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Doubts on TFG and Truworths

Clothing retailers Truworths and The Foschini Group $($TFG$)$ have long been mainstays of the domestic fashion scene. For

years, Truworths was a front runner in the sector, with strong operational performance and world$-$class metrics making it a

standout performer. But things have shifted. TFG has changed its business model and focused on diversifying itself in

terms of product categories and expanding the number of geographies in which it operates. Where TFG used to be

immersed in mass$-$appeal women's apparel and not operating as efficiently as its competitor, analysts now increasingly see

it as the stock to back. But apparel retail has its challenges. SA had its weakest growth in seven years last year and clothing

retailers were hit hard. Single$-$digit growth is forecast for the sector. Evan Walker, fund manager at $36$One Asset

Management, says the outlook for the SA consumer is still deteriorating and he finds the TFG strategy a bit confusing. $$I

certainly wouldn't be exposed to Truworths yet and I$\text{'}$m not sure about the TFG strategy. It's still a little perplexing for me$.$ It is

moving to the UK where the retail landscape is weakening by the hour. It is not moving to geographies that are shooting the

lights out. It seems to be a bit of a land grab." But many see TFG as the preferred "buy" now. Atiyyah Vawda, retail analyst

at Avior Capital Markets, says it prefers TFG for several reasons. Its growth profile is more resilient as it is less exposed to

womenswear $($a segment of the market that is highly saturated$)$ and more exposed to high$-$growth areas like sportswear.

"Overall TFG$\text{'}$s strategy is the one that is supported," even though it includes a jewellery offering which is struggling due to

the weak economic environment. $$A number of its brands operate in underpenetrated or niche segments which also allows

for more resilient growth," says Vawda, adding that it seems to be gaining market share from Truworths. Vawda points to its

cost structure and room for improvement. It has a wide array of brands, and duplication of roles and costs so there is the

potential for improvement by focusing on cost management. Operating cost growth used to be faster than revenue growth at

TFG$,$ but this is changing. And inventory levels are high because it has slowed$-$ moving stock like jewellery, but this can be

improved "and we're already seeing evidence of this in the most recent results$.$ Vawda says Truworths has a premium

product offering but its product tends to lack innovation. $"$It is a very strong operator, but the top$-$line growth is weak, hence

sustainability of margins is a concern. $"$TFG has gone for mass diversification overseas, and its overall strategy is to have

$50\%$ of revenue from offshore with possibly a listing overseas at some point.

As one analyst points out, the difficulty with diversification is that you can buy stocks as a portfolio manager directly

overseas$$ there is no need to buy it through a local company with an offshore portfolio. TFG$\text{'}$s response is that it can pick

specialty brands and, through that, facilitate ownership of these brands. $$It has definitely improved its operating leverage,

cost centres, management of working capital and allocation of capital," says Kaeleen Brown, SBG Securities equity analyst.

Truworths is on the opposite end. It is sticking to its original nature. It has the best operating retail metrics, operating profit,

margins, return on equity and return on investor capital. $"$It is the best retailer in SA in terms of numbers," says Brown. The

question is how sustainable that is$.$ "Everyone has been predicting the demise of its gross margins and that hasn't

materialised$.$ Alec Abraham of Sasfin Securities says TFG is doing better than Truworths. "The main concern in terms of

Truworths is that, given its position in the market, it has upper$-$income customers looking for internationally inspired fashion.

That puts it firmly in the firing line of Zara, for instance. $$He says of all the SA retailers, Truworths is most in danger from

Zara, yet it seems to have done the least in terms of trying to defend against that danger. "I don't think the loss of market

share of the wallet can be recovered. $$Abraham says Truworths has simply doubled its bet in the space of high$-$income

individuals, buying Earthchild and Naartjie."I don't think it has done enough to defend against the onslaught of Zara.

Strategically it is weaker than it was." The purchase of Office in the UK has given it some diversification geographically,

which was prudent, but it's not particularly big in the context of its business. Abraham says TFG has done a far better job of

diversifying risk geographically and in income groups. It is weighted slightly more to the middle market but also has

upmarket brands like Fabiani and G$-$Star. Geographically TFG is exposed to the UK$,$ Australia and SA$.$ It has been active in

terms of the supply chain with the acquisition of Prestige. Due South covers the outdoor sports scene, which gives access

to the younger market and diversification of merchandise categories. $$From a diversification of risk perspective, they've

done a far better job. It seems the management have been a little more on the ball in terms of managing the business in the

sense of understanding the customer better. $$From a fundamental point of view, Truworths seems to be stagnating in terms

of strategic thinking, says Abraham.Damon Buss, equity analyst at Electus Fund Managers, says strategically Truworths

has the wrong model and hasn't adapted to the new age. "The price points of the product are set too high. The only way

consumers can access the product is through credit. Its credit sales and cash sales growth are both negative, which shows the consumer can't afford the product and is choosing to shop where better value is offered.

$"$We like TFG$.$ Strategically it is doing the right thing in terms of increasing local manufacturing capacity. $$Buss talks of the

new local manufacturing facility in Caledon that gives a huge advantage in terms of flexibility and quick turnaround, which

increases the proportion of on$-$trend product and makes it more competitive with the fast$-$fashion multinational operators like

Inditex $($Zara$)$ and H&M$.$TFG orders a small percentage of what it wants for the start of the season, then it tracks what is

selling well and sends orders to its factories. The factories turn the undyed fabric they hold into finished product on shelf in

stores in under $56$ days $-$ which is quick turnaround, says Buss. The other attractive aspect of TFG is that historically it has

let each of its brands negotiate terms of trade on its own, on such matters as rental and security. Now, it is doing so as a

group and with favourable economies of scale it is able to invest savings into prices and make product cheaper, and$/$or

increase margins. $$Truworths has far less levers to pull in this tough environment," says Buss, adding that while its product

has always been good quality, it is expensive.

QUESTION $2(25$ Marks$)$

Comprehensively analyse the financial impact of TFG$\text{'}$s delay in incorporating post transaction elements into its customer

service strategy