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A good company in bad company – Moneyweb

May 23, 2013

An old fashioned business model that is based on personal contact rather than call centres and which empowers store managers to make ‘executive’ decisions appears to be paying dividends for credit retailer Lewis Group.

Despite the tumultuous times the company posted solid results for the year to March. Revenue rose 6.8% to R5.1bn and the operating margin rose 50 basis points to 24%. Tight control of operating expenses and debtor costs, coupled with increasing credit sales helped lift headline earnings per share by 13.6%.

The healthy dividend remained, rising 16.3% to 514c for the year.

However Lewis could not escape the financial devastation caused during last year’s widespread strikes, though it appeared to weather it better than competitor Ellerines, part of African Bank. In Lewis’ case furniture sales rose by 6.6% in the first half of the financial year, and by just 2.7% in the second half, between October and March. Ellerines, which reported its six month earnings to March on Monday, saw sales fall by 11% in the same period.

Lewis made sure that the majority of its customers continued to pay their debts – despite the tough collection environment. The growth in debtor costs was contained to 3.3% and debtor costs as a percentage of net debtors improved from 10.8% in 2012 to 9.4% in 2013.

Lewis chief executive Johan Enslin attributes this to the decentralised business model where stores are responsible for their own collections. “We employ people from the community to collect.” And where a customer runs into trouble, “the store manager is empowered to make a repayment plan with that customer.”

Ellerines on the other hand saw bad debts rising significantly. In March it was forced to write off non performing loans to improve the quality of its loan book. This contributed to the 26% drop in African Bank earnings and prompted the company to warn that the furniture business would likely faces losses this year, as demand from cash-strapped consumers wanes.

Both Lewis and Ellerines have seen their decline rate on credit applications increase. In Lewis’s case it rose to 36.5%, from 33% last year and from 25% in 2008. “The increase in unsecured lending and consolidation products has impacted customers negatively and increased indebtedness,” Enslin says.

That said, Lewis saw credit sales (from existing and new customers) increase to 75.3%, up from 68% two years ago and 71% last year. “We think that customers find our credit offer attractive and our stores situated in locations that are convenient,” says Enslin.

“The difficult trading conditions are visible in the top line growth,” says Cadiz Asset Management retail analyst Warren Buys. “They are doing everything they can to drive sales, including lengthening the book. To have grown earnings as they have is indicative of a strong management team that has been through a few cycles.”

Without detracting from the results, he points out that the lower bad debt costs as a percentage of the book may have more to do with the fact that the costs remained stable, while the debtors book grew. “The size of the book has increased from R5.8bn to R6.9bn, that is significant growth,” he says.

Looking ahead, Enslin admits that there are “a few dark clouds on the horizon.”

“The job market is weak, inflation is high. These things dampen consumer confidence, which leaves us with a big challenge. The next 12 months will be tough.”

A secondary headwind is of a regulatory nature. The task team made up of the National Credit Regulator, the FSB and National Treasury is still busy with its investigation into the credit insurance that the furniture companies sell with their products. At this point there is no hint of possible findings, despite analyst reports on the subject, and a report is expected in July.

Earnings from insurance are not separately disclosed, but in Lewis’ case, insurance sales account for about 19% of turnover – a material number.

However shareholders were hugely relieved at the results and the share surged upwards by 13% from R52 to R58.86. This helps, but it has a way to go if it is to reverse the 25% fall in the last six months.