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Edited Transcript of MSM.J earnings conference call or presentation 29-Aug-19 8:30am GMT

Q2 2019 Massmart Holdings Ltd Earnings Presentation

Sandton Sep 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Massmart Holdings Ltd earnings conference call or presentation Thursday, August 29, 2019 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Alan Johannes Van Lierop

Massmart Holdings Limited - Advisor

* Guy Robert Hayward

* Mitchell Slape

Massmart Holdings Limited - CEO & Executive Director

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Conference Call Participants

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* John Morris

BofA Merrill Lynch, Research Division - Director, Senior Strategist on the EEMEA Equity Strategy and Investment Strategist for South Africa

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Presentation

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Alan Johannes Van Lierop, Massmart Holdings Limited - Advisor [1]

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Welcome to the Massmart interim results presentation for the 6 months to June. You can imagine how much I've been looking forward to this presentation or making this particular presentation. Thank you all for being here. Apologies for the slight delay. We had sort of standing room only for a while, while we sorted that out.

Got some introductions to make. Always a pleasure to have Kuseni Dlamini here, Chairman of the Board. Kuseni, thank you for being here. And then it's a thrill to have with us Mitch Slape, the incoming CEO, Mitch; and Mohammed Abdool-Samad, the incoming CFO. Welcome guys. Good to have you with us. Mitch, I hope you have a wonderful time in the country and an even better time in the company. And Abdool -- excuse me, Abdool, Mohammed, wonderful to have you with us and look forward to your contribution to the business as well.

Let's get right into it. I'm doing the whole thing. Mohammed wasn't particularly interested in presenting these results, so I'm going to do that. And a sign of my advancing age, I need to do it with my glasses on. Let's get right into it.

So we've gone into kind of detail because, obviously, the performance was disappointing and we felt that we needed to, in a sense, [overshare] with you. So apologies if we do seem to be duplicating ourselves. I'm just giving you a lot of information, so you can sort of interpret the financial performance.

The accountants have managed to make things tricky this year. You would have heard of IFRS 16 which is the capitalization of all leases. It has an enormous impact on many retailers' income statements. We are the first retailer to report under IFRS 16. And the accountants require us to only restate this year and not restate last year. So you are literally comparing apples to pears.

What we're going to -- what we've done on the slide in front of you is we have taken IFRS 16 out of the current year and we're showing you what's called an adjusted June 2019, so that is to compare apples-to-apples being June 2018. You can see that the impact of the accounting standard is that there's a very high depreciation charge because you've now capitalized a lot of assets. There is a much lower lease charge because those leases are now capitalized. And then, of course, interest goes up because you have capitalized a large liability and there's now a notional interest charge. I think it's from the income statement. So for the sake of clarity, for the rest of the presentation, we are referring to the 2 darkened columns which are -- shaded columns, which are like on like.

Similarly for the balance sheet, so because of IFRS 16 has quite a large impact, you can see that assets go up by ZAR 8.5 billion as we capitalized the leases and put that onto the balance sheet as an asset. And there's an approximately equal liability that gets raised, which is the lease liability that was previously are not capitalized.

So the headlines are obviously tough reading. Although sales were up slightly, gross margin was down, expenses were up. And we ended up with a very small trading loss, our first trading loss in 20 years. And we will explain to you in the next few slides what caused that.

So the headlines in brief on what caused our performance is, there were a few external issues that are well known and there were a few internal issues, I guess you could call them on goals if you wanted, or controllables that we could have done better at. But certainly, the sales environment was brutal. And what was marked was how much slower sales growth was in quarter 2 to June. What's quite concerning is that Easter was in quarter 2 this year and in quarter 1 last year. So actually, quarter 2 should have gone up because Easter moved. And in fact, the sales growth slowed further. So it gives you a real sense of how tough it is in the economy.

The second thing we saw was, not unexpectedly, is as consumers struggled with cash, we saw food sales growth and liquor sales growth stay steady, but non-food sales, sales growth declined in that second quarter as well.

We saw margin pressure, gross margin pressure. It's only 36 bps, but at our size, that's nearly ZAR 200 million of less income, less margin. It was from 2 things which was mixed. So [food] sales is a lower-margin business than microwaves. And so quite simply, as the food sales growth increased as a mix, the blended margin declined. And we also saw lots of promotional activity -- excuse me, lots of customers buying on promotion from us. Just a story that Llewellyn was telling me, Walters from Builders Warehouse. Builders is not particularly promotionally driven. They'll have a spring promotion or a back-to-site promotion, but they're not -- they don't have a regular cadence, but they don't have any more paper in the market than last year. They have no more product on promotion than last year, and their participation, their promotional participation has gone from 19%, I think, to 24%, so without a change in our own behavior. So that's customers shopping on promotion to save money.

And then expenses. We've, I think, set the benchmark for several years on expense control. It partially caught up with us in this year. The main expense categories of depreciation, people and property were fairly well controlled. I mean there's 75% of total costs and they were up about 9%. But there were a whole sort of bunch of other costs that caught up around us, and I'll go into the details around those.

Just interesting to look at the geography and the category mix of sales. We're still a sort of 91% and 9%, South Africa, non-South Africa split. Ex-SA sales actually grew quite nicely, which is sort of unusual if you look at other recent competitors' sales updates. So we are seeing some sales growth. In South Africa, you can see that our mix between food and liquor and durables is 56%-44%. 5 years ago, that was probably 50-50, if not 45-55 in the other direction. You can also see the sales figures in food and liquor were up 7.9%, whereas in durables, it was only up 1%. So you get a sense of how the shape of the sales are shifting inside Massmart. Similarly, in Africa, we saw strong sales growth in food and liquor. Although sales growth was good in durables, it was still lower than sales in food and liquor.

So I mentioned, gross profit being down. It's down through mix, which is more food being sold than durables. It's down because of the promotional participation from customers. You'll see in a few slides, we describe that we're still not robust enough on margin management inside Game and Masscash. And similarly, we had some stock aging begin to affect us in Game, and that charge goes into margin.

So looking at the 4 major cost categories.

Total expenses grew at 11% and comps grew at 9%. That's not really acceptable, particularly when your sales growth is 5%. So certainly, we are clear on the challenge that we need to reduce our cost growth. I mean, in fairness, we did add 3% more space, so you'd expect your expenses to go up by 3%, let's say, inflation is 5%, maybe 8%, expense growth would have been reasonable, but it's still higher than sales growth and so we need to manage it further.

Depreciation is up 20%. You may recall, we did an IFRS reassessment of useful lives last year. So actually, the depreciation charge was reduced by that last year, so there's sort of a disproportionate charge. If you excluded it, depreciation is only up 9%. As we -- as our IT work is converting from design into implementation, we see costs start to come into income statement and we see depreciation start to pick up as we move from capitalizing those costs through charging those costs, and that impacted depreciation as well.

Employment costs up, as you can see. I think going up 8% total. I think it's quite a good performance given 3% new stores. And also in-sourced, quite a few -- several hundred -- several thousand previously outsourced employees, temporary employees we brought back -- we brought on to our books, along with the new legislation.

Occupancy costs are up 8%. That's rental staying quite low at sort of 3, 4s, and 5s. But as everyone else has remarked, all the administered costs are up, rates and tariffs are just up, costs of running generators during the few -- the 2 months of load shedding, et cetera.

And then other operating costs, which is a lot of other stuff, was up 19%. That is really, really high. I've given you some detail there. An interesting thing and also a sign of the tough times that we see credit card usage go up. I spoke of less and less cash. The cost of that is about ZAR 50 million because, of course, you pay for using -- or rather the retailer pays for using the credit card.

IT implementation. As we switched from design to implementation, those costs are capitalized, a ZAR 50 million impact there. And we've got some quite big preopening costs because we opened a Makro and several new Builders Warehouse stores in the last few months, and that's also up. So a combination of those 3 issues is nearly ZAR 100 million, which is almost 1/3 to 1/2 of that increase.

I'll touch briefly on 3 other things that affected our earnings performance. We saw a large ForEx loss. So just -- the 81 million is actually a loss and the 23 million is a gain. In May and June, the currencies in Zambia and Nigeria in particular weakened very dramatically, and so we've moved into a loss situation.

Finance costs are up slightly as average borrowings in the half are up on the previous year. And then, sort of unusually, as we had a tax charge this year, I mean you'd expect if you made a loss before tax, that there would be a sort of a credit. Instead, there's a charge. And the reason there is a charge is that we decided to impair some of our deferred tax assets and then we were very conservative on what we did with not raising new deferred tax assets. It's quite a technical conversation. If you want to have it offline, with pleasure.

So just getting into the sales performance per division. They would be what you'd expect given my food and nonfood distinctions that I'm making.

Massdiscounters up 3%. That actually masks a very nice sales performance in Game where we saw Game SA sales up 3.5%, but their customer count up 5%. The difference between those 2 is we're seeing more customers come in, but they're buying food. So the basket sizes are small, so the sales growth of 3% is lower than the traffic growth of 5%, but still nice to see 5% footfall growth in Game this year. Ex-SA also grew nicely, in rands 5.8%, and flat in constant currency.

We don't mention DionWired here but DionWired sales below last year, partially a function of the economy. And I don't think we were really doing ourselves any favors in some of our merchandise assortment and innovation inside that business. Product inflation remains low in Massdiscounters, which you'd expect with its very high proportion of general merchandise.

Makro is, of course, the classic blend of food and liquor and general merchandise, about half-half. So we saw a nice growth in food and liquor. And we saw general merchandise nearly flat or just below last year in sales. It was a thrill to open our 22nd Makro store to the north of Durban in Cornubia across from Gateway and it's doing nicely for us.

Massbuild was, I thought, exceptional performance, 5% sales growth. But what that masks is that, that was almost entirely amongst our retail customers. In our professional customers, our contractor customers, sales to those folks actually below last year. So negative, which obviously read through into a very difficult construction industry and building of residential units and commercial units, et cetera.

In South Africa, we -- excuse me, outside South Africa, we've got very nice sales growth. Llewellyn and team opened quite a few new stores, so it's a very robust 25% growth. I think comps is more like 10-odd, but still a great performance.

Masscash is, of course, our wholesale and retail business. Wholesale is about 3/4 of the business and retail is about 1/4. Wholesale had nice sales growth, benefiting slightly from a bit more inflation in our categories, whereas retail grew at 2.9%. Looking at other results, 2.9% in that [through] end of the market for food seems to be sort of around what everyone else was achieving as well. And Masscash has a nice business outside South Africa which also did nicely.

I won't go through a lot of detail because, as I mentioned, there's a slight repetition between sort of giving a group overview and getting into the detail. But here is our thoughts on gross margin. You can see that gross margin percentage was down in 3 of the 4 businesses. It was only up slightly in Massbuild, and that was because of mix. So as we sell -- as we proportionately sell more to our retail customers, they are higher margin than sales to our contractors who would be buying sort of bricks, and cement, and steel and so on, which is much lower margin. And so margin pressure across the business other than in Massbuild.

We've also covered expenses, but here, we sort of go into sort of per division, the expense growth and we give a bit more context to what has caused that expense growth. You'll see that inside Massdiscounters and Masscash, we saw a slightly higher employment cost growth than you might normally expect, and that was through the insourcing of our temporary employees as a result of the changes to the law. We also saw some quite high preopening costs inside Makro and in Builders. Also, as other signs of stress in the economy are a bit more -- we're seeing a bit more bad debt inside Masscash. Bear in mind, Masscash is wholesaling, so we're selling to small retailers. And of course, they'll be feeling a pinch as well. So we saw bad debt provisions go up inside that business.

So the summary of sort of those 4 or 5 slides: sales, margin and expenses is this picture here, which is, unfortunately, a large loss in Massdiscounters of ZAR 396 million. Profit in Makro and Builders, although both of those figures below last year. And then the last inside Masscash, which was also a loss last year, but not as big.

Turning to the balance sheet.

I thought we did a good job here considering the circumstances. We managed to pull stock down by 3 days compared to June last year. We've been very deliberately destocking the business or rather trying to run the business on less stock rather than destocking. Just as an aside, if you're destocking your business, you will appreciate that your sales from suppliers will start to drop or your purchases from suppliers will start to drop, and that affects market share reading. So for the last few months, market share readings on Massmart have looked sort of like we're suffering, it's just because we're buying less from suppliers while we rebalance our stock levels, and they're actually picking up quite strongly now.

Our credit today is tightened by 4 days. We believe that's mostly due to the shift between food and nonfood. Food suppliers, of course, would be quite short term, maybe 30 days of funding, whereas someone supplying you fridges and microwaves will probably give you 60 to 90 days funding. So again, the sales mix is affecting our creditor profile. And watching our debt very carefully, our trade debt. And it's at the same number of days as last year.

And then just sort of keeping with the theme on balance sheet management. One of the problems we have with our first half to June is that it's actually quite a small earnings period for Massmart. We make about 60% to 70% of our profit in the second half of the year. So in the first half of the year, quite a small rand number, kind of a very large percentage impact. So just out of interest, I put the 12-month rolling EBITDA figure here, 12 months rolling to June, and it's down 20% on last year. Our net debt is below last year. Our gearing ratio is approximately the same. And then cash utilized in operations, although a negative, is better than last year as well. So really starting to manage -- maintaining a quite an intense focus on the balance sheet.

Deep in the appendices, you'll see, for example, our forecast store openings through to [by] 2022. It is only 5% space growth per year. This time, 6 months ago, I stood again in front of you and I said it was going to be 7.6%. So you can see, we're pulling back on new store openings in response to the environment.

Getting into operational overview. These are real growth figures from the reserve bank for the quarter to March. No surprise, slightly up in services and non durables and semi durables and down in non durables, which would be -- 45% of our sales would be in the durables category in the bottom right.

So what are we doing? Are we doing kind of more of the same? Probably with renewed energy and vigor and maybe a shift in focus in time, as Mitch and Mohammed put their fingerprints on the business. We have to improve the profitability of Game and Masscash, and we'll go into some detail on that in a moment. We've got to keep driving our operating costs lower on a structural basis. It's not about canceling our Christmas Party, it's about running the business more efficiently to permanently save and reduce operating costs. As part of that, and you've heard us talk about this, we are driving a group-wide DC and logistics program. It's definitely paying for itself. We believe, in the long run, we'll probably reduce our cost to serve by about 1%, which we've shared with you previously.

We are still doing well online. I'll give you some detail on that in a moment. And we're going to be quite selective about our growth in Africa, and I'll give you a detail on that, too. VAS or financial services, still doing nicely for us, growing at 12%. And I'll give you a bit more detail on that. And then, of course, we're always trying to do good business, to do it the right way and be a responsible citizen. I'll give you a few points on that, too.

So fixing our controllables. Here are the things that sort of got through us.

Game, we had weak margin management and we also had the SAP implementation delay. We have changed leadership in that team. And we've also made a very exciting appointment as the Head of the Merch -- the Merch Director, rather, who runs Game, is Neville Hatfield. Neville Hatfield actually was the Game Merch Director in the early 2000s, and he moved to Builders, where he's been for the last 10 years. And we managed to pry him out of Llewellyn's hands and we've put him back into Game, and we're very excited to have him there. And I think Neville will make a tremendous difference to the merchandise offering and customer value proposition inside Game. And with that, he's going to bring much greater capacity and process and control around managing margin inside that business.

You all know that we've been on an SAP journey in Game for a couple of years now. We've put in point of sale, we've put in online, and a big ERP system was meant to be switched on in quarter 3 this year. We've moved it to quarter 2 next year. We work very closely with a third-party system integrator. And they've taken our eye off the ball quite dramatically, and we are engaging very assertively but constructively with them to make sure that they can compensate with additional resources, whether using other people and other professionals. We believe that we will launch ERP in the quarter 2 next year, but we're also getting a lot of SAP Germany support, which is just fantastic.

Masscash, too, is a story of quite poor margin control. We've had a leadership change there as well. And the team will be looking very hard at bringing in process and structure to better manage margin inside that business. In retail speak, you have sort of the front margin, which is really the difference between the selling price and your cost of product, and that's the margin you make at the [toll] . And then there's back margin, which is the suppliers sort of incentivizing you to double sales in this category or to widen that category, and we call that back margin. And it's really about managing that back margin in particular. Suppliers are very keen for us to succeed in Masscash because they want this route to market. I think everyone recognizes that informal trade mom-and-pops are going to outgrow formal retail. And certainly, our business would be that -- one of those routes to market.

Massfresh, you will remember that 6 months ago, we were sort of embarrassed and disappointed to discover that our control environment was weak, sort of contrary to how the business runs itself. We've had a complete leadership change there. We also have redesigned our SAP system and improved our business rules. And we are sort of regaining control of that business. And with that regained control, we can begin to sell more assertively and better control our trading margin. Our sales in Massfresh in particular are still about 9% below last year, but improving month by month, and margin improving as well.

So to continue with those priorities that I mentioned earlier. You've heard us describe what we're doing on the DC and logistics program. To put it [currently] , you want to put more and more of your purchases through your own DC structure. And it's called centralization or centralizing. And we actually increased the throughput by a further 5%. So 5% more produce within our produce product was coming through our DC structures in the first half of this year.

Omnichannel remains a very important focus area for us. I personally think we're probably the best bricks-and-mortar retailer to do omnichannel. Omnichannel is a combination of online and offline. Having said that, our sales were actually below last year, and we quickly explained that. We have used SAP Hybris, which is their online platform in Builders and Game. And earlier this year, we converted this in Makro. Unfortunately, the conversion wasn't as slick as it normally is. Unfortunately, it involves the same third-party who's struggling within Game, and so the implementation wasn't good. Maybe you experienced it yourselves, but certainly, there was a lot of noise around Makro online for about 3 months of the year, and so sales are below last year as a result. Right now, sort of this week, sales are higher than last year's sales in the week, so we've recovered, but still cumulatively, we are below last year.

And then Builders Warehouse is also below last year, but it's because this time last year, we were selling -- or 15 months ago, we were selling more water management items than you could imagine into the Western Cape. And we knew we couldn't supply it through our store infrastructure, so we moved customers online, and we sold a small fortune of water management and control devices. If you exclude that, every other category inside Builders online is double the last year. So once you are -- once you've annualized that water sales into the Western Cape, the rest of the sales are doubling.

And those stats are for the group. So basket size is up 20%, online traffic growth up 36%. We really are nailing this and winning. And it's certainly very encouraging to see the pure-play guys begin to move to a physical presence as well. Take a lot to doing it, [gumption] for doing it. So omnichannel is kind of obviously becoming the battleground and I think it's no longer pure play, and we think we're well placed to succeed and compete.

Africa. We've had a slight pivot from West Africa to East Africa in the last year or 2. We've now got 3 stores in Kenya, and we'll open a few more this year and next year. We're cautious on Africa. The thing that really sort of wipes you out is currency weakness because a lot of your costs is actually in hard currency, whether it's expat salaries in dollars or in particular store lease charges in dollars. And so when currencies weaken dramatically, local currencies, these hard currency costs can really hurt. The countries that have a more wider export offering other than just oil or steel or diamonds tend to have a more robust currency. So we see Kenya, for example, with quite a robust currency, whereas Zambia, which is reliant on copper, has seen severe currency weakness.

VAS continues to do very nicely for us. This is not a means to an end. It's -- excuse me, it's not an end in itself, it's a means to an end. It's to attract customers to our stores. Many of our stores are destination stores. We want to make it worth your trip where you can do a money transfer, you can buy an extended warranty, you can buy an airline ticket or a bus ticket. And it's growing nicely for us almost across the board.

You'll be aware that private label is a high focus area in all retailers, and we're no exception. At the bottom, you can see the sales penetration rates in food, gen merch and home improvement have all increased from last year, so more and more stuff is moving to private label. In Builders, for example, the private label penetration, I think, is now 21%, whereas 2 years ago, it was probably 15%. So we really are trying to win in private label. You can present a wonderful quality positioning with your customer or price proposition to your customer through a very strong private label program.

Just some interesting stats about where we're doing well. Still, very, very strong market shares in small and large appliances, 40% mentioned there for large appliances. Very strong liquor sales growth. And then Builders opened what we think is probably the first bricks-and-mortar omnichannel offering in Botswana. So Builders now has click-and-collect inside Botswana. It has a store in Gaborone and Francistown. But we think it's the first retailer to offer pure online shopping and click-and-collect in Africa, which is very exciting.

You'll be aware that Makro has run a very successful ZAR 100 campaign for years. Suppliers love it, customers love it. And we've also mimicked that inside Game, to great success, in its -- Game's own program, but it will be the same items on the promotion.

And then, of course, good business. Doing good business is very important to us. And something that I'm particularly proud of -- and Brian, where's Brian? Brian and his team has taken the most credit for our success in our Supplier Development Fund. You will remember that one of the conditions of the Competition Commission when Walmart bought us was we have to establish the Supplier Development Fund. And I think we have sort of set the benchmark on how to do it. In fact, we've spent time with several ministers as they want to understand how we got it to work so effectively. We believe that, cumulatively, we've bought about ZAR 1 billion from small suppliers who we either put in seed capital or we helped them redesign their plant or we gave them industrial engineers to improve their product quality or spec. And we're seeing great success in it.

You would have seen the solar paneling that also acts as shade in your -- for your cars in Makro. And that is saving us a lot of money. We're also one of the few retailers who truly has lots of standalone stores. So we can put solar panels on our roof, provided we've got the right strength roof structure, and we will increasingly use more and more renewable energy in our businesses.

And then I think this is a particularly powerful slide, and so I want to spend a little bit of time on it. So this is us testing spontaneous consumer awareness. And I say consumer, not customer because if you walk into a Game store and ask a Game customer, do you like Game? It's like going to a Liverpool Supporters Club and saying, do you like Liverpool? But if you just intercept someone walking through a shopping mall who is just a consumer and you say, "Who comes to mind first when you think of these items?" You can see that Game, Game is mentioned first in every single one of those items. I think it was 1,000, 1,200 customers, Brian? Okay. Consumers, excuse me. So incredible brand awareness amongst our target customers in Game. And so when the environment turns favorable for selling more general merchandise and more games, a typical product category [is Heartland], we -- the customers will come to us first.

Similarly, Makro comes up as the second choice, a very close second, Doug, in case you're worrying, in -- what's that, 5, 5 or 6 of those categories. And then, of course, Builders Warehouse is a strong second choice. And then once you'd get into sort of tools and home improvement, of course, it will be a first choice. But a very powerful slide about how strong the Game brand and its awareness is. And that, when the consumer cycle turns more favorable, we believe that we will be the first to be shopped at.

Obviously, everyone pays attention to the outlook statement. It's extremely difficult to give useful guidance, but you'll appreciate that we're not optimistic just given that we give you a sales update for the 7 weeks since June, and you can see quite clearly that sales growth has slowed further since June. It's actually slowed across almost all of our businesses except Game South Africa where it's picked up a bit and -- or actually quite nicely, and we -- that is mostly on the food side. So sales growth has slowed since June. We've got some very ambitious plans and projects in mind to try and have a better second half. And so we're giving you, on an IFRS 16 basis, we will be about 100% down on last year for the full year. And on a non-IFRS basis, we'll be about 50% down on last year, provided the economy doesn't weaken further.

That brings me to the end of the presentation. I'm happy to open to Q&A on the floor or through the website.

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Questions and Answers

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Unidentified Analyst, [1]

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It's Victoria from Bank of America Merrill Lynch. I just have a question on the earnings outlook for the full year. It looks like quite a big recovery for the second half. What's driving this given trends in the last 7 weeks have actually weakened?

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Alan Johannes Van Lierop, Massmart Holdings Limited - Advisor [2]

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Yes. It's -- just to remind you that because of our general merchandise product mix, quarter 4 of every year is always enormous for us. But December is a double month, for example, and Black Friday is big for us as well. So just mathematically, the second half would be strong anyway. We're not -- we haven't dialed in any sales improvement. We've dialed in better expense control or improved expense control. And we've dialed in some better margin management. But we've done nothing sort of overly ambitious. The second half will still be below last year's second half, so it's going to be better than last year.

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Unidentified Analyst, [3]

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And just one more question. On Game, are things settled there now with replacing head office staff and getting new employees in? Just an update on that division.

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Alan Johannes Van Lierop, Massmart Holdings Limited - Advisor [4]

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Yes. Obviously any management change creates some uncertainty and it takes time for people to settle down and get used to new working styles or new priorities. We've not just changed the Merch Director. We've got a new Finance Director in there as well, a new Marketing Director, and they're all making their own impacts, and I believe, very positively. I think Neville has gone a long way to settling the team down. He's a seasoned pro, forgive the expression, and he is really sorting out the merch structure. It's obviously a leadership challenge to keep heads up with this sort of performance. But that's what we get paid to do is to lead our teams.

You will also note a sense that the -- they're pushing the IT implementation out is sort of not ideal. And so we're needing to work hard to keep the IT folk motivated, which we're succeeding at and keep the business focused on -- or now focused on Black Friday in quarter 4 and then focus on this ERP switchover next year. So we are very conscious of the challenges that come with management changes and what the performance can do to morale. And we are doing many things to intervene around that.

Mr. Rosenberg?

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Unidentified Participant, [5]

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Mr. Hayward, I noticed that there's been a massive adjustment of ZAR 10 billion into the lease liability item. And it's a long note explaining why this has come about. It's an IFRS requirement. The problem I have in getting around this adjustment is that a year ago, you didn't owe the money to anybody. Now who do you owe the money to by making this adjustment because it does appear under noncurrent liabilities. Who is going to get that money?

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Guy Robert Hayward, [6]

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So it is the -- I'll have to use my words carefully. It's the accountants who've come up with this invention. A year ago, we had a 10-year lease with IPG, Investec Property Group, for [Game Voice] or whatever, in a Game in Mall of Africa. And that would -- you would have seen 2 things that I'll note. You would have seen an annual charge, being a lease charge, and you would have seen a lease commitments note, which would -- which should be -- which would aggregate the next 9 years' worth of that lease payment. Under IFRS, those -- that 9 years' worth of lease payments are now capitalized. So you discount them forward, let's say, it's ZAR 100 million, you raise the liability ZAR [400] million, and you raise an asset, being the store, ZAR 400 million. As the aggregate of all our stores gets to ZAR 10 billion. So actually, our risk profile hasn't changed. Our lease profile hasn't changed. Our cash profile hasn't changed. We now just capitalize what used to be off-balance sheet and better costs.

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Unidentified Participant, [7]

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In other words, this is the total that's to be paid over the life of all the leases. Is that correct?

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Guy Robert Hayward, [8]

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Correct, correct. Thank you, sir. It's causing a lot of -- it's the financials -- the banking ..

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Unidentified Participant, [9]

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I don't mind you mentioning the accounting a bit.

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Guy Robert Hayward, [10]

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The 4-letter IFRS word. It's -- everyone's getting used to the new accounting under IFRS. The banking sector isn't quite sure how it's going to manage covenants and what our covenant is going to be. We're not sure, for example, what dividend policy should be, is it on HEPS, is it on free cash flow. So it's going to unsettle everyone for a while. We have -- we haven't we [first] out on this. And I think the next retailers to report under IFRS 16 will be the September year-end, Spar and Pick n Pay, I think. Sure.

Any questions?

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Unidentified Participant, [11]

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In the second half of the year in terms of IFRS, have you taken most of the pain for the time being? And will we see a major turnaround in 2020 numbers?

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Guy Robert Hayward, [12]

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So you'll appreciate that the earlier you are in your lease profile, the higher your liability. So to Mr. Rosenberg's question, if you're in year 1 of a 10-year lease, you're capitalizing 9 years of payment. If you're in year 7 of your lease, you're capitalizing 3 years of payment. On average, we're at about 5.5 years through our cycle. So in a year's time, the lease liability will be reduced by another year. We think that -- we think it works in our favor mathematically from 2 years' time. So not next year, but the year after, we believe we get into the average age being old enough that the IFRS starts working in your favor.

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Unidentified Participant, [13]

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So it will be around then -- over the course of time then?

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Guy Robert Hayward, [14]

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Yes, but not next year. Next year I think -- I'm looking for someone to nod. Next year -- it's 2 years, 2 years. Next year not -- does not get easier -- lower. The year after, it gets lower.

Any questions on the web? Excuse me.

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John Morris, BofA Merrill Lynch, Research Division - Director, Senior Strategist on the EEMEA Equity Strategy and Investment Strategist for South Africa [15]

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John Morris from Merrill Lynch. I was just wondering what Walmart's strategy is for Massmart in the medium and long term.

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Guy Robert Hayward, [16]

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Sure. At the end of Q&A, Mitch is going to pop up and address you just briefly. I don't think it's changed at all. They've owned us for 8 years. And sending one of their best guys, I think, is a message in itself. But I'll toss that to Mitch to answer in a few minutes. Any questions on the website?

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Alan Johannes Van Lierop, Massmart Holdings Limited - Advisor [17]

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Guy, I'm going to give the opportunity for anyone on the conference call first. Any questions from the conference call?

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Guy Robert Hayward, [18]

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There's also a question.

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Operator [19]

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There are no questions on the line.

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Alan Johannes Van Lierop, Massmart Holdings Limited - Advisor [20]

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Thank you.

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Unidentified Participant, [21]

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In the Masscash division, the loss that's there is greater than -- so it's equal to the profits that you delivered for the full year. So you lost the ZAR 187 million that you made for the full year, and yes -- and the loss is even higher than what you achieved in the first half. Can you just give us color on what exactly were the big line items that's attributed to that? Is it the life -- useful life readjustments? Or just looking at the numbers, I can't quite get to the magnitude in the swing.

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Guy Robert Hayward, [22]

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Fair. It was 2 things -- 2 headlines, if I could. 3? 3 headlines. Despite strong sales in the wholesale business, our margin was below last year. So our margin growth was well below the expense -- excuse me, well below the sales growth. So we gave up money there. We've opportunity cost there. The sales growth in Cambridge at 2.9%, although it's comparable with competitors, was just way lower than expense growth. And then finally, in expenses in both -- or in particular, in wholesale, we saw bad debt start to pick up, security costs pick up, shrinkage pick up. So very crudely, margin lower than last year and expense growth above sales growth. Done.

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Unidentified Participant, [23]

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And the benefits from the restructuring, have those come through or are they delayed?

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Guy Robert Hayward, [24]

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They have come through, but they're sort of -- they lost in the -- well, they've come through. We've banked them. But the margin challenge and the greater expense challenge is higher than the expense savings or the restructure. I think we said it would be ZAR 35 million would be the expense savings, and we've seen that.

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Unidentified Participant, [25]

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[Ian Drew Sean], [Institute of Investor Relations]. Just looking at Slide 11, ForEx, interest and tax. See there's been quite a significant turnaround in the movement from ZAR 23 million profit, ZAR 81 million loss, ZAR 105 million turnaround. Is that because of the extreme volatility of the market because [that has gained] ? There is more volatility? Or you're running bigger positions?

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Guy Robert Hayward, [26]

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No. We are some sort of seasoned African veterans, and so we know that the smaller your net asset value in Africa, the better, because, of course, your maths will draw it off the size of your net asset in Africa. So we maintain very small net positions in Africa to the extent possible, but the currency weakness in Nigeria and Zambia in May, June was profound. If I'm not mistaken, that ZAR 81 million loss at June was only, I think, ZAR 20 million 2 months earlier. So our position didn't change. The currency has just absolutely collapsed.

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Unidentified Participant, [27]

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It's not surprising you talk of a brutal environment.

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Guy Robert Hayward, [28]

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I could use other words as well, but I'll stick with that.

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Unidentified Participant, [29]

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Can you just say, under the current labor laws that we have in the country, what options do you have to readdress your employee base?

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Guy Robert Hayward, [30]

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Well, a tough question, but good question. Look, I think the insourcing laws that were implicit -- enshrined in the new LRA, I think, were good, and I think many people were outsourcing staff. We're using outsourced staff we've actually been using for 10 years. They're employees. So we happily brought those folk on board onto our books. And the cost that changes really is that they now earn the normal employee benefits, medical aid and retirement, et cetera. So the costs of in-sourcing someone goes up between 10% and 15%. I think in this environment, you don't easily shed jobs. But I think what you do is you allow flexible working hours, obviously, in agreement with the employee and the employer. And one of the best ways to achieve that is to get a -- have a sophisticated IT system, which is called Workforce Management, where, on a quiet Monday, you only need 40 people in your store, but on a crazy Saturday, you need 300 people in your store. And so there are employees who like flexible working hours. Maybe they only want to work Fridays and Saturdays and Sundays, or maybe they never want to work Friday, Saturday, Sunday, they want to work the previous 4 days. So I think we will not manage the headcount. We will manage working hours and reduce or manage the costs of employment through that.

Simon, can we go to the questions from the webcast?

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Unidentified Company Representative, [31]

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Yes. Thank you, Guy. We've got 3 questions from the webcast.

The first question is from [Denish Ranchaud] from Templeton. And his question is, what is the strategy on Cambridge given the exceptionally competitive landscape, especially in the demographic that Cambridge caters to?

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Guy Robert Hayward, [32]

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It is drive costs down and compete aggressively in the market. I think it's very important in these tough times that you maintain your market share with your customers and with your suppliers. But we do need to reduce our cost base, maybe get out of some stores that are loss-making with this very difficult environment, but reduce costs by mainly an improved margin.

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Unidentified Company Representative, [33]

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Then another question also relating to Masscash from [Dirk van Floundren] from [Fakiso AN].

And it is, in Masscash, was the retail business profitable in H1 or was most of the pain felt in the wholesale division?

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Guy Robert Hayward, [34]

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No. Cambridge was loss-making for the first time in H1.

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Unidentified Company Representative, [35]

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Okay. Perfect. And then there is a question that was asked from 2 different sources. The one is [Stephen Hertz] from 361 Asset Management and the other is Andrew Bishop from Element Investment Managers. And it's around covenants. The question is, what are the emerging borrowing covenants for Massmart, and especially in light of the lower earnings as well as new accounting policies?

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Guy Robert Hayward, [36]

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I believe that there are actually no covenants in place for Massmart. I think that's correct. Do you want to jump in? Okay.

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Mitchell Slape, Massmart Holdings Limited - CEO & Executive Director [37]

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I guess there is one covenant in place with one bank, and that bank has adjusted the covenant levels to take into account IFRS 16, which I think is very positive, and I think most banks would [lean] with that. And that makes up probably only about 10% of Massmart's funding. The rest of the debt is overnight funding, which has no covenants.

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Guy Robert Hayward, [38]

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Thanks.

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Unidentified Company Representative, [39]

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Thanks, Guy. And then there's one last question from Paul Steegers from Bank of America Merrill Lynch. And it's just a question around CapEx. Can you please provide an update on your CapEx plans? What is your budget for the next few years? And what are the big IT projects that require the spend?

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Guy Robert Hayward, [40]

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I'll just pop in my management accounts for the next few years. I won't go into the high level detail. Of course, Mitch and Mohammed will -- may have different thoughts. But very high level, at the start of the year, we had a CapEx plan in place. And I believe by the end of the year, we will have spent 25% less than that. As I mentioned, our space growth that we planned for next 3 years was 7.6%. It's not 5%. So we are pulling CapEx back quite heavily. About half our CapEx this year will actually be on IT, not surprisingly, and that, too, will come to an end. And so the CapEx, I believe, will slow down quite dramatically.

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Unidentified Company Representative, [41]

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Thanks. It's all the questions from the webcast.

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Guy Robert Hayward, [42]

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Nothing else. Anything else in the room?

Okay. Well, it's my very great pleasure to welcome and invite Mitch to join us on stage.

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Mitchell Slape, Massmart Holdings Limited - CEO & Executive Director [43]

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Thank you. Thanks, Guy.

Let me start off by saying, first of all, what a pleasure it is to be here in South Africa finally. Interestingly, my visa process, which has been written about a little bit, was quite fluid with South African authorities. It was all of the police clearances I needed to obtain from all the other countries that I've worked in that was really the hold up. But this is I -- as you know, I'm kind of a lifelong Walmart retailer. This is the 6th market that I've worked in outside of the United States. I'm extremely excited about being here in South Africa. And I wanted to come to South Africa because I believe in the opportunity that we have at Massmart.

One of the things that really attracts me to this job is that we have, as Guy alluded to, we have great brands in this business. But what has been even more impressive to me as I've learned more about the business and I've had an opportunity to talk with people is we have great people. We have really wonderful people who, I believe, are going to help lead us to better places as time goes by. And I'm excited to work with them and have the privilege to lead them as we make this journey together.

I come to South Africa in response to the gentleman's question with a mandate, to a degree, from Walmart, which is we want to build the strongest and healthiest retailer in Africa. And we want to do it with the concept of being powered by Walmart. And you'll notice that in the branding that we have on the screen, it's a not too subtle reference to that. It's an important concept because we have the great privilege of being part of a retail group that spans the world in many different countries, with tremendous ideas, innovation, opportunity to take our business to the next level.

One of the things that I've been asked repeatedly is, "So Mitch, what's the game plan? What are you going to do?" I've been here for 7 days. Actually, I just landed last Thursday. I'm still shaking off the jet lag just a little bit. I woke up at 4:00 a.m. this morning, so it's getting a little better. But I have 3 big priorities that I want to focus on. Priority #1 is really deliver the forecast that we've got right now. We're going to buckle down as a leadership team and we're going to be focused on that. Priority #2 is I really want to engage our people around understanding the power of working together, the concept of being unbeatable together as a Massmart team. And I really want to engage our people around the idea of being powered by Walmart and what that can do for us. So we'll be focused on that together as a team. The third priority is we're going to step back as a leadership team and we're going to take an objective view of the business and where we need to take it going forward. And that's going to be a work in progress. And I know all of you will appreciate that that's going to take some time.

I'm going to be engaged in doing a lot of listening and learning and clarifying and trying to understand, because one thing that I've learned in my travels around the world is that retail is different in every market. Even though we can learn from great retail concepts, the way that it manifests itself, the way that you go to market, the way you serve consumers is different. And I need to learn and spend the time that it takes to really get my arms around that.

When the time is appropriate, in the not too distant future, we'll come back and we'll share with you what those plans, and thoughts and ideas are after we've completed our assessment. And so we'll keep you posted on the timing for that.

I guess the last thing that I would say is I really want to thank Guy Hayward for everything that he's done. You've dedicated, I think, the last 2 decades of your life to building this business and to making it what it is today, and I greatly appreciate that. But more importantly, I appreciate how gracious you've been in transition. In providing advice, thoughts, guidance, it's been wonderful. And so I'd just like to invite everybody, if you would join me in a round of applause for Guy. Thank you very much.

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Guy Robert Hayward, [44]

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Thank you, Mitch. Thank you, sir. That brings us to the close. So thank you so much, and have a good day. Thank you. Thank you, Mitch.