Delinquency scars credit retailers
Retailers have come under pressure because of the uncertain economic times but the problem is being compounded for credit retailers by a market in which cash is king.
The retail sector has been supported by consumer spending, accounting for almost 60% of economic growth, which has been spurred on by the lowest interest rates since the 1970s and increased credit extension.
But things are taking a turn for the worse as the growth of credit extension slows down and consumer confidence, as monitored by the FNB/BER (Bureau of Economic Research) consumer confidence index, declines to a nine-year low.
A recently released research study on alternative dispute resolution, commission by the National Credit Regulator, showed the most common type of credit used by respondents was clothing accounts, followed by personal loans, furniture, cellphone contracts and credit cards.
Clothing retailers have for a long time, and increasingly, played in the field of financial services but financial results show business models dependent on credit are revealing their soft underbellies.
In the clothing arena debtor cost levels have put pressure on the margins of credit retailers like Truworths and Foschini, and both have warned investors the credit environment is expected to deteriorate further in the months ahead.
"You can't fight it"
“It is the state of the economy; you can’t fight it,” said David Shapiro of Sasfin, adding that African Bank’s lower-than-expected results in May heightened concerns about the financial services sector. Retailers had since seen a sell-off of between 20% and 30%.
Truworths’s interim report for the 26 weeks ended December 30 2012 reported that retail sales increased 14.8% and operating profit was up 13% to R1.9-billion.
With credit sales contributing 72% to total sales for the period, gross trade receivables grew by 15.8%, to R4.5-billion.
But the doubtful debt allowance and net bad debt increase contributed to trade receivable costs increasing 33% to R379-million, almost R100-million more than the year before.
In the Foschini Group’s 2013 annual report, the company stated the ratio of credit sales to turnover was 60% and reported 1.8-million credit customers and 1.2-million cash customers.
Retail turnover increased to R6.1-billion and the debtor’s book amounted to R5.2-billion, with the active account base growing by 6% to 2.6-million accounts.
Cash-based businesses show resilience
Net bad debt as a percentage of closing debtors’ book increased to 10.5% from 9.4% in the previous year, but remained within management expectations.
Finance costs increased by 15.1% to R327.9-million from R284.9-million, the group said.
But, cash-based businesses like Woolworths and the Mr Price Group have shown resilience.
In its latest interim results Woolworths’s reported turnover increased 18% and profit before tax was up 20.8%.
Although the company’s overall debtors’ book reflected year-on-year growth of 12% at the end of December 2012, the annualised impairment rate for the six months to December 2012 was 1.5% (compared to 1.6% in the same period in 2011).
In clothing, 27% of sales are made with store credit and 14% in foods. Trade and other receivables were reported as R944-million at the end of the period.
Catering for the top end of the market
Woolworths caters for the top end of the market, which has shown more flexibility.
Its book is also of better quality because its clients can repay their debts.
The Mr Price Group, whose total sales comprise 80% of cash sales, claims to lead the industry in terms of the health of its debtors’ book.
Trade and other receivables increased by 27.9% to R1.5-billion, as reported in its annual report for the period ended March 2013.
Net bad debt as a percentage of the debtors’ book increased from 3.9% to 6.5% as new accounts did not perform in line with expectations and resulted in higher write-offs. Its provision for impairment has been set at 9% of trade receivables.
Edcon’s cash and credit sales are split almost 50/50 and the sale of its debtors’ book to Absa has seen Edcon strengthen its balance sheet and improve its performance.
Absa took on substantial credit impairments from the card division, which has served to fuel concerns as it struggles to grow its fee income in retail.
Most analysts agreed there was a preference for cash retailers at the moment but Chris Gilmour, an Absa investment analyst, said there would be a preference for credit retailers in a normal environment in which the economy grew at 3% to 5% and where there was a concomitant increase in credit.
In its monetary policy committee statement last month the South African Reserve Bank forecast that growth for 2013 would be 2%, 3.3% in 2014 and 3.6% in 2015.
“It is quite an abnormal environment,” Gilmour said, noting that a boom in unsecured credit lending saw credit retailers doing very well until recently.
“Traditionally, when you go into an environment like this is when you get a contraction in an economy. I expect, for all retailers, we will see the credit-to-cash ratio decline. It is a natural thing; it happens every [economic] cycle.”
“It is a cycle,” said Shapiro. “But you have to get through that cycle.”
Ian Moir, chief executive of Woolworths, said that bad debts tended to increase in difficult economic times and that could lead to some retailers offering smaller annual credit limit increases and fewer new account acceptances.
“This naturally has a direct impact on sales. However, as a predominantly cash retailer, Woolworths is not negatively impacted as directly as credit retailers in such times.”
Mark Blair, chief financial officer of the Mr Price Group, agreed: “We are less impacted during tough economic times and therefore are not as exposed to increased bad debt as the credit retailers.
“Retailers and credit retailers are facing a double whammy … there is less credit available and people are out of work, so their ability to repay their debts becomes less,” said Gilmour.
On July 30, the Statistics South Africa quarterly labour force survey showed that unemployment rose to 25.6% — the highest since 2008.
Blair said the Mr Price Group wished to remain a cash-based retailer and had set a ceiling so credit sales could not exceed 25% of total sales, although this was not a target.
“Almost a year ago the company started tightening up on its credit offer by reducing credit limits and ensuring a certain percentage of new accounts were opened with six-month payment terms, as opposed to 12 months.”
In its latest annual report the group said maintaining high levels of cash meant it was less affected by the cyclical nature of retail, less exposed to bad debt, not dependent on releasing more credit into the market to drive turnover and able to fund future growth without gearing.
But credit retailers say they have seen it all before and are not changing their business model.
“We believe credit is core to our business,” said Emanuel Cristaudo, customer relations management director at Truworths.
“The group uses credit as an enabler of retail sales. The group launched credit in 1955 and has therefore been through many economic cycles.”
Cristaudo said merchandise was the key driver of sales. “Good merchandise leads to good sales, irrespective of the credit environment.”
“We continually monitor our strategies and adjust these as required, in good times and in bad, so this cycle is therefore no different. We follow what is called a ‘champion-challenger’ approach and therefore always have a number of strategies running at the same time so we can make an informed decision as to how to adjust and what the impact of this would be on our portfolio.”
Consumers under pressure
Foschini did not respond to questions, but its 2013 annual report acknowledged that consumers would remain under pressure and said “credit customers will therefore receive significant attention with the aim of ensuring that appropriate risk management methodologies are applied both to the granting of credit and collection thereof”.
The group said that huge growth in unsecured lending by “other credit providers” had increased delinquencies.
“The big question is where to from here,” Shapiro said. “Our three economic drivers — mining, manufacturing and credit — are under pressure.”
Shapiro said he expected Woolworths and the Mr Price Group would hold up because of cash levels and good management.
Store credit 101
The ability of a customer to pay back debts to a credit retailer is governed by the terms and conditions of the National Credit Regulator and therefore takes care of itself, according to Absa investment analyst Chris Gilmour.
Mark Blair, chief financial officer of the Mr Price Group, said interest rate guidelines are governed by the National Credit Act, which allows up to the repo rate times 2.2 plus 10%. At Mr Price stores, the interest generally applies from the day of purchase.
At Woolworths, the in-store card operates on the same basis as a credit card, with a minimum payment of 7.5% of the balance but up to 50 days interest-free credit if the full balance is paid.
Interest is then charged at 21% in line with the National Credit Act, says Woolworths chief executive, Ian Moir.
Truworths has a six-month interest-free offer and nine- and 12-month plans that offer up to 55 days interest free if the full balance is settled.
The Foschini group and Edcon also have six-month interest-free plans as well as longer repayment periods for qualifying customers, which are subject to interest.
“Truworths, Identity and Young Designers Emporium assess consumer risk using internal and external scorecards and does everything possible to comply with the NCA and has a rejection rate of 65%,” said Emanuel Cristaudo, customer relations managing director of Truworths. A higher rejection rate is true for many other retailers too.
“It shows the level of desperation amongst consumers. If they qualify, they are more than happy to pay it,” said Gilmour.
Banking on debtors
Absa acquired the Edcon debtors’ book in November 2012, consisting of 3.7-million active store cards with a gross receivable value of about R9.4-billion.
Absa’s headline earnings (as reported in its latest financial results) increased by 10% to R896-million, primarily because of the acquisition.
However, impairment losses on loans and advances for the same period stand at R3.5-billion and include a R440-million charge related to the Edcon portfolio.
“The Absa/Edcon relationship means that we have freed up capital for our various growth and capital expenditure initatives, allowing Edcon to focus more on improving our offering and serving customers better,” said Mark Bower, Edcon’s chief financial officer and deputy chief executive.
“Absa has the credit risk-management expertise and capacity, enabling it to provide a more enhanced offering to Edcon’s customers,” he said.
Arrie Rautenbach, Absa’s head of retail banking, said the bank was well suited to the job as it had deep expertise in credit risk management locally, enhanced by its global credit-risk capability from Barclaycard [Barclay’s credit card division] “whereby we are able to optimise credit risk, collections and fraud strategies to provide an enhanced offering to Edcon customers”, he said.
Rautenbach said the book was generally in line with expectations, considering the current economic environment. While the agreement allows for Edcon to potentially take the book back in future, the company is currently satisfied with the relationship with Absa.