In the wake of falling confidence in the local banking industry, credit retailers have also come under the hammer. JD Group's Jan Bezuidenhout gives his views on the difficulties facing these companies, and where the future lies for the retail industry. Bezuidenhout believes that many of the problems in the credit retail industry stem from the companies involved being their 'own worst enemies'. Businesses have been irresponsible about granting weak credit in order to grow revenue and earnings, but this kind of growth strategy plays itself out every few years, he says.
Credit risk in emerging markets is also particularly high because of the 'aspirational' mass market, which wants to buy more expensive products before having the capacity to pay for them. The inability of this market to buy goods with cash will, however, ensure that credit sales remain a part of our economy. 'The cash sales component of credit businesses will change and grow slowly as South Africa moves towards becoming a first world country', says Bezuidenhout, 'but that could take many years'.
The biggest mistake of the industry, says Bezuidenhout, has been the focus on sales, with companies believing they are retailers when in fact they are also part bankers. He puts some of the blame on the banks as well, saying that 'they have short memories, and continually give businesses the tools to overtrade with'. The players in this market need funding in order to grow their debtor's book, but as soon as growth slows, debts begin to catch up with the company, and it is easy to find yourself in trouble.
Banks have traditionally overextended themselves to a single company or industry, effectively putting all of their eggs in one basket. Currently, FNB, a division of First Rand, is the most highly exposed bank to the retail sector. FNB has recently agreed to underwrite a new rights offer for Profurn shares, from which the company plans to raise R600m to repay its short-term borrowings.
This kind of continual funding is common in the retail industry, as banks can't afford to write-off the capital they have 'given' these companies. Instead, they often have keep even the 'not-so-healthy' companies alive by continually topping up the funding.
Technology and the use of poor systems has also played its part in the slow reaction to the 'bad debt catch-up' phase, but Bezuidenhout adds that even the best systems can be used to analyse the wrong things. 'It is an approach issue', he says, and companies need to realise that historical statistics are not always an accurate predictor of the future. Given the current situation of overtrading in the retail market, as well as the concerns in the banking sector, it is important to have systems which look forward as well.
At the end of the day, in this industry it all comes back to the time horizon of the retailer, he says. You can make a lot of money in a short space of time, but if you plan to be around for many years to come, then you cannot afford to grow too fast.
Not all credit retailers are affected in exactly the same way, however. Clothing retailers haven't been as badly affected as the furniture retailers, for example, because they work on revolving credit, the credit terms are shorter, and the items are smaller in price, says Bezuidenhout. In addition, credit sales are a smaller component of total sales, so the effect of a debt catch-up is smaller on the business. 'Clothing retailers did take the first hit when they originally introduced in-store 'credit' cards, but the furniture blows have just been more spectacular', he says.
In a recent trading statement for the first four months of its financial year, JD Group said that its 'earnings have been aversely affected' by a decision made by management to 'protect the group's asset base' through a new focus on credit controls and improved risk management. Bezuidenhout says this is because, in the current economic climate, the company feels it would rather take the pressure now in order to position itself for the future. It is possible to grow sales by 20% in this market, he says, but in two years time who will pick up the debt?
The credit granting industry was originally started when Eric Ellerine began giving small amounts of credit to his customers. Credit retail has since developed into a 'fairly unique' industry in the world, being made up of both retail and banking components. Although the retail operations of these companies give analysts a view that they are 'normal' retailers, this is not correct, says Bezuidenhout. On the other hand, they are not true banks either, as they only offer the lending side of the business, without having the ability to take deposits.
The problem of excessive growth by retailers has been exacerbated by an oversupply of space on the property market. This is a result of investment companies being forced to invest domestically, and putting that money into property. They then offer retailers low rentals in order to get them to open new shops, resulting in the rapid growth of retail stores, and an overtrading situation in the industry.
The consequence is a highly competitive local market, which in recent times has brought product margins down substantially. Bezuidenhout says margins have been squeezed to such an extent that JD Group while the income from its furniture sales is used to cover all of its business costs, the group needs income from its financial services operations to make a profit.
Bezuidenhout says that if you want to do prudent credit business in the mass market in South Africa, a company needs two things:
1 A low cost structure, and
2 Management must be realistic, and must have a clear understanding of the environment in which the credit is being granted.
With a view to taking the business into the future, in 1998 JD Group undertook an in depth research project, focusing on the impact of HIV-AIDS on the local economy and its business. As a result, the group has taken a more proactive approach to changing market demographics, and in forecasting what will happen to its customer base. Bezuidenhout says they know that spending patterns will change as a result of HIV-AIDS, but exactly how and when they will change is uncertain. 'We need to do something to compensate for this', he says. JD Group believes the following will be key to its survival in the future:
1 Securing a long-term banking alliance to enable them to lend money to people in all spheres of the local economy, not only to those people buying
furniture in JD Group stores;
2 To diversify the group geographically to obtain revenue streams from areas that are in different stages of the AIDS cycle to Africa;
3 To ensure that its local credit controls and systems are in place and will keep the group's credit risk to a minimum
Recent trends have seen traditional banks decreasing their expensive branch networks by increasing the number of ATM's, while trying to continue servicing the mass market. As a result of this trend, JD Group has formed an alliance with Nedcor, through which it is rolling out People's Bank 'points-of-presence' within its stores.
JD Group has also recently started operations in the UK (BoConcept) and Poland (Abra), which it hopes will grow to contribute significantly to its earnings in the future.
Bezuidenhout says the aim is that by 2005 these additional revenues streams will start to compensate for the possible loss of revenue in Southern Africa that will be caused by changing spending patterns as a result of AIDS. In this way, the focus of the group has moved further forward than it would normally have done, with research being done into what are considered vulnerable areas of both the group and the industry.
At the same time, the group is trying to move to more predictive credit granting systems, which will minimize risk and ensure the book the company is running in three year's time will be healthy enough to cope with the domestic economic situation.
The riskier part of credit granting is clearly in the lower end of the market, resulting in JD Group repositioning itself away from that market in
order to decrease its risk profile. At the same time, this will allow the group to move into a market segment in which the percentage of AIDS victims
is expected to be lower.
Although AIDS is extremely important, Bezuidenhout says the company cannot ignore the economic factors playing out in the market either. The consumer has not been helped by the downward trend in interest rates and tax due to the rising fuel price, which has had a far more direct impact on his pocket. It was with similar factors in mind that, two years ago, JD Group started to look at trading patterns in various micro economies and began to address these with localized marketing strategies.
At the moment, JD Group is looking towards 2015, after which they believe economic principles will return to a more normal pattern. 'All businesses in this environment need to think more forward than they have in the past and be more flexible with their strategies', says Bezuidenhout.
As far as the retail industry as a whole is concerned, Bezuidenhout believes that consolidation is inevitable. Most at risk in the retail industry is the health of suppliers, who will be threatened by customer blowouts, he says. Although JD Group tries to offer some support to its suppliers, Bezuidenhout feels that while vertical integration might provide a short-term solution, it is not sustainable as it would drive down efficiencies.
Nonetheless, 'the current state of the industry is exciting as it creates opportunities', he says, adding that 'JD Group will look to play a role in the rationalization process if it makes business sense'. He cautions, however, that the need for rationalisation is not a 'retail only' dynamic, and should be watched by all the players in the economy.
Publisher: Moneyweb
Source: Shirley Kemp
In the wake of falling confidence in the local banking industry, credit retailers have also come under the hammer.
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