Measured progress in a challenging market

Review of operations

Key financial indicators

	26 weeks to   31 August   2014	26 weeks to   1 September   2014	%   change
Total till sales	R37.4 billion	R35.0 billion	7.1
Turnover	R32.1 billion	R30.1 billion	6.8
Gross profit margin	17.7%	17.9%
Trading profit	R386.6 million	R317.5 million	21.8
Trading profit margin	1.2%	1.1%
Profit before tax	R366.8 million	R271.8 million	35.0
Profit before tax margin	1.1%	0.9%
Basic earnings per share	54.39 cents	40.05 cents	35.8
Headline earnings per share	53.98 cents	40.81 cents	32.3
Interim dividend per share	19.60 cents	14.80 cents	32.4

Results summary

Pick n Pay delivered a substantially improved profit performance for the half-year ending 31 August 2014, demonstrating sustained progress against our plan to improve the business.

A determined focus on cost control and operating efficiency is strengthening our business and is continuing to drive our profit growth in a challenging trading environment. Trading profit increased by 21.8% on last year. Improved working capital management resulted in stronger cash balances and a considerable saving on net interest paid, driving profit before tax up 35.0% on last year. The profit before tax margin is 1.1%, up from 0.9% last year.

Headline earnings per share are 32.3% up on the same period last year. The Group declared an interim dividend of 19.60 cents, up 32.4% on last year.

Turnover growth of 6.8% reflects the growing financial pressure faced by customers in a very competitive market. Our core customers are becoming increasingly price sensitive in the face of rising utility, transport and commodity prices and higher borrowing costs. The situation is even more challenging in the emerging markets which Boxer serves, where unemployment remains a major concern and there is considerable reliance on social grants.

We supported our customers over the period through substantive investment in price, containing food price increases at 6.7%, against CPI food inflation of 8.4%. This price investment is reflected in a decrease in our gross margin from 17.9% to 17.7%. We are encouraged by the progress we are making in improving our business. Our supply chain and store operations are simpler and more effective. As a result, operating costs and like-for-like stock holdings are lower. Centralisation of our administrative functions means better support for our stores, and benefits our customers through improved availability, better service and more innovation.

Operational review

Growth in a competitive market

We opened 46 new stores over the period, bringing Pick n Pay and Boxer to a number of communities in which we had not traded before. We are on track to create more than 3 000 new jobs this financial year, a significant contribution to the national priority of building employment, training and skills. To improve the quality of our estate, we closed five under-performing stores and invested R110 million on improving existing stores.

The Group now has 1 117 stores, comprising 665 company-owned stores and 452 franchise stores, across multiple retail formats and six southern African countries. In addition 52 stores, four of which trade under the Pick n Pay brand, are operated in Zimbabwe by our associate, TM Supermarkets.

Our space growth over the period was behind that of our sector. We are determined that new space should deliver acceptable and sustainable returns, and have reviewed our plans against this requirement. By using the flexibility available across our Pick n Pay and Boxer formats, and the opportunity to satisfy the growing demand for convenience, we are confident that we can grow sustainably. We will therefore accelerate our opening programme, with more than 80 new stores planned to open in the second half of the year.

Improved financial control and operational efficiencies

We are pleased with the enhanced efficiencies and cost reductions that are being achieved through our investment in centralised category-based procurement, distribution, administration and related systems. In the first half of this year we completed the rollout of our fully integrated forecast and replenishment system, and substantively improved our two main distribution centres. We implemented a specialised high-density picking area (pick tunnel) in our Philippi Distribution Centre in the Western Cape, significantly increasing the efficiency of handling slow-moving and single-item units. This has increased the capacity of the facility from 8 000 line items to 14 500, enabling us to centralise an additional 50 suppliers in the Western Cape. We have implemented the EWM SAP warehousing system in our Longmeadow Distribution Centre in Gauteng. This system had been introduced successfully at Philippi, and we expect it to contribute to a 40% increase in picking efficiency at Longmeadow by the end of the financial year. Notwithstanding the costs associated with these two initiatives, we reduced our distribution costs in both facilities compared to the same period last year.

Our improved systems have enabled more effective inventory management, with stock levels reduced by two days in the distribution centres and the total value of stock on hand being down 6% on a like-for-like basis. Stock availability remains a challenge, and while we have seen a 2% improvement over the period, we continue to work closely with suppliers to achieve further improvement.

We have reduced trading expenses as a percentage of sales by 0.2 percentage points, from 17.7% to 17.5%, largely through improved labour scheduling and productivity at store level, and a more streamlined support office function following the head office restructure in the previous financial year.

Investing in our customer offer

As well as driving profit growth, cost and operational improvements strengthen our ability to enhance the shopping trip for customers. This is crucial to our strategic aim of sales-led growth. Lower costs enable us to invest more in the customer offer in a period of high inflation. Internal food inflation for the half-year was held to 6.7%, compared to food CPI of 8.4%.

We recognise that our customers are increasingly price sensitive in this current market and are shopping around for the best deals. We responded through the launch of Pick n Pay Brand Match at the end of August. Customer feedback and the results to date have been very encouraging. Brand Match is strengthening confidence in the competitiveness of our prices, and building even greater loyalty in Pick n Pay.

We have improved the quality of our fresh, perishable and pre-packaged convenience ranges. Through our “Fresh Promise” we have reaffirmed our commitment to the quality of our fresh produce, and this has been positively received by our customers. We have used smart shopper insight to enhance our in-store offer, and have added new value-added areas into stores, such as biltong bars and fresh flowers.

Customers are seeking greater convenience. As a result, our smaller, more convenient stores have out-performed our larger hypermarket format. However, hypermarkets remain a valuable part of our business, attracting a large number of customers and generating significant revenue for the Group. There are substantial opportunities to improve their efficiency and offer for customers, and we are developing an overall strategy as well as an individual plan for each hyper. We have already refitted three larger stores as part of this strategy. We have appointed a member of our senior management team, Neal Quirk, as the head of our Hypermarket business. Neal’s focus and operational expertise will ensure that trading densities improve through better use of space and stronger customer focus.

Our clothing business delivered strong growth over the period, through both an expanded range and additional space allocations in our supermarkets.

We continue to invest in our online business, which we believe will become an increasingly valuable asset in the future of South African retail. We have built confidence in the online experience, through improved availability, quality and reliability and as a result, we have delivered 37% growth in customers over last year.

We continue to innovate, offering our customers a wide range of value-added services aimed at increased convenience and lower household costs. Mobile money, our partnership with MTN, continues to perform well. The service has 1.8 million customers, 400 000 of whom use money transfers regularly and 250 000 utilise their mobile money account as their low-cost bank account.

Our smart shopper loyalty programme was recently voted the best loyalty programme in South Africa for the second year running at the Sunday Times Top Brands awards. More than 10% of South Africans now have a smart shopper card, with 10 cards swiped every second that our doors are open. Loyalty sales account for 65% of our turnover, with the value of a smart shopper basket consistently and meaningfully growing ahead of a non-loyalty basket. Our smart shopper programme is a key differentiator for Pick n Pay, and we are determined to keep it relevant and meaningful for customers. We have built on the point of sale enhancements introduced last year, with the introduction of targeted promotions, personalised cash off vouchers and a number of new partners. As a result, our smart shoppers are more engaged than ever, with redemptions of customer offers up 42% over last year. We have given back R1.5 billion in smart shopper points since the inception of the programme.

Rest of Africa: establishing a second engine of growth

We continue to strengthen our position outside South Africa with established franchise businesses in Botswana, Lesotho, Namibia and Swaziland, and a growing company-owned business in Zambia. These operations have performed well over the period. Segmental revenue is up 15.0% to R1.7 billion, with like-for-like growth of 7.8%. Segmental profit has grown by 43.0% to R135.1 million, partly driven by the Group’s strategic decision to exit Mozambique and Mauritius last year.

TM Supermarkets, the Group’s 49% held investment in Zimbabwe, has had a more difficult time over the period, with our share of their income falling by 22.9% to R11.1 million. This reflects significant deflation in Zimbabwe, resulting in price decreases across a broad range of categories. We remain confident of the prospects for this business, which has embarked on a substantial store refurbishment programme.

We continue to actively examine opportunities for sustainable growth outside South Africa. As a result, we plan to extend our operations in the medium term by opening stores in Ghana, one of the most rapidly growing markets in Africa. We are also close to completing our analysis of the opportunities available to us in Nigeria. Our approach outside our borders remains measured, and no investment will be undertaken without a comprehensive understanding of a market and its supply chain capacities.

Creating a high-performance team

We are beginning to benefit from our new talent-spotting and performance management processes. We are investing more in training and development to ensure we have the right skills and capabilities in place, and are continuously reviewing our head office structure to ensure we offer an efficient and effective support function for our stores.

We have made a number of new senior management appointments from within the talent pool at Pick n Pay. This strengthens our decision-making capacity and demonstrates our commitment to recognising and developing talent within the business, and rewarding successful leadership. In addition, Jonathan Muthige has joined Pick n Pay as our head of human resources, replacing Isaac Motaung, who is retiring after 42 years of incredible service to our business. Jonathan will add momentum and experience to our determination to make Pick n Pay the employer of choice wherever we operate.

Doing good is good business

We remain determined to play a strong and positive role in the communities we serve and in the prosperity of the country as a whole. We have expanded the number of Pick n Pay Women’s Walks in association with Pink Drive, helping to increase public awareness of breast cancer. We have increased our support for Community Food Gardens and other community programmes. On sustainability, we have exceeded our target to reduce our energy use by 30% against a 2008 baseline. Our overall climate change strategy has been recognised by our inclusion in the renowned CPD Global Leaders Index and the international Dow Jones Sustainability Index.

Conclusion: More to come

The Group is encouraged by this improved profit performance. Good expense control and improved operational efficiency is delivering higher returns and strengthening the capacity of the business to deliver on our strategy of customer-focused, sales-led growth. We are impatient to lead more change in Pick n Pay and accelerate progress on our plan. A great deal of hard work remains to be done under increasingly challenging economic conditions, but we intend to sustain the momentum we have built up over the past 18 months.

Financial review

Turnover

Group turnover increased by 6.8% to R32.1 billion (2013: R30.1 billion). Total sales growth has slowed over the period, due in part to lower growth from net new space. New stores contributed 2.8% to our turnover growth, compared to 4.4% in the prior year. Net trading space grew by 1.6% over the period. We are pleased, however, with the improvement in our like-for-like turnover growth, which has increased to 4.0% from 2.7% for the year ended February 2014. The Group demonstrated stronger growth at overall point of sale level, with owned and franchise stores collectively growing till sales by 7.1%, with like-for-like growth of 4.7%.

Gross profit

Gross profit of R5.7 billion is 5.8% up on last year. The gross margin has decreased from 17.9% to 17.7%, reflecting our ongoing commitment to keeping prices as low as possible for our customers in challenging economic times.

Other trading income

Certain elements of trading income previously included under cost of merchandise sold (within gross profit) were reclassified during the 2014 financial year and disclosed separately. This was done to improve the visibility of all other trading income, specifically commissions received. The prior period has been restated to align with the current year disclosures, please refer to note 6 of the summarised financial information presented on page 16. The 15.4% increase in other income is largely attributable to the increase in commissions received, which reflects the launch of a number of new initiatives, such as mobile money and the sale of iTunes vouchers, which attracted high commissions on launch.

Trading profit

The trading profit margin improved from 1.1% to 1.2%, due to improved expense control and operating efficiency. Trading expenses increased by 5.3% and as a percentage of turnover decreased from 17.7% to 17.5%. The Group contained like-for-like expense growth (removing the impact of new and closed stores) at 3.0%, against CPI growth for the period of 6.3%. We are very pleased with the meaningful and sustainable progress being made across all areas of the business.

• Employee costs increased by 5.3% over the period, with like-for-like growth contained at 3.0%, notwithstanding new store growth and a wage rate increase in line with CPI. The Group remains resolutely focused on reducing labour costs in the business through improved productivity and efficiencies.
• Occupancy costs have increased by 12.9%, reflecting our space growth since the beginning of September last year. Like-for-like occupancy costs are up 8.3%, reflecting above-CPI regulatory increases in rates and taxes.
• Costs of operations are down 0.1% on last year, and down 3.0% on a like-for-like basis. This is mainly due to reduced amortisation and depreciation charges as a result of assets impaired in the prior year. Our operational teams have improved the cost of opening new stores and improved the efficiencies of existing stores. We have exceeded our target to reduce our energy usage by 30.0% against our 2008 baseline, which is saving the business money in the face of increasing energy costs.
• Merchandise and administration costs have increased by 7.4% or 8.8% on a like-for-like basis. The main driver in this category is bank charges. As South Africa’s largest acceptor of electronic tender, we are sensitive to increases in bank charges, particularly as our customers move from debit cards to hybrid cards. The Reserve Bank has taken action to reduce bank inter-change fees with the benefits expected to flow in the 2016 financial year.

Interest

The net interest expense of R33.9 million is R21.0 million better than the prior year’s expense of R54.9 million. Improved working capital management, particularly our focus on optimising inventory levels, has resulted in stronger cash balances and enabled the repayment of short-term debt under our DMTN programme.

Tax

The tax rate improved from 29.5% to 28.6%, as a result of our increased profit margin and with no change in the value of our non-deductible expenses.

Earnings per share

Basic earnings per share (EPS) increased 35.8% from 40.05 to 54.39 cents per share.

Headline earnings per share (HEPS) increased 32.3% from 40.81 to 53.98 cents per share.

Profits on the sale of assets, net of tax, of R2.0 million have been deducted from headline earnings, against an add-back of losses on the sale of assets, net of tax, of R3.6 million in 2013.

Financial position

	Sunday,   31 August   2014   Rm	Sunday,   31 September   2014   Rm
Inventory	4 153.6	3 950.7
Trade and other receivables	2 709.4	2 390.1
Cash and cash equivalents	965.4	1 340.3
Current liabilities	(9 162.7)	(9 157.2)
Net working capital	(1 334.3)	(1 476.1)

We are pleased with the improvement in net working capital of R141.8 million, particularly in the context of the store expansion programme. Inventory has increased by R202.9 million or 5.1%, with like-for-like inventory (excluding the impact of new stores) decreasing by 6.0%, mainly due to efficiencies derived from our supply chain channel, including the benefits from our enhanced forecast and replenishment system. The increase in trade and other receivables of R319.3 million relates both to new franchise stores and a reduction in our bad debt provision. On a like-for-like basis, our cash position is R425.1 million stronger, which is testament to the good work being done in respect of inventory management and improved control over both capital and operating expenditure. The decrease in cash and cash equivalents of R374.9 million is after the repayment of R800 million of short-term debt over the last 12 months.

Shareholder distribution

The Board declared an interim dividend of 19.60 cents per share, 32.4% up on last year.

We would like to thank our whole team for their efforts in refocusing the Group, and for all their hard work which has delivered this improved result.