ONLINE ANNUAL REPORT 2010

MASSWAREHOUSE DIVISIONAL REVIEW

Despite trading in a difficult consumer market in South Africa, Masswarehouse delivered a solid performance with four Makro stores achieving record sales in excess of R1 billion for the period under review. The Division also achieved R4 billion worth of general merchandise sales and more than R2 billion in liquor, both for the first time.

Despite the national retail chains continuing their expansion into the liquor market, it was a noteworthy achievement that we reported 17.8% sales growth in liquor and therefore gained market share. We also managed to reduce our average stock holding by R37 million or 3.2% of inventory, while substantially increasing in-stock service levels and rolling out forecasting and replenishment IT systems across our business.

Makro stores successfully implemented a 2010 FIFA World Cup-related merchandise and sales strategy, helping to drive R70 million worth of sales during the tournament.

Our two stores in Bulawayo and Harare in Zimbabwe have been excluded from our financial figures since 2007.

THE MAKRO FORMULA

The Makro retail model is unusual in that it sells general merchandise to retail customers, while most of its food and liquor is sold to wholesale customers. This blend gives the brand a robustness that enables it to trade comfortably through most economic cycles. The big-box warehouse club format with our no-frills approach keeps costs down and provides the platform for our high-volume, low-margin sales offering of quality branded merchandise. Our customer database generated by customers’ Makro store cards used at the point of purchase helps us to keep track of the spending patterns of our 1.5 million active members and we communicate regularly with them through targeted promotional material.

  • Now 13 stores in SA
  • Operating in SA, Zimbabwe
  • Food/liquor/general merchandise
  • Liquor and general merchandise LSM 6 Ė 10 and food LSM 2 Ė 6

Insight

Living Standards Measure (LSM)
The South African Advertising Research Foundation (SAARF) Living Standards Measure (LSM) has become the most widely used segmentation tool in South Africa. It is a means of segmenting the South African market that cuts across race, gender, age or any other variable used to categorise people. Instead, it groups people according to their living standards.

OUR VALUE PROPOSITION

Makro’s offerings are tailor-made to fit a variety of customer needs across all our merchandising categories.

Our food offering caters to wholesale shoppers ranging from informal traders and grocery store owners to hoteliers, restaurateurs, offices and schools. Wholesale customers account for up to 75% of Makro’s food sales and most shop during the week for the convenience of our wide range of good value, quality consumables. At weekends, our focus shifts to promoting good buys for retail food and grocery shoppers who can achieve substantial savings on their monthly household basket compared to other mass retail outlets.

Our liquor offering also caters to both the retail and wholesale customer. Our liquor outlets, immediately adjacent to our main outlet, continue to increase their range of premium brands, especially in wine and whisky. These products are sold at a low margin to maintain and grow our share of the market. At the same time we have maintained a strong presence in beer and budget brands for liquor wholesalers looking for good value.

OUR OPERATING ENVIRONMENT

Highlights

  • General merchandise sales reach R4 billion for the first time
  • Improved B-BBEE rating to Level 4 contributor
  • Dropped stock levels and improved service levels
  • Four new stores to be opened in next four financial years

It was another tough year for retailers and the impact of the nationwide job losses in 2009 affected both the food and liquor side of our business. This was compounded by general merchandise experiencing recessionary trading conditions while the food category experienced high deflation. Consumer confidence improved somewhat in the second half of the financial year, partly as a result of the World Cup, and so we saw an increase in the demand for general merchandise from early 2010.

Operating margins came under pressure, driven by a shift towards greater promotional spending by customers, heightened competitor discounting in the market and disinflation within the food category. Faced with these trading challenges, we managed to rein in Wexpenses and reported expense growth of only 4.8%, well below inflation. This was despite slightly higher volumes through our stores and huge increases in electricity tariffs. Personnel costs grew just 2.8% and we managed this through tighter labour scheduling and by reducing headcount through natural attrition, without resorting to retrenchments.

Operating margins contracted slightly in 2010. All three major categories’ margins declined, with the greatest decline being in General Merchandise. The exception was our cellular business where margins improved as a result of a change in mix from contract to pre-paid business, a direct consequence of the 2009 introduction of the new Regulation of Interception of Communications and Provision of Communication-Related Information Act (RICA).

The impact of the 2010 FIFA World Cup changed the momentum of our sales patterns not only across obvious categories such as soccer balls and television sets, but also in food and liquor as corporate customers increased their entertainment spend during the tournament.

In previous years, Makro saw sales to foreign customers from neighbouring countries grow rapidly, this trend however, slowed as a result of the stronger Rand and with economic activity declining in Zimbabwe.

During the year we refurbished our largest and most profitable store, Germiston. Our new store in Vanderbijlpark will open in October this year (2010).


FINANCIAL PERFORMANCE

    2010 2009 2008 2008
    52 week 52 week 52 week 53 week

Sales

Rm 11,501.2 11,102.4 9,912.0 10,103.8
Trading profit before interest3 Rm 700.8 713.0 616.0 640.3
Trading profit before interest as % sales % 6.1 6.4 6.2 6.3
Operating profit before interest Rm 680.7 718.6 615.9 640.2
Operating profit before interest as % sales % 5.9 6.5 6.2 6.3
Net finance costs Rm 57.8 89.6 88.1 90.6
Trading profit before taxation3 Rm 758.6 802.6 704.1 730.9
Trading profit before taxation as % sales % 6.6 7.2 7.1 7.2
Operating profit before taxation Rm 738.5 808.2 704.0 730.8
Operating profit before taxation as % sales % 6.4 7.3 7.1 7.2
Inventories Rm 1,161.0 1,159.2   1,043.6
Inventory days days 44 45   45
Net capital expenditure1 Rm 77.3 102.3   153.7
Cash flow from operating activities Rm 246.3 145.5   286.3
Number of stores   13 13 13  
Trading area m2 118,208 117,859 117,859  
Average trading area per store m2 9,093 9,066 9,066  
Number of employees   2,644 2,805 2,770  
Sales per store R000 884,708 854,031 762,462  
Sales per m2 R000 97 94 84  
Sales per employee R000 4,350 3,958 3,578  
1 Net capital expenditure is defined as capital expenditure less disposal proceeds.
2 The ratios have been calculated using year-end balance sheet figures.
3 Trading profit is earnings before asset impairments, BEE transaction IFRS 2 charges and foreign exchange movements.
4 The above results exclude Makro Zimbabwe. Details can be found in note 8.
5 Definitions/explanations to the ratios and terms above can be found here.

Store progress

Makro  
Opening balance 13
No store movement during the current year
Total stores in 2010 13
* Excluding two Zimbabwean stores, deconsolidated since 2007.  

Sales for the year totalled R11.5 billion, up 3.6% over the past year. Food and Liquor contributed 63.3% to total sales (2009: 63.6%) and General Merchandise 36.7% (2009: 36.4%).

Trading profit before interest and taxation of R700.8 million was 1.7% lower than the prior year and grew below sales growth. Working capital management remains a strength of Makro and this year was no exception. Due to lower commercial interest rates, trading profit before taxation of R758.6 million was 5.5% lower than the prior year. The Division’s resultant return on sales (profit before tax/sales) of 6.6% was very satisfactory given the difficult South African consumer environment.

Capital expenditure for the year amounted to R77.5 million, down on the R102.6 million spent in 2009. This was partly due to delaying some replacement and refurbishment in recognition of the difficult business environment. Material investments during the year included R15.7 million for various store refurbishments (2009: R34.1 million); R11.3 million on IT replacements and upgrades (2009: R19.9 million); and R16.2 million on the construction of the new Vanderbijlpark store of which only a small portion of the spend is included in 2010. In addition, R4.1 million was spent on an Eskom Demand Side Management project to install energy-efficient lighting in all stores.

A reduction in closing inventory of R1.8 million (0.2%) compared to June 2009 was achieved despite higher volumes and increased cost of stocks. A 20% improvement in the Stock Funding Ratio (an indicator of the level of inventory funded by trade payables) was also achieved. There was a six-day improvement in stock turns and seven-day improvement in the working capital cycle, resulting in an increase of R194.7 million in cash at year-end.

TRADING PROFIT BEFORE TAX RETURN ON SALES

Actual 2010 Medium-term target International benchmark Metro AG C&C

6.6%

7.0%

5.0%

Trading profit before tax return on sales has been calculated using profit before tax adjusted for asset impairments, the BEE IFRS 2 charge and net foreign exchange movements.


IMPROVING EFFICIENCIES

We continue to drive process optimisation by leveraging our existing IT infrastructure and applications. An advanced SAP Forecasting and Replenishment solution that was first implemented 18 months ago, continued to be steadily rolled out across suppliers and we were able to significantly reduce stockholding in the stores while at the same time increasing in-stock service levels.

During the reporting period we streamlined the in-bound supply chain, implementing a revised logistics process whereby stock ordered from suppliers was picked up at the supplier’s premises or warehouse as opposed to being delivered to Makro stores by the supplier. The initiative was successfully piloted with our key sugar suppliers and will be expanded across more product categories in the coming year.

When we moved to our new purpose-built head office in Sunninghill, Sandton, in April 2010, we deployed the latest network and telephony infrastructure. The move to an IP-based telephony solution is in partnership with Alacatel-Lucent and Cisco. This has established a platform for future IP-based communications across Makro and the Massmart Group.

We continue to refresh our technology by replacing point of sales devices across three stores towards the end of 2009, with no disruption. The new devices not only limit potential down-time, but enhance customer service and enable us to deploy more energy-efficient technologies across our stores.

In order to improve pricing accuracy and enhance customer service, we successfully implemented an Electronic Shelf Edge Labelling solution at the Makro Woodmead liquor store and will look to roll it out to other stores.


INVESTING IN AFRICA

Our operations in Zimbabwe remain deconsolidated from our financial results. Our stores in Bulawayo and Harare are profitable but will require large investment to enable them to carry sufficient stock to grow significantly. Uncertainty around that country’s proposed Indigenisation legislation has meant that we have had to delay this investment for the time being. If enacted, it appears that this legislation would force foreign-owned companies to sell a majority shareholding to indigenous Zimbabweans.

We continue to look for attractive investment opportunities, including opening new Makro stores on the rest of the continent, though first and foremost we remain focused on growing in the South African market.


INVESTING IN OUR HUMAN RESOURCES

Read more

More information on the Groupís investment in Human Capital

Corporate Accountability

The retention of quality management and staff remains a priority for our division. We maintain low levels of staff turnover due to our policy of offering our staff fair and market-related remuneration, rewarding incentive schemes and consistent world-class training and development opportunities.

We performed exceptionally well with our B-BBEE scorecard, improving from a Level 6 contributor at 50.4% to a Level 4 contributor with 65.6%. Our pipeline of black employees is robust, with 78% of our skilled technical staff; 51% of professionally skilled staff; 16% of our senior management; and 25% of top management being black.

With staff turnover being low, one of the biggest challenges is to find suitable empowerment candidates at the top, senior and professionally qualified management levels. There are however, a number of programmes in place to develop future talent across all levels including those targeting graduates, school learners, as well as junior and senior management.

During the reporting period, ten employees graduated with a Retail Management Diploma and three cadets completed their BCom degrees. We also granted loans to black wholesale customers of R4.5 million and made more than R45 million in early payments to black owned suppliers.

In addition, we provided training, marketing expenses and discounts to various Banner Groups. These members meet to select products for upcoming specials and members’ Makro cards are loaded with details of the promotional prices. SMS alerts are sent to them when their discounts have been activated. In this way we’ve helped many small entrepreneurs grow their businesses.

INVESTING IN OUR COMMUNITY

Read more

More information on the Groupís investment in Corporate Social Investment

Corporate Accountability

Each Makro store sponsors CSI initiatives that help the local communities in which they operate. At a divisional level Makro continues to sponsor 500 meals a day through the African Children’s Feeding Scheme which reaches children in poor communities in Soweto. We also provide food to the Centurus Trust Feeding Scheme which serves 400 meals a day to children in the farm schools around Hartebeestpoort Dam near Johannesburg.

In keeping with our focus on sponsoring projects that improve education, we donated R1.2 million in vouchers for 35 schools in the Excellence in Education Awards, an initiative which recognises the exceptional improvement in a school’s Matric results. The vouchers can be used to buy stationery, educational aids and sports equipment.

Makro also partners the Starfish Foundation and the Thandanani Community-based Organisation which provide support to orphaned and vulnerable children affected by HIV/Aids.

The division supports the Vacation Schools initiative, which is run by the Tomorrow Trust. This project provides mentors as well as educational and community support to students from vulnerable households to bolster their secondary studies.

INVESTING IN OUR ENVIRONMENT

Read more

More information on the Groupís investment in Climate Change and Environment

Corporate Accountability

Building our new Makro store in Vanderbijlpark has given us the opportunity to install the latest energy-saving technologies. Most exciting is the store’s 100% green refrigeration plant. This will not only consume just half of the energy required by traditional refrigeration processes, but will also use sophisticated technology to reclaim all heat generated by the refrigeration units to heat hot water geysers. The building will also utilise high efficiency freezer glass doors and automated sliding doors to reduce the energy needed to keep our products cold by 70%, as well as using natural lighting for the trading floor, saving approximately 48,000Kwh per month. Motion detectors activating the overhead lighting will also be installed in all offices.

In conjunction with Fujitsu IT Company, Makro E-waste container hubs at all Makro sites have been widely used by the public. The containers provide a way for customers to safely dispose of their electronic waste such as laptops, desktops, printers, monitors and cell phones. These are then reused, recycled or deployed, preventing hundreds of kilograms of electronic waste ending up in the country’s landfills.

We were also the first retailer in SA to embark on a programme with Eskom where rebates were offered to customers who exchanged their old electric cooking appliances for gas cookers. Eskom is also currently undertaking a light bulb exchange programme at various Makro stores.

We now offer three recycled stationery brands under the brands Remarkable, Renewed and Recycled. These are available in the stationery department as part of our Eco-wise offering.

Wherever possible, our merchants are requested to support products that are green, such as ensuring that the wood used by suppliers is from sustainable forests and is certified by the Forest Stewardship Council (FSC).

As part of our sustainability drive, we embarked on a store-wide IT infrastructure and server consolidation project utilising the latest virtualisation technology. This helped us to significantly reduce the infrastructure required to operate stores successfully and to reduce each store’s carbon footprint. The approach will now be adopted for all future store rollouts and technology upgrades.

RISKS AND REWARDS

The South African economic environment remains uncertain and volatile. In this environment, knee-jerk responses by our competitors and suppliers to slash prices can disrupt commercial activity. We mitigate this risk by sticking to our model of driving volumes off a low-cost structure.

Any future weakening in the value of the Rand will lead to higher inflation in food and general merchandise, and therefore possibly higher interest rates too, and so we remain focused on managing our costs and pricing accordingly.

Some South African provinces have still not finalised their liquor regulations and our attorneys remain engaged with the authorities to address licence-related issues.

In order to meet the requirements of the forthcoming Consumer Protection Act, training sessions were held to help educate staff and vendors about the new regulations. All our buyers and merchants have attended and a website has been created where vendors can download quality assurance certificates.

We also appointed a new ethics officer during the reporting period who manages all ethics-related calls to our tip-off line. Most of the 64 calls received were related to HR issues and almost all calls suggesting potential fraud or misappropriation were investigated and shown to lack foundation.

During the year we also designed, implemented and embedded a Makro Risk Framework to provide a structure within which risk management, risk reporting, compliance, governance and internal control self assessment can be managed and directed.

FUTURE OUTLOOK

Our strategy at Makro remains one of securing a greater share of our customers’ discretionary spending. We do this by offering more exclusive deals and focusing on everyday low prices. By being 7% – 8% cheaper on a basket of goods and not limiting quantities, we are able to reduce the overall cost of a monthly shop for our customers, making sure customers see value in a bulk buy and that they keep coming back.

Makro’s new store in Vanderbijlpark represents another excellent growth opportunity as we will be able to access an entirely new customer base.

Makro will also utilise the buying power of our commercial clients. By supplying them with a wider range of products, from their office equipment right down to their tea and coffee, and by expanding our service delivery, we plan to drive mutual growth with our top suppliers and business customers over the coming year.

Masswarehouse directorate

Grant Pattison
Chairman

Kevin Vyvyan-Day
Chief Executive

Bruce Cayzer
Food Director

Guy Hayward
Non-executive Director

Garry Hendry
Liquor Director

Doug Jones
Financial Director

Derick Kalan
General Merchandise Director

Gert Lourens
Operations Director

Chris Nezar
Marketing Director

Pieter Schoeman
IT Director

Llewellyn Steeneveldt
Non-executive Director

Ilan Zwarenstein
Non-executive Director

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