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The Foschini Group has an ambitious strategy and, in a tough environment, success is not particularly evident as yet. But the company’s shares seem to be undervalued, writes Mohamed Mitha.
Over the past decade, The Foschini Group (Foschini) has evolved remarkably, from a primarily credit-focused South African retailer, into a diversified player with significant presence in the UK and Australia.
In addition to expanding geographical reach, it has also shifted to focus more on cash-based sales and developed an ambitious platform for growth.
Foschini’s key strategic characteristics and unique merchandising approach underpinned its ability to effectively adapt to the changing retail landscape.
Customer focus
To thrive in the fiercely competitive retail environment, retailers must continuously adapt to capture and retain their customers’ attention and cater to new trends.
Foschini has effectively embraced new trends and generally ensured that its offerings remain relevant and appealing. It is presently the only listed apparel retailer in South Africa to be selling more units on a like-for-like basis.
To date, it has established the broadest exposure in the local market, boasting a diverse portfolio of 26 brands covering most consumer segments.
Two of Foschini’s notable successes, Sportscene and Totalsports, have tapped into the growing demand for athleisurewear. Sportscene is a leading authority in sneaker culture and streetwear, whose reputation and brand strength have enabled it to secure exclusive supply deals with renowned brands such as Nike.
Furthermore, flagship Sportscene stores now have tattoo and body-piercing parlours, bubble tea outlets and even DJ booths – a dynamic approach to in-store experiences.
Similarly, the group has positioned Markham to succeed in the rapidly expanding menswear market and leading Markham stores have also incorporated experiential offerings such as in-house tailoring and barber services.
Agile management
Foschini operates according to a decentralised model, whereby each division is empowered with its own management team that is responsible for performance. While this type of structure incurs additional costs, the resulting levels of accountability have been instrumental in achieving strong sales growth. Merchandise selection and store management are key areas of divisional focus.
Additionally, Foschini has been quick to proactively adjust price points for key product lines given the current strained consumer climate, further demonstrating adaptability.
Integrated manufacturing
In South Africa, Foschini has focused on the vertical integration of their supply chain more so than competitors. Approximately 16% of apparel sold is produced by their seven factories, with plans to expand production capacity.
The aim is to shorten lead times between design and delivery through the ownership and management of production facilities strategically located near end market points. This allows Foschini to test product demand and adjust production volumes accordingly, which enables better matching of products in stores with consumer preferences.
The result is materially more full-price sales, limited excess stock and consequently reduced markdowns. This is very positive for profitability.
In theory, this approach presents clear advantages compared to the traditional sourcing model of procurement from Asian factories, where huge volumes are ordered upfront, often up to six months in advance.
In assessing this with Foschini’s results to date, it is inconclusive as to the degree of competitive advantage that vertical integration provides over alternative local sourcing strategies. Other South African retailers (Mr Price, Woolworths and Truworths in particular) successfully outsource some production to local independent operators.
Mr Price, for example, can supply most of its lines to stores within a three- to six-week period, comparing favourably to Foschini’s six-week lead time using their own factories.
Managing factories adds management complexity, capital requirements and additional costs and there has not been a noticeable improvement in Foschini’s stock turnover rate or overall gross margin.
Too early for omni-channel?
Foschini has invested heavily in creating a comprehensive omni-channel retail platform that is building online distribution capabilities to augment its store base, in order to house their South African brands. The group employed the founders of Superbalist, a prominent online clothing retailer, to spearhead the project. This has culminated in the recent launch of their Bash app, which boasts the country’s largest product catalogue.
Through early investment into a sophisticated inventory management system, Foschini is able to utilise each of its more than 3 000 stores as distribution centres for online sales. Such an extensive store network means that many products are within 5km of the end market. This presents a notable advantage, particularly as customers become more demanding of same-day (or even 60-minute) deliveries.
Acquisitions such as Quench, a technology firm specialising in end-to-end delivery fulfilment, have also bolstered Foschini’s capabilities in this area.
As of March 2022, Foschini had already spent R1 billion on digitalisation since 2018, with plans for an additional R500 million in the next three to five years. The launch of Bash is a proactive step against competitors like Shein and Amazon (who are set to launch in South Africa this year).
Considering that online retail is still nascent in South Africa (accounting for less than 5% of total sales compared to 26% in developed markets like the UK), Foschini’s investment is well ahead of the market need.
Several structural challenges may hinder widespread online adoption by South African consumers, including:
- low credit card penetration (only 10% of those over the age of 15 have credit cards);
- a lack of formal street addresses for many people;
- poor delivery infrastructure; and
- a prevailing distrust of online shopping.
The success of a viable online retail platform hinges on achieving very large scale numbers and the above factors may impede the delivery of a satisfactory return on investment.
Online retail is, however, growing rapidly from a small base and the entry of Amazon to South Africa may accelerate this trend faster than we expect.
Mixed acquisition success to date
Foschini has grown through organic and acquisitive means. Some of its most successful store brands (Markham, Sportscene and Totalsports) were acquired many years ago, while newer stores (Archive and @Home) have been developed in-house.
Foschini’s dealmaking frequency has ramped up significantly since 2015, including offshore acquisitions in the UK and Australia. This presents a host of risks such as potentially overpaying (sellers have more information than buyers) and over-estimating management’s ability to add value to the businesses Foschini acquires.
Foschini’s acquisition track record is mixed. Its venture into the UK, initiated through the purchase of upmarket womenswear retailer Phase Eight, has proven disappointing. Fierce competition from online retailers, an ailing economy, the closure of partnered department stores and elevated operating expenses are some of the factors that have contributed to underperformance.
We estimate the return Foschini has achieved has been well below the cost of capital.
In stark contrast, Foschini’s 2018 acquisition of Retail Apparel Group (RAG) in Australia has delivered phenomenal growth. Despite the Australian clothing market being fiercely competitive, RAG has successfully established itself as a predominantly menswear business.
We estimate that this acquisition has provided Foschini with an impressive return of 20% per annum to date on its investment.
On the domestic front, Foschini opportunistically acquired Jet in 2020 from the ailing Edcon group, out of business rescue. They paid a low price of R333 million, which was a very low (0.1x) multiple of Jet sales revenue.
Jet had long been the outperformer within Edcon but lacked the capital for growth. It boasts a loyal customer base and a reputation for quality and affordability in the value-end of the market – a segment where Foschini was previously under-represented.
Upon acquisition, Foschini could cherry-pick 382 commercially viable stores. With improved buying practices, enhanced stock planning systems, a more efficient distribution centre and new store formats like Jet Home, we see opportunities in abundance for Jet within Foschini.
Undervalued?
Foschini has been very active in building vertical integration into manufacturing, an impressive omni-channel platform, a broad offering across most target markets in South Africa and operations in the UK and Australia.
Success with this strategy is not particularly evident as yet and execution in the tough consumer environment will be challenging.
We, however, consider the company’s shares to be undervalued relative to even our modest base case expectations.
Mohamed Mitha is an investment analyst with Camissa Asset Management.
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