In keeping with the general earnings boost reported in the market, OK Zimbabwe announced a record growth in revenues of $582.5 million for the year ended 31 March 2018; its highest since dollarisation. OK`s revenues have been growing at an average annual rate of 25.5% for the past 9 years, as the leading retailer has been focused on expansion.
However this attractive trend in sales growth faces growing threats from the cut-throat competition for market share in Zimbabwe`s retail space, where margins are already wafer-thin. By its own admission, OK faces stiff competition from SPAR, seeking to establish itself under a new management structure, Pick n Pay as well as wholesalers doubling up as retailers such as N Richards, Metro Peach and Gain Cash and Carry.
Record Earnings
The 23% growth in revenue from $472.4 million to $582.8 million in 2017 was attained against a backdrop of positive inflation experienced since February 2017, after a protracted period of price deflation. This translates to revenue per employee of $134,327.31. The obvious implication of this, is that OK now realises more revenue on similar volumes, than it did during the price deflation era.
Gross Margins were marginally flat for the year at 17.6% compared to 17.8% achieved in 2017 as the company`s product mix shifted toward low profit margin goods in an attempt to defend market share. In spite of the decline in gross margins, EBITDA leapt 90% to $31.6 million, as overheads were restricted to 16.6%, on the back of the closure of two OK Stores (OK Cameroon and OK Wynn Street, both in Harare). Two new stores in Harare opened in the preceding financial year however, bringing its total store count to 62 (OK Retail – 48; Bon Marche – 8 and OK Mart 6).
Profit for the year witnessed a huge 175% spike from $6.05 million in 2017 to a record $16.6 million. Return on Equity stood at 21% against sector peers averaging 11.9%, while Return on Assets was 9.52% compared to regional peers at 5.4%. OK remains largely debt free, evidenced by low interest costs of $856, with expansion financed from internal sources. Capital expenditure for the year was $15.5 million as the group seeks to improve the ambiance of its shops as well as increase the trading space.
Challenges in the short term
The inflationary pressures witnessed the two last quarters of 2017, contributed to the spike in revenue as OK managed to effect upward price adjustments. The inflationary pressures that are likely to persist for the near future invariably bring with them increased demand for goods and services. The least of OK Zimbabwe`s worries going forward therefore will be consumer demand, which for the most part of 2018 has been sustained by the staggered bonus payments to civil service, meaningful agricultural and mining sector activity and will also further receive an uplift from the 2018 national election related expenditure.
However, competition for market share in an increasingly informalising Zimbabwean economy, which has the possibility of eroding big retailers` low-pricing strategy capabilities, is ever growing. The advantages that had accrued to OK through having systems and infrastructure in place to accept digital payments when cash shortages beset the market seem to be plateauing, as informal retailers can now take swipe and mobile money payments for some goods and services. Furthermore, grey imports flooding the informal market add to the competitive pressures in the retail space. Resultantly, convenience to the customer will be a major determinant of growing market share.
Foreign currency shortages
The foreign currency conundrum will be an albatross weighing in on the retailer`s back, affecting product supply. This has been a recurring theme in the market of late, although the hope is that the foreign currency crisis thaws post the July elections. On its part, OK has been sourcing some of its products locally, especially fruits and vegetables. However even with local sourcing of these, the challenge of obtaining adequate foreign currency to pay offshore suppliers remains.
OK is pinning its hopes on the Kawena diaspora remittance service, which enables payment of goods in the diaspora (mainly South Africa) for collection at Ok supermarkets locally. South Africa remains the major source of imported products for the retailer.
In a market with narrow moats, OK will seek to boost income through commissions realised from mobile money transfers, banking and insurance services as well as the sale of prepaid electricity coupons. The rollout of in-house bakeries where OK gets decent margins will likely be pursued further. The group currently has 45 full in-store bakeries nationwide. However, markdowns and promotional discounts will chip into income growth, as market share defence becomes the name of the game going forward.
Valuation
On a valuation perspective, Ok trades at a trailing PE ratio of 15.4 that is lower than the sector average of 18.8. OK is currently trading at a price-to-sales ratio of 0.45 against a sector median of 1.0. South African retailer Shoprite has been averaging a price-to-share ratio of 0.8. Reflective of its cash generative capabilities, OK continues to pursue a rather aggressive dividend pay-out policy, achieving a dividend yield of 3.23% compared to peers averaging 2.08%. Compared to a price-to-cash flow sector average of 11.8, OK trades on a price-to-cash flow of 8.5.
Ok trades on a price-to-book ratio of 2.73 higher than average of 1.8. In the main, OK appears undervalued in relation to sector peers, and seems a good play for value seeking investors in the long term. Furthermore, as it is a consumer facing business, it exhibits defensive characteristics that make it attractive in the medium to long term. However, growth is highly dependent on how it navigates medium term challenges affecting it, such as foreign currency access bottlenecks, increasing informalisation of the economy as well as the existential long-term threat from competitors.
Using the blended DCF and multiples valuation models, I arrive at a 12-month target price of 14.7 cents, implying a 33% downside from OK Zimbabwe`s current price of 22 cents. For profit seeking investors, now might be a good time to sell.
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