Sunday, August 2, 2015

Why I Bought Lewis Group Ltd.

In the last year or two the US economy has been looking stronger and stronger. It is quite clear by now that it is in the mature stages of a recovery from the recession that began in 2008. Unemployment is going down as smoothly as a plane coming in to land. The fiscal deficit is down from the abnormal levels at the height of the recession. Housing inventory is no longer full of bank-owned foreclosures. US manufacturing and consumer confidence are all up. The US dollar is at the highest level in four years. The market appears to be fully aware of this and the US market valuation reflects this economic situation. So though the economy still has room to run, US companies are probably fully valued. Indeed, I am finding it harder and harder to find those knock-out bargains of two or three years ago. That is why I have been buying outside the US recently. This all a drastic change from 5 years ago, when news pundits were saying that the US premier position in the world will be eclipsed by China and Europe. Well there is a saying I keep: You're never as good as everyone tells you when you win, and you're never as bad as they say when you lose.

I find it also interesting that the market has taken the opposite view of the emerging markets six years ago and today. In the last year or two, money has consistently flowed out of emerging countries. The headlines are full of bad news everywhere you look. Russia doesn't respect shareholder's and will steal or confiscate at will. China has a colossal property bubble. Hong Kong is too close to China to be immune. In fact that goes for every other country in Asia. Japan is growing old and will forever be in recession. The commodity slump and mismanagement have meant that Brazil, Indonesia and South Africa all have high inflation and capital flight This juxtaposition of emerging markets and the US may be partially based on fact but I think it is also very much a matter of psychology. Someone always has to be a darling and someone always has to be the dog.

So, it is with this idea in mind that I decided to dive into my third South African stock: Lewis Group Ltd (JSE:LEW). Lewis Group is a large furniture retailer in South Africa and nearby countries. The company is extremely profitable and very shareholder friendly. I know of no other company that regularly pays a 8% dividend. The down side is that the company is very susceptible to the South African consumer. The company serves lower and middle class South Africans, and 70% of them buy from the company on credit. The company makes relatively low margins on the sale and makes most of its money from financing, interest and insurance on the debt. This model has worked well for Lewis as well as its competitors. But recently, over expansion has hurt furniture retailers. One big competitor with a thousand stores, Ellerine, filed for bankruptcy last year. Its one thousand stores have been sold to various competitors. Lewis Group bought 63 stores under the Beares name.

Price ZAR 57.800
Market Cap ZAR 5178.01 M
(USD $ 424 M)
P/E TTM 6.2 x
Div yield 8.9 %
P/BV 0.89
Debt / Equity 0.27
ROE14.4 %
Now critics of companies like the Lewis Group may point out that such companies take advantage of those less well-off. I can't say I disagree with such critics. And now government is on to the company. In early July, the South Africa National Consumer Tribunal, fined the company ZAR10M for misrepresenting the insurance they sold. This apparently was the catalyst for the stock to drop by 40%! The fine was only 1% of last year's earnings but it reminds us there is regulatory risk. And that's all. It shouldn't be significant. But in reality it has had a big impact on the stock price, which gives me a buying opportunity.

Today at ZAR 58 it is back where it was a year ago before Ellerine's bankruptcy. Since then I feel things are much more clear for the industry and Lewis group. The company has had record earnings, although the economic situation in South Africa is considered negative because of the global slowdown in commodities.

Lewis Group Stock TTM in ZAc

Lewis Group has over 700 stores in three segments. The largest with 80% of sales is the Lewis chain of furniture stores. The Best Home and Electric chain sells electronics. And the just-purchased Beares chain sells furniture to slightly wealthier demographic.

The company's balance sheet looks strong. The largest asset item on the balance sheet is accounts receivable, which stands at ZAr 5400M. That is almost equal to the company's equity. Needless to say, customer debt management is a crucial aspect of the business. Almost 70% of the debtor customers pay their obligations in full. The company bad debt / impairment costs are about 13% of total debt. I am not an expert on consumer finance, but 13% seems like a very adequate number for a developing country like South Africa.

Below is part of the credit summary from Global Credit Rating Co., a local credit rating agency.
Lewis´ liquidity has strengthened over the past year. This has been a result of the initiation of its listed debt programme, which has increased its financial flexibility and enabled it to increase unused bank funding lines. Note is also taken of the sizable cash balances reported at FYE14, as well as the fact that the group´s asset base is entirely unencumbered; further boosting financial flexibility. In addition, the ability to tighten underwriting criteria and reduce credit origination is a tool available to management to improve cash flows if needed. Thus, despite continued working capital pressure associated with growth, Lewis has reported positive operating cash flows over the review period. With limited capex (as stores are typically leased and not owned), this has enabled moderate gearing levels and sound debt serviceability to be sustained. Further to this, net gearing and net debt to EBITDA were slightly lower at 24% and 105% respectively at FYE14 (FYE13: 30% and 111%), while net interest cover remained sound at 10.5x (F13: 12.8x).

I think Lewis Group is the financially healthiest furniture retailer in South Africa. Any shakeout would make the company stronger. Any bad macro economic scenario is covered by the company's cheap valuation.


  1. Hi there - do you worry about the impact of FX on your foreign holdings?

    I am a UK investor and often am put off from investing in emerging markets not because of the underlying business's but due to my lack of view on the FX.

    Many thanks,

  2. hi Kaizen,

    That this a very good question. In my opinion, the biggest constant factor in FX is the two countries inflation. The S Africa inflation rate is around 5% which is actually lower than that in the last several years. The US inflation rate is around 2%. So one can expect the Rand to slide against the USD while this continues. So there is a 3% cost of investing in S Africa. But my S. Africa companies compensate by giving higher dividends, often 3% more than a comparable company in the US.

    But recently, the news is about the currency devaluation policies expressed through ridiculous interest rates. I believe this cannot continue much longer. The US currency index is at 96 from 80 a few years ago and it has to drop.

    The other factors are the trade balance and foreign reserves and debt levels. S Africa is net even in trade and it has a reasonable debt to GDP of 35%.

    So yes I do worry about FX but it is the cost of doing business in foreign markets. It just adds to my required margin of safety when I analyze stocks. Other than that I have no good answer.

    But no I do not hedge.

  3. Thanks for the reply. Great blog.

  4. Thanks for the reply. Great blog.

  5. Thanks Kaizen, that means a lot to me. Please comment more often.

  6. Hi.
    Your blog is well thought out and to the point.
    Lewis AGM is covered in one of the 2 main South African business weeklies the Financial Mail:
    Does not seem to change your thesis and coming from South Africa and being a WRC year they had to use a rugby analogy.

  7. Thanks zenkiter, from the AGM transcripts there is evidently a big squabble between the board and Summit Financial partners. I am not anywhere near S Africa and so didn't get the bad investor sentiment from this insurance debacle. Now it is much more clear to me why the stock tanked 40%.

    This information actually makes me feel better because now with everything out in the open, I can make a more informed accessment about the stock.

    1. Hi Bovine bear, I thought I would share some company specific and economic headwinds that have weighed on Lewis of late:
      Financial Mail article:

      Since the headless chicken cabinet shuffle of December where South Africa has had 3 Finance ministers in a week the ZAR has been under severe pressure as global capital takes flight. It is at 16 versus below 13 at the time of your recommendation, an almost 20% decline. South African Sovereign Debt is close to junk status and will probably be downgraded after the budget later this month. The political mismanagement has infected the whole economy. In addition with the rout in commodities miners a big source of employment are shedding assets and workers which will hit anything related to retail.

  8. Hi, zenkiter, thanks for pointing out the article.

    The article about predatory practices doesn't worry me so much. But yes I am somewhat aware of the financial crisis in S Africa. I didn't know they had 3 finance ministers in a week. In retrospect my biggest mistake was not getting into Lewis but NOT HEDGING MY CURRENCY EXPOSURE!!!!

    I would like to communicate via email. If you like plz contact me at, my email id is just the name of the blog (w/o