The investment case for Steinhoff | Fin24
 
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The investment case for Steinhoff

Oct 31 2017 08:05
Lloyd Gedye

Late last year Steinhoff was ranked amongst the top 50 global shares to watch in 2017 by Bloomberg Intelligence. 

The Bloomberg analysts looked at revenue growth, market share, profit margins, debt and economic conditions to select the top 50 companies.

Incorporated in the Netherlands, Steinhoff has its primary listing on the Frankfurt Stock Exchange and a secondary listing on the JSE. 

It operates in 32 countries, employs 130 000 people and is the world’s second-largest furniture company after IKEA.

The Bloomberg analysts highlighted Steinhoff’s aggressive expansion in the US, UK and Australia, which at the time included over R70bn worth of deals.

This included the acquisition of Poundland (R11.4bn) in the UK, Mattress Firm (R55bn) in the US, Fantastic Holdings (R3.93bn) in Australia and Tekkie Town (undisclosed) in South Africa.

Market concerns

But 2017 hasn’t been smooth sailing for Steinhoff. In fact, it’s had a busy last few months. 

It successfully listed its African subsidiary Steinhoff Africa Retail (Star), while facing down legal challenges in Germany and the Netherlands as well as a falling share price.

While Star is up and trading, the share price sitting at R24.20 at the time of writing on 11 October, the Steinhoff share price has taken a knock due to concerns over the bedding down of its recent acquisitions and its legal troubles in Europe. 

The group is adamant that there has been no wrongdoing on its part.

Many investment fund managers that finweek spoke to during the first week of October suggest that the market will take a wait-and-see approach with Steinhoff shares until the legal matters are resolved.

“It’s causing uncertainty,” says Wayne McCurrie, fund manager at Ashburton Investments. “It’s definitely affecting the share price.”

Victor von Reiche, investment analyst at Citadel, doesn’t think the dropping share price is specifically related to the legal troubles as Steinhoff has already made provisions for it. 

“The company has really changed its stripes,” he says. “The big question mark is what returns will investors see over the next two to three years.”

Von Reiche adds: “Steinhoff has gone from a South African logistics/manufacturing company to a global integrated retailer. It’s a corporate mergers and acquisitions machine.” He adds that the market wants to see it deliver on these acquisitions.

Legal troubles

In August, Germany’s Manager Magazin reported that prosecutors were investigating Steinhoff CEO Markus Jooste and some other senior managers at the group in connection with suspected accounting fraud. 

The magazine reported that prosecutors in the northern German city of Oldenburg, near where Steinhoff’s European business is based, have since 2015 been looking into whether revenues had been inflated in the group’s books.

Steinhoff denied any wrongdoing and identified the magazine’s source as a former joint-venture partner, who is pursuing legal action. 

Then, on 21 September, a hearing was held at the Enterprise Chamber of the Amsterdam Court of Appeal. 

This hearing had been brought about through a petition from OM Handels GmbH and MW Handels GmbH (OM & MW), who asked the courts to order a probe into Steinhoff’s annual accounts.

The company maintained that the dispute relates to the resolution of a European retail joint venture, which is set to be heard in Germany. 

It maintains that it had hired independent lawyers and auditors in Germany to investigate the matter and their conclusions are that there is no evidence of any wrongdoing.

Jooste is confident the petition will be dismissed. “The annual accounts of Steinhoff International were established according to all applicable rules and to our best knowledge,” he stated a few days ahead of the hearing. 

“The 2016 annual accounts are correct and received an unqualified opinion, by our financial auditors.

“The allegations brought against Steinhoff are unfounded and rejected by Steinhoff,” he added.

The day of the hearing Steinhoff again stated that it was confident the matter would be dismissed. “The chamber will now deliberate and Steinhoff expects a court decision to be presented within the next two months,” read its statement.

Driaan Jansen, portfolio manager at Unum Capital, says the allegations had impacted sentiment towards Steinhoff negatively, which has been felt in the share price: “Since both of these allegations come from the same joint-venture partner one has to wonder whether there may be some ulterior motives behind the allegations.”

Steinhoff Africa Retail (Star)

Meanwhile, Steinhoff recently announced that Star’s September listing on the JSE had resulted in the issuance of 800m shares, raising an aggregate amount of approximately R16.4bn. 

Post the listing Steinhoff still holds 77% of Star’s issued share capital.

Von Reiche says that Star is a cash-generative business, with lower-than-average risk, which means you can justify its high price-to-earnings ratio (P/E). 

“Growth is going to be unlocked over many years,” he adds.

Von Reiche expects most of Star’s growth to come from Pep and Ackermans, arguing that Star will look to change up the mix of products being sold because it was realised that it can gain rapid market share in some categories. 

He also expects an aggressive roll-out of new stores. 

Sales in Pep and Ackermans stores have held up well in a difficult environment. New stores and a change in the mix of product lines could yield 11% to 12% sales growth, according to Von Reiche. 

McCurrie is very positive about Star, arguing that it is made up of retail companies that are well-known in South Africa and has a massive African footprint. 

He says one issue is that the Star shares are rather illiquid. “In reality only 12% to 13% of Star is listed on the JSE,” McCurrie points out.

While 23.19% of Star was listed, the difference was taken up as part of a BEE deal. “We tried to buy some stock – it was difficult to get hold of,” he comments.

Steinhoff clearly wants the market to value Star independently, which is one purpose of the listing, but McCurrie says he can’t understand why the whole of Star wasn’t unbundled.

But he suggests that it’s still “early days” and perhaps more of the business will be listed in the future.

Jansen describes himself as the “contrarian” on Star, as most investors appear to be very positive. “I’m not overly excited – it’s trading rather expensively already.

“I’m seeing limited upside for Star going forward,” he says, adding that retailers could be facing tough times if South Africa suffers further rating downgrades.

Star trades on a forward P/E of 20.73 for the next 12 months, according to Jansen. He finds that expensive when compared to Steinhoff’s own forward P/E of less than 10, and a peer average of 12.25. 

“The long-term annual growth forecast of 14.3% per annum is above those of its peers, but one still has to ask whether it justifies a P/E premium of 30% above Mr Price, which is already trading at a premium compared to the other retailers,” he argues. 

Taking control of Shoprite 

But according to McCurrie, there is massive upside potential for Star, especially when it takes control of Shoprite near the end of the year. 

Star has secured the rights to acquire a 23% economic interest and 51% voting control in Shoprite via a series of call options. 

“There is tremendous potential for rationalisation between Star and Shoprite in the areas of distribution, logistics, back office systems and information technology,” he maintains.

But Von Reiche isn’t so sure about the synergies between the two companies: “One is a discount food retailer and the other is a discount clothing retailer.” He expects that any synergies will be introduced gradually.

Jansen also finds it difficult to see a lot of synergies between Shoprite and Star, and accordingly how this combination will add additional value to Star’s share price.

“The market currently has, as per Reuters, a hold recommendation on Shoprite, which implies that the market sees little upside from the current value over the next year,” he says.

“One can also refer back to how the market reacted late last year when Steinhoff announced it was in talks with Shoprite to sell its African retail businesses to Shoprite.

“The market reacted with Steinhoff’s share falling 7% on the day of the announcement,” Jansen recalls.

Sorting out Mattress Firm

There has been suggestion that another factor affecting the Steinhoff share price is the market’s concerns about the group’s ability to bed down its August 2016 acquisition of Mattress Firm. 

Mattress Firm is hardly Steinhoff’s first big deal, McCurrie says, arguing it has expanded massively over the last 10 to 15 years. “So far they have been successful with every single deal,” he adds.

He says that Steinhoff bought Mattress Firm at a low price as the company wasn’t doing well, and now it has to improve the company’s performance in a highly competitive market. 

“They’ve bought a very big footprint,” he says. “If they turn things around and start selling other goods through that footprint, it could be very successful.”

Mattress Firm, which has a 25% market share in the US, has been subjected to extensive rebranding and restructuring, which resulted in the cancellation of a contract with Tempur Sealy International in January this year. 

“Tempur Sealy accounted for over 40% of Mattress Firm’s cost of sales in 2016,” says Jansen. “The market is worried about whether that gap can be made up.”

The company has subsequently struck up a partnership with Serta Simmons Bedding, the largest mattress maker in the US. Steinhoff has also acquired a majority stake in US manufacturer Sherwood Bedding, a supplier of private-label goods.

According to Jansen, the Serta Simmons deal will help plug the gap, which should result in a substantial recoupment of sales losses. Jansen warns, however, that it all depends on how loyal Mattress Firm’s customers are. 

“Mattress Firm is an established company in the US,” he says. “Over the last 37 years it has had growth of over 5% per annum.

“Mattresses are not a market that is going to go away. Why would people stop buying mattresses? 

If and when Mattress Firm can prove that it was able to recapture some of the lost revenue due to the Tempur Sealy contract termination, it is sure to rerate,” says Jansen.

McCurrie expects the market to sit back and wait for a year or so to see what happens with Mattress Firm. However, personally, he is very positive on the company’s stock: “We own a lot of Steinhoff – and the current share price is cheap.”

Jansen says that the Thomson Reuters average analyst valuation for Steinhoff is R85. With the share currently trading at around R60 per share, this suggests that there is a one-year potential upswing of 41%.

“The share is trading on a discount even on a forward P/E basis,” he says. “On a 12-month forward P/E basis it is trading on a P/E of 9.94, compared to its peers who are trading at a forward P/E of 14.23.”

This is a shortened version of the cover story that originally appeared in the 19 October edition of finweek. Buy and download the magazine here.

The article has been updated to reflect that Victor von Reiche is an analyst at Citadel, not Cannon Asset Managers, as originally reported. We regret the error.

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