Get in there, Lewis

• South Africa
• Consumer discretionary, Furniture, Lewis, Retail
• January 27, 2021

Get in there, Lewis!

You’ll hear this at the end of almost every Formula 1 race, much to my annoyance as a fan of many other drivers.

The statement is equally applicable to the furniture and appliance retailer that is a favourite among value investors.

Remember value investors? Those highly educated people who take time to make investments, carving out returns of 15% p.a. while the TikTok and Reddit crowd choose what colour Lamborghinis they want?

Only one approach is sustainable. It’s not hard to work out which one.

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Lewis has released strong results for the final quarter of 2020, as sales grew 16.6%. For the nine months from March to December 2020 however, total revenue is only up 3.5%, so the impact of the hard lockdown months can clearly be seen.

If you aren’t allowed to operate, you can’t make money.

Although Lewis targets lower-LSM groups, the consumer realities of lockdown have applied throughout the consumer market: people have been stuck at home and couldn’t spend money on travel and entertainment. Those who didn’t lose their jobs decided to improve their living environments instead.

We’ve seen it in Cashbuild. We’ve seen it in Italtile. We’ve now seen it in Lewis. These companies do different things (with some overlap across Cashbuild and Italtile), but the consumer theme has been similar.

Importantly, cash sales for the quarter grew just under 36% while credit sales only increased 2%. That’s good news for investors who might be feeling concerned about the overall quality of credit in South Africa (like me).

Importantly, and unlike some retailers that blew themselves up with crazy levels of debt on the balance sheet (like Edcon), Lewis runs a relatively low financial risk model. Retail of furniture and appliances is already a difficult space, so it’s been a wise decision to keep the financial leverage down.

I get nervous when companies have too much risk in the system. With a dependable model and steady revenues, you can layer on the debt to drive equity returns. With a riskier model that can swing wildly with consumer health, it’s not smart to owe the bank tons of money as well.

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However, there is still risk in Lewis beyond the ability of consumers to keep buying furniture. Like any furniture retailer, Lewis does have a considerable debtors’ book. For the nine months to December, collections only averaged 69.5% vs. 77% for the comparable period in 2019.

My worry is whether we will see this level of consumer spending sustained into 2021. Thousands upon thousands of South Africans lost their jobs in 2020 and the job market isn’t exactly booming. Many have spent several months living off slush funds, withdrawn retirement savings and perhaps even loaded up the credit cards.

This wouldn’t have stopped people from trying to buy a little happiness through a new TV or fridge from Lewis, or the home improvement project they always wanted to do through Cashbuild or Italtile.

Lewis is a R1.8bn company trading on a Price / Earnings (P/E) ratio of 8.5x. Italtile is worth over R20bn on a more demanding P/E multiple of 19.4x. Cashbuild is in the middle, with a market cap of around R6.7bn but an even higher P/E ratio of 23.7x.

If the music stops for discretionary consumer retail in South Africa, I would rather have paid 8.5x than over 20x for this trend. Italtile has been a dependable performer and has a powerful market position, but I can see why value investors seek out companies like Lewis.

Lewis is currently trading at around R25 per share. There is a huge resistance line at around R30 per share, which means the share price will really struggle to break above that and will need highly convincing results to do so.

Still, there’s a 20% return between the current level and the resistance line for those swing traders who are feeling a little brave. Will they close that gap?

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