Decreased Marginally Decreased Flat Marginally Increased Increased 4

Market Concentration low fairly low average fairly high high 4

5 Year Margin Analysis poor below average average above average excellent 3

5 Year Avg ROE poor below average average above average excellent 4

5 Year Avg ROA poor below average average above average excellent 4

5 Yr Avg EPS growth poor below average average above average excellent 3

poor below average average above average excellent 3

3.2.2. Qualitative

1 2 3 4 5 Score

Ease of Understanding complex fairly complex average fairly simple simple 5

Forward looking strategy weak fairly weak average fairly strong strong 4

Execution risk associated with strategy high fairly high average fairly low low 3

Vertical intergration of the value chain poor below average average above average excellent 3


3.2.2. Qualitative

1 2 3 4 5 Score

3.3.2.1. Corporate Governance Corporate Governance poor below average average above average excellent 4

3.3.2.2. Ownership Structure Management's ownshership in the company is acceptable poor below average average above average excellent 4

Mangement has created shareholder wealth poor below average average above average excellent 4

Management has delivered on expectations poor below average average above average excellent 4

Management are highly experienced in their field of expertise poor below average average above average excellent 3


3.4.2. Qualitative

1 2 3 4 5 Score

3.4.2.1.1. Revenue growth Revenue growth has been satisfactory over the past 5 years strongly disagree disagree neutral agree strongly agree 4

3.4.2.1.2. Margin analysis Margins have been sustained over the past 5 years strongly disagree disagree neutral agree strongly agree 4

3.4.2.1.3. Financial Leverage Financial Leverage is healthy strongly disagree disagree neutral agree strongly agree 3

ROE (via Du Pont Analysis) is attractive strongly disagree disagree neutral agree strongly agree 4

Profitability ratios are satisfactory strongly disagree disagree neutral agree strongly agree 4

Solvency ratios are satisfactory strongly disagree disagree neutral agree strongly agree 2

Liquidity ratios are satisfactory strongly disagree disagree neutral agree strongly agree 2


Overall poor below average average above average excellent 3

3.4.2.1.4. Ratio Analysis

3.1.2.3. Financial Comparison

3.2. Business Model

3.3.2.3. Track Record

3.1. Market Position - Sector Specific

3.1.2.2. Market Share Analysis

3.1.2.1. Economic Moat

3.4. Financial Strength

3.3. Management

3.2. Business Model

7. Overall Quality Conclusion

Idea Generation Screening Tools Theme Other

Quality Assessment Report: Conclusion Weak Average Strong

Houseview

Call Negative Stable Negative Stable Stable Positive Positive

Equity Negative Stable Negative Stable Stable Positive Positive

Sector Negative Stable Negative Stable Stable Positive Positive

Economic Cycle View Early Recovery Mid Recovery Late Recovery Recession

Industry Outlook

Stock Classifaction Turn Around Slow Grower Stalwart Cyclical Fast Grower

Industry life-cycle Classification Introduction Growth Mature Decline

Stock Market Cycle Analysis: When does the stock perform best Early Recovery Mid Recovery Late Recovery Recession

Business Drivers

1)

2)

3)

4)

Final Comments

Positive food inflation

Disposable Income Levels

African expansion

-

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7 VALUATION Please find below a summary of the Spar Valuation. For a more detailed breakdown, please refer to valuation template.

Weighted Valuation Weight Buy Price Target Price Sell Price

Historical Valuation 60% 126.07 198.68 181.32

Relative Valuation 40% 128.78 149.54 136.48

Weighted Valuation 100% 127.16 179.02 163.38 Source: Efficient Select

8 SOURCES Nedbank UBS Factset Spar company website

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9 APPENDIX

9.1 FINANCIAL STATEMENTS

9.1.1 Income Statement

Sep-12 Sep-11 Sep-10 Sep-09 Sep-08 Sep-07

Final Final Final Final Final Final

Sales/Revenue 43557.40 38814.00 34844.20 31962.10 26742.20 21704.00

Cost of Goods Sold (COGS) incl. D&A 39846.70 35336.60 32083.70 29393.00 24582.50 19926.90

Gross Income 3710.70 3477.40 2760.50 2569.10 2159.70 1777.10

SG&A Expense 2188.70 2065.70 1759.60 1648.10 1437.70 1201.40

Other Operating Expense 13.00 12.90 13.00 136.20 0.00 0.00

EBIT (Operating Income) 1509.00 1398.80 987.90 784.80 722.00 575.70

Non-operating Income (Expense) - Net 32.30 34.20 340.00 390.40 297.30 229.80

Interest Expense 26.00 24.70 20.90 29.50 19.30 10.30

Unusual Expense (Income) - Net 0.10 3.70 #N/A -1.00 1.50 0.50

Pre-tax Income 1515.20 1404.60 1307.00 1146.70 998.50 794.70

Income Taxes 459.80 452.00 391.60 401.50 316.90 271.70

Equity in Earnings of Affiliates 3.50 0.00 0.40 0.00 0.00 #N/A

Consolidated Net Income 1058.90 952.60 915.80 745.20 681.60 523.00

Minority Interest Expense 0.00 0.00 0.00 0.00 0.00 0.00

Net Income 1058.90 952.60 915.80 745.20 681.60 523.00

Net Income available to Common 1058.90 952.60 915.80 745.20 681.60 523.00

EPS (recurring) 5.71 5.23 5.06 4.26 #N/A 2.99

EPS (basic) 6.16 5.56 5.36 4.39 4.07 3.13

EPS (diluted) 5.71 5.21 5.06 4.26 3.91 2.99

EBITDA 1634.40 1521.30 1096.20 877.20 795.00 629.10

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9.1.2 Balance Sheet



Assets

Cash & ST Investments 841.60 96.40 85.20 68.50 57.90 453.50

Total Accounts Receivable 5379.80 4919.80 4449.90 3735.60 3376.20 2721.50

Inventories 1415.60 1135.00 959.20 853.10 795.70 594.50

Other Current Assets 35.80 26.60 28.60 26.40 24.20 45.50

Total Current Assets 7672.80 6177.80 5522.90 4683.60 4254.00 3815.00

Net Property, Plant & Equipment 1588.00 1550.40 1521.00 1425.80 1083.30 736.20

Total Investments and Advances 60.90 23.60 41.50 17.30 56.10 117.50

Long-Term Note Receivable 171.70 154.10 139.10 143.30 145.60 124.60

Intangible Assets 391.00 381.90 299.70 245.60 245.60 245.60

Deferred Tax Assets 10.90 13.20 3.20 22.00 15.70 14.50

Other Assets 0.00 0.60 1.50 2.20 33.60 4.10

Total Assets 9895.30 8301.60 7528.90 6539.80 5833.90 5057.50

Liabilities & Shareholders' Equity

ST Debt & Curr. Portion LT Debt 0.00 114.90 531.10 351.00 310.00 11.30

Accounts Payable 5513.90 4308.90 3506.60 3099.60 2873.50 2956.60

Income Tax Payable 6.70 40.60 0.40 2.30 121.30 71.30

Other Current Liabilities 1300.80 1131.20 1094.10 937.20 856.60 738.80

Total Current Liabilities 6821.40 5595.60 5132.20 4390.10 4161.40 3778.00

Long-Term Debt 0.00 0.00 0.00 0.00 0.00 115.00

Provision for Risks & Charges 103.40 85.50 75.10 67.90 60.80 54.80

Deferred Tax Liabilities 3.90 0.60 #N/A #N/A #N/A #N/A

Other Liabilities 129.00 130.40 134.40 141.50 123.90 0.00

Total Liabilities 7057.70 5812.10 5341.70 4599.50 4346.10 3947.80

Common Equity 2837.60 2489.50 2187.20 1940.30 1487.80 1109.70

Total Shareholders' Equity 2837.60 2489.50 2187.20 1940.30 1487.80 1109.70

Accumulated Minority Interest 0.00 0.00 0.00 0.00 0.00 0.00

Total Equity 2837.60 2489.50 2187.20 1940.30 1487.80 1109.70

Liabilities & Shareholders' Equity 9895.30 8301.60 7528.90 6539.80 5833.90 5057.50

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9.1.3 Cash Flow Statement



Operating Activities

Net Income / Starting Line 1510.20 1404.40 1303.30 1141.30 971.90 774.70

Depreciation, Depletion & Amortization 125.40 122.50 108.30 92.40 73.00 53.40

Other Funds 0.00 0.00 0.00 0.00 0.00 0.00

Funds from Operations 1201.60 1158.00 1074.90 846.70 845.80 649.10

Changes in Working Capital 622.40 204.30 -257.50 -163.60 -870.10 521.90

Net Operating Cash Flow 1824.00 1362.30 817.40 683.10 -24.30 1171.00

Investing Activities

Capital Expenditures -74.10 -41.50 -36.30 -51.10 -60.80 -38.70

Net Assets from Acquisitions -9.10 -82.20 -54.10 0.00 0.00 0.00

Sale of Fixed Assets & Businesses 2.30 4.90 2.00 100.60 5.20 18.00

Purchase/Sale of Investments -141.10 -135.40 -183.90 -390.40 -365.30 -275.90

Other Funds 0.00 0.00 -8.70 72.40 64.60 -97.20

Net Investing Cash Flow -222.00 -254.20 -281.00 -268.50 -356.30 -393.80

Financing Activities

Cash Dividends Paid -670.50 -624.60 -578.50 -467.70 -355.40 -246.30

Change in Capital Stock -71.40 -56.10 -121.30 22.60 29.60 -80.50

Issuance/Reduction of Debt, Net 0.00 0.00 0.00 41.00 -0.40 -37.60

Other Funds 0.00 0.00 0.00 0.00 0.00 0.00

Net Financing Cash Flow -741.90 -680.70 -699.80 -404.10 -326.20 -364.40

Exchange Rate Effect 0.00 0.00 0.00 0.10 1.20 -0.80

Net Change in Cash 860.10 427.40 -163.40 10.60 -705.60 412.00

Free Cash Flow 1749.90 1320.80 781.10 632.00 -85.10 1132.30

9.1.4 Ratios


Valuation

Price/Earnings (x) 20.79 17.33 17.33 14.72 12.42 17.61

Price/Sales (x) 0.51 0.43 0.46 0.34 0.32 0.42

Price/Book Value (x) 7.78 6.65 7.27 5.69 5.77 8.44

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Price/Cash Flow (x) 13.02 12.91 20.56 16.57 -363.40 8.23

Enterprise Value/EBIT (x) 14.06 11.85 16.55 14.42 12.24 15.70

Enterprise Value/EBITDA (x) 12.99 10.89 10.89 14.91 11.11 14.37

Enterprise Value/Sales (x) 0.49 0.43 0.47 0.35 0.33 0.42

Total Debt/Enterprise Value (x) 0.00 0.01 0.03 0.03 0.04 0.01

EPS (recurring) 5.71 5.23 5.06 4.26 #N/A 2.99

EPS (basic) 6.16 5.56 5.36 4.39 4.07 3.13

EPS (diluted) 5.71 5.21 5.06 4.26 3.91 2.99

DPS 4.30 3.77 3.62 3.22 3.22 1.85

Dividend Yield (%) 3.36 3.92 3.90 4.98 5.05 3.36

Dividend Payout Ratio (%) 69.84 67.85 67.54 73.28 62.73 59.11

Profitability

Gross Margin (%) 8.52 8.96 7.92 8.04 8.08 8.19

SG&A to Sales (%) 5.02 5.32 5.05 5.16 5.38 5.54

Operating Margin (%) 3.46 3.60 2.84 2.46 2.70 2.65

Pre-tax Margin (%) 3.48 3.62 3.75 3.59 3.73 3.66

Net Margin (%) 2.43 2.45 2.63 2.33 2.55 2.41

Return on Assets (%) 11.64 12.03 13.02 12.04 12.52 12.17

Return on Equity (%) 39.76 40.74 44.38 43.48 52.48 52.25

Return on Total Capital (%) 38.92 35.79 36.56 36.45 44.93 47.21

Return on Invested Capital (%) 39.76 40.74 44.38 43.48 50.26 49.03

Basic DuPont ROE (%) (3 Step) 39.76 40.74 44.38 43.48 52.48 52.25

Efficiency

Revenue/Employee 11.16 10.17 12.91 12.11 10.41 9.07

Net Income/Employee 0.27 0.25 0.34 0.28 0.27 0.22

Receivables Turnover (x) 8.46 8.29 8.51 8.99 8.77 8.88

Days of Sales Outstanding 43.15 44.06 42.87 40.61 41.61 41.12

Inventory Turnover (x) 31.24 33.75 35.41 35.65 35.37 38.18

Days of Inventory on Hand 11.68 10.82 10.31 10.24 10.32 9.56

Payables Turnover (x) 8.17 9.09 9.75 9.86 8.50 7.47

Days of Payables Outstanding 44.67 40.16 37.45 37.01 42.93 48.88

Cash Conversion Cycle (Days) 10.16 14.71 15.73 13.83 9.00 1.80

Total Asset Turnover (x) 4.40 4.68 4.63 4.89 4.58 4.29

Working Capital Turnover (x) 51.16 66.67 89.18 108.90 288.79 586.59

Liquidity

Current Ratio 1.12 1.10 1.08 1.07 1.02 1.01

Quick Ratio 0.92 0.90 0.89 0.87 0.83 0.85

Cash Ratio 0.12 0.02 0.02 0.02 0.01 0.12

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Credit Analysis

Net Debt/EBITDA (x) -0.51 0.01 0.41 0.32 0.32 -0.52

Net Debt/(EBITDA-Capex) (x) -0.54 0.01 0.42 0.27 0.34 -0.55

Total Debt/EBITDA (x) 0.00 0.08 0.48 0.40 0.39 0.20

EBITDA/Interest Expense (x) 62.86 61.59 52.45 29.74 41.19 61.08

EBIT/Interest Expense (x) (Int. Coverage) 58.04 56.63 47.27 26.60 37.41 55.89

Fixed-charge Coverage Ratio (x) 58.04 56.63 47.27 26.60 37.41 55.89

CFO/Interest Expense (x) 70.15 55.15 39.11 23.16 -1.26 113.69

LT Debt/EBITDA (x) 0.00 0.00 0.00 0.00 0.00 0.18

LT Debt/Equity (%) 0.00 0.00 0.00 0.00 0.00 10.36

LT Debt/Total Capital (%) 0.00 0.00 0.00 0.00 0.00 9.30

LT Debt/Total Assets (%) 0.00 0.00 0.00 0.00 0.00 2.27

Total Debt/Total Equity (%) 0.00 4.62 24.28 18.09 20.84 11.38

Total Debt/Total Assets (%) 0.00 1.38 7.05 5.37 5.31 2.50

Net Debt/Total Capital (%) -29.66 0.71 16.40 12.33 14.02 -26.47

Total Debt/Total Capital (%) 0.00 4.41 19.54 15.32 17.24 10.22

Net Debt/FFO (x) -0.70 0.02 0.41 0.33 0.30 -0.50

LT Debt/FFO (x) 0.00 0.00 0.00 0.00 0.00 0.18

FCF/Total Debt (x) #N/A 11.50 1.47 1.80 -0.27 8.97

CFO/Total Debt (x) #N/A 11.86 1.54 1.95 -0.08 9.27


Spar Research Report

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