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Chief Executive Officer’s Report

Group overview

In last year’s annual report we indicated that the year to 31 March 2008 would be one of the most difficult that the group would experience for many years.

This year has been a tale of two halves. While trading conditions in the first half were challenging, the group nevertheless achieved acceptable performance in this period, with retail turnover increasing by 8,8% and headline earnings per share increasing by 12,2%. The tempo of business started to slow considerably towards the end of June and the second half of the year proved to be difficult, with turnover growth of 3,7% and a reduction in headline earnings per share of 4,0%. For the year as a whole turnover was up 6,1% over the previous year while headline earnings per share increased by 2,4%. Diluted headline earnings per share were up 4,5%.

Prior to the introduction of the National Credit Act (NCA) our group adopted a conservative approach to the opening of new pre-approved accounts, thus opening far fewer accounts than our major competitors and other credit providers. Whilst this negatively affected the level of our retail turnover, it seems that it was the correct strategy for current economic conditions, as it has resulted in our group entering these more challenging times with a healthy retail debtors’ book, in contrast to what appears to be happening in the credit industry.

The businesses in which we trade are cyclical in nature and after our previous six years of above-average compound growth in earnings it was inevitable that a slowdown would occur. It is still not known how long and how severe the current downturn is likely to be. However, the group is positioned as favourably as possible to weather any downturn and emerge stronger than ever to continue our above-average growth when the economy turns. All our divisions are in good shape, with strategies in place to contend with difficult times, with no areas requiring additional corrective action or restructuring. The retail debtors’ book is moreover performing well in the current climate, in contrast to what appears to be taking place in the wider economy. The emphasis next year will be on cost containment to levels appropriate to expected trading activity, whilst continuing with strategic initiatives to ensure above-average growth in the future.

Trading environment

Having approached this year with a good deal of caution, the group had an acceptable first six months. The second half turned out to be difficult, particularly from the end of June, after the introduction of the NCA. A combination of the consequences of the NCA, interest rates which have been increased nine times since June 2006, frequent petrol price hikes and above-average food inflation, has considerably dampened the economy and placed severe constraints on the budgets of most South African consumers.

In the last annual report, issued at the end of May 2007, we expressed the view that the interest rate cycle was at or very close to its peak and that interest rates might be expected to start declining towards the end of the 2008 financial year. Inflation has however been higher than anticipated, with the result that the Reserve Bank continued to increase interest rates. The prime overdraft rate is now 15,0% and the outlook for interest rates is still unclear. There is potential for further increases, particularly as the inflation numbers have not stabilised, and as matters now stand we do not see interest rates starting to decline before the middle of 2009.

The consumer environment is likely to deteriorate still further before it starts to improve and we are under no illusions about trading conditions, which we expect to be challenging in the next financial year.

Areas of particular concern to the group in the next year are the rate of exchange of the South African currency and expected inflation in the price of merchandise coming from China, both of which have the potential to cause greater inflation in our product supply line than we have seen for many years.

In addition, the electrical power outages currently being experienced throughout the country may continue. Whilst our head office and distribution centres are not affected, as they are covered by backup power generators, our stores in shopping centres are not able to trade as there is insufficient lighting in these centres. Discussions are presently under way with our major landlords in order to provide adequate lighting and some sort of airflow into shopping centres when the power is down, and it remains to be seen whether these discussions will be successful.

Financial performance

Whilst the group’s detailed financial performance for the year is described in the Financial Director’s report, I would like to draw attention to the following:

  • operating margin was 24,8%, close to our record of 26,1%;
  • net profit before tax in excess of R1,7 billion;
  • the final dividend being maintained at 170,0 cents per share;
  • good performance from our retail debtors’ book; and
  • the group’s return on equity of 29,6%.

Trading performance

All our divisions performed satisfactorily in the first half of the year, but since mid-June trading conditions have become difficult. Product inflation averaged approximately 4% for the year. Sales and sales growth in the various divisions were as follows:

    Retail  
  Number turnover %
  of stores Rm Change
@home 61 458,0 11,1
Exact! 182 707,2 3,6
Foschini division 400 3 070,5 5,5
Jewellery division 328 1 090,7 6,7
Markham 201 1 190,9 6,6*
Sports division 221 1 151,4 8,4
Total 1 393 7 668,7 6,1
* Growth excludes the discontinued RJL brand.

Total same store turnover for the year grew by 2,2%, with apparel growing 2,2%, cosmetics 6,6% and jewellery 3,5%. Homeware declined by 0,3% and cellphones by 0,7%.

Cash sales as a percentage of total sales increased from 33,3% to 36,4%.

The @home division continued to expand, increasing its number of stores to 61 during the year and growing its turnover by 11,1% to R458,0 million. Trading results were encouraging at the three @homelivingspace stores and the number of these stores will be expanded over the next two years to ten. In an extremely competitive sector this division’s same store results showed a decline of 0,3%.

Exact!, which has a lower LSM customer base than most of the group’s trading divisions, traded marginally worse than expectation, yielding growth in turnover of 3,6% and same store growth of 1,7%. Customers with limited disposable income bought less than had been expected in the summer season and it was necessary to take more markdowns than planned.

Of the division’s total turnover, 44% is generated in shopping malls as opposed to high streets and rural areas and this percentage will continue to increase with planned store expansion.

The Foschini division achieved turnover growth of 5,5% and unsatisfactory same store growth of 1,2%. Particular emphasis is being placed on the Foschini stores business and the results of this focus should become evident in the forthcoming summer season. The Donna-claire and Fashíonexpress brands continued to trade satisfactorily and are now well established in the marketplace. Both of these brands are under-represented and will be actively expanded in the next year.

The jewellery division, comprising American Swiss Jewellers, Sterns and Matrix, performed better than expected with turnover growth of 6,7% and same store growth of 3,3%. The division remains the dominant player in the mass middle market jewellery sector. It has been severely impacted by the increase in the gold price and by movements in the rand/dollar rate of exchange, the combined effect of which has been an increase of more than 30% in the input gold price during the year. This required proactive planning to ensure that the product mix was adjusted to soften the impact on price points.

The Markham division, which had a disappointing first half, traded more successfully in the second half and achieved turnover growth of 6,6% for the full year. Same store growth was 3,4%. The repositioning exercise undertaken in the past few years towards a younger and more fashionable customer is now beginning to bear fruit and its new “Markham Relay” casual range format has been well received in the marketplace.

The sports division, trading as Totalsports, Sportscene and DueSouth, traded satisfactorily and achieved turnover growth of 8,4% and same store growth of 3,7%. Ongoing focus remains on gaining maximum benefit from the World Cup 2010, where the division is the partner of choice for some of the major brands.

FG Financial Services, the retail debtors’ book, which amounts to R2,4 billion, grew by 8,0% during the year. Because of the group’s conservative approach to new account openings before the implementation of the NCA, the performance of the debtors’ book continues to be satisfactory. Net bad debt as a percentage of credit transactions increased marginally from 3,0% to 3,5% and net bad debt as a percentage of the closing debtors’ book increased from 7,4% to 8,3%. During the next financial year, in line with current market practice, we will provide customers with a 12-month account as an alternative to the current 6-month option. This should positively impact our interest revenue as well as retail turnover.

RCS Group

The RCS Group provides a range of broader financial services to customers of the group and also to customers of unrelated retailers. This group consists of two separate business units, namely Transactional Finance and Fixed Term Finance. At present the Transactional Finance business comprises the RCS general-purpose card and other private label card programmes. The Fixed Term Finance business comprises RCS Personal Loans and RCS Home Loans. The division experienced a challenging year having been affected by the introduction of the NCA, which resulted in a reduction in the number of new loans advanced and accordingly a reduction in the loan receivables book. Net bad debt and provisions increased significantly in line with current market trends. Profit before tax for the year reduced from R322,7 million to R269,6 million. Loan advances to customers following the year-end will remain tightly controlled, though an increase in advances and profitability in this division is anticipated. RCS is in the process of acquiring the consumer credit division of Massdiscounters, which is awaiting final Competition Commission approval. The group’s shareholding in the division has been 55% from 1 April 2007, with the balance being held by The Standard Bank of South Africa Limited.

Strategy

The strategic focus across our divisions is to improve our customers’ experience through targeted expansion of our store base and by constantly developing our merchandise offering to meet our customers’ needs.

A key element of the group’s strategy is to optimise the efficiency of its supply chain, ensuring that lead times in ordering, acquiring and distributing stock are reduced to the minimum. In consultation with an external consultant the group set up its supply chain project during the year to deal with supplier relationships, replenishment and merchandise pipelines. This will result in improved lead times and increased stock turns, ensuring our ability to be first to market with key products, whilst at the same time reducing overheads. The benefits of this initiative will take time to make their impact, but a good start has been made.

Strategies of the individual divisions are referred to in the divisional review section of this report.

Prospects

In the last number of years we have been cautious in the opening of new stores. Whilst this remains our approach, there are certain of our formats which are ready for further roll-out and accordingly we anticipate opening in excess of 100 new stores in the year ahead.

Retail turnover for the first ten weeks of the new financial year remains difficult. Budgeted costs for the new year have been curtailed to levels appropriate to the expected turnover. Notwithstanding the downturn in the economy, all the trading divisions are in good shape which places the group in good stead to weather the current consumer downturn, although we are mindful of the uncertain and challenging macroeconomic environment.

Thanks

Having been appointed as CEO on 1 January 2008, I was aware that I was taking over the position in difficult times. I have had tremendous support from my colleagues, for which I thank them. I look forward to working with them to steer the group to new heights and achieving much with them in future years.

Thanks are extended to the group’s 15 000 staff members for their contributions to its development and success. I extend my sincere appreciation to each and every one of them.

Thanks are also due to all the members of the board for their wisdom, guidance and direction.

To our shareholders, I extend thanks for their support of the group. I trust that their loyalty will continue to be rewarded.

Finally, I would like to express the group’s appreciation to our suppliers, advisers, corporate stakeholders and customers for their contributions to the group’s activities and its successes.

Doug Murray
CEO

11 June 2008