As the Lewis Group’s share price takes strain from concerns about prospects for future dividend payments, whispers are spreading about a possible bid for control of the furniture retailer by people brave enough to believe they can restore it to its former glory.
It’s early days though, and analysts are sceptical.
It’s difficult to imagine who would buy a furniture retailer in the current climate. It’s not just that the outlook for economic growth is grim but with over 60% of sales done on credit, government’s increasingly aggressive stance on unsecured lending is eating into this group’s margins.
Retail analyst Syd Vianello doesn’t dismiss a possible bid out of hand but is adamant about one thing: "It won’t be done at the current sort of share price."
Vianello, who has tracked the company for years, says at the right price Lewis "probably is a play". But no-one is going to get it at R36/share. The current market capitalisation is just under R3.6bn, down from R7.5bn in 2012.
Even a deal at a higher price wouldn’t put too much of a strain on would-be bidders.
But the big question is: who would have the appetite for this sort of business in the current economic and political climate?
Given that the competition authorities would promptly rebuff existing players such as Steinhoff, a more likely option is a consortium of business people who believe the Lewis business model can be resuscitated.
Despite the tough conditions and outlook, Vianello says the group has a lot going for it.
It has a long and profitable tradition in the business and has more than 760 stores spread across the country. With regard to competition, Ellerines is essentially out of the picture and JD Group (Steinhoff-owned) is about half the size it used to be, so there’s huge market potential.
Among its many positive attributes is that it is almost debt-free, despite having just acquired some of the Ellerines and Beares stores and paying out generous dividends.
Vianello acknowledges one possible area of concern: "legacy issues" relating to the debtors’ book. That’s a polite way of saying the value of the book, a major component of the group’s valuation, could be compromised by poor-quality loans that might never be recoverable, or recoverable only at steep cost.
The "noughties" were a good time for Lewis. The economy was reasonably strong, sales were on a fairly steady upward trajectory and the National Credit Act (NCA) hadn’t yet intruded into its business model. Return on equity was comfortably above 20%, as was its operating margin, which peaked at an impressive 26% in 2007. At around that time the average age of the debtors’ book was just over 14 months.
Signs of stress from the global financial crash, which destroyed a million SA jobs in 2009, began to show up in results from 2010. Return on assets and return on equity began to flatten. Operating margins held up well for a few years but dropped below 20% in 2015. In the just-released interims it slumped to 10%.
A longer-term perspective confirms that the good times are over, at least for now. Since 2011 headline earnings have shrunk on a compound annual growth basis of 4%/year as credit losses and operating expenses increased at significantly faster rates than total income.
Dave Woollam, a director of Summit Financial Partners, which has launched a number of legal actions against Lewis on behalf of clients, says the long-term picture is of a tyre with a slow-leaking puncture.
"Every single operational measure is getting weaker," he says. Not only are sales growing at a weaker pace, he adds, but the 20%-plus annualised hike in charge for bad and doubtful loans means that even this low rate of growth is based on poor-quality business.
One of Woollam’s major concerns is the quality of the debtors’ book.
He says the recent much higher rate of provisions still doesn’t adequately reflect the true picture of the quality of the book and estimates that provisions should be around R800m higher than they are.
The introduction of the NCA in 2007, while an initial fillip to earnings, has been a major source of Lewis’s challenges. In the past several years, in a bid to address affordability requirements, it has pushed out the average term of its loans from around 14 months to 30 months.
Another of Woollam’s concerns is that the sluggish earnings growth is increasingly dependent on what’s termed nonmerchandise sales, which includes interest, insurance and fees for delivery, club membership, initiation and extended warranties. Much of this fee income has been the source of legal challenges and inevitably, given signs that the National Credit Regulator is waking up from a long sleep, is set to shrink.
All-in-all, while not for the faint-hearted, Lewis may look enticing to those who enjoy a challenge.