ONLINE ANNUAL REPORT 2010

CHIEF EXECUTIVE OFFICER’S REVIEW

After five years of a strong consumer economy in South Africa which boosted net operating margins, the 2010 financial year was the second consecutive year that Massmart’s net operating margin declined. As the effects of the global economic crisis filtered through to the African economies, sales growths declined below expense inflation.

Grant Pattison
Chief Executive Officer

Prior to the global economic crisis, we believed that South Africa and Africa had an exciting consumer growth story where mass-merchants such as ourselves would have an increasing role to play in society, bringing good quality and well-priced goods that enhance consumers’ lives. We still believe in this exciting opportunity but feel that it has been briefly postponed due to the crisis.

So our response to effects of the crisis was threefold. Firstly, we did not try to predict the future but rather managed the business tightly to the most recent trading and economic trends. Secondly, we traded with confidence, certain that consumers would respond to value more so than ever. And thirdly, we continued to invest for longer-term growth, taking advantage of the opportunities that presented themselves in property, acquisitions and talent.

FINANCIAL PERFORMANCE

Our 2010 second-half results suggest that the South African consumer has begun to recover as for that period the Group increased sales by 14.4%, operating profit before foreign exchange losses by 9.7% and headline earnings by 29.0%

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More detail on the financial performance can be found here

Chief Financial Officer's Review

The Group’s full-year financial performance, however, bears the scars of the challenging first half with the year’s sales increasing by 10.0%, operating profit before foreign exchange losses increasing by 0.1% and headline earnings decreasing by 5.7%.

With Group comparable-store sales growth of 2.6% and product deflation of 0.4%, we therefore saw volume growth across all categories. With this level of comparable sales growth however, it was critical that we closely managed expenses and so comparable expenses increased by only 2.8% for the year.

The large difference between total sales growth of 10.0% and comparable sales growth is indicative of the Group’s continued investment in growth, with store space increasing by 8.5%, of which 3.1% is in new stores and 5.4% through acquisition.

Excellent control of expenses, margin and stock protected the income statement, enabling us to grow operating profit before foreign exchange losses by 0.1%.

Definitions

Comparable sales

Comparable sales are sales figures quoted for stores that have traded, and will trade, for all 12 months of the current and prior year. These stores’ sales would therefore exclude new store openings or store closings in the current and prior years.

After adjusting for foreign exchange losses operating profit reduced by 4.3%.

Independent data sources indicate that the Group has been trading well relative to our competitors in all major categories and has gained market share, particularly in large ticket items such as Multimedia, Technology and Appliances.

ENVIRONMENT

The South African economy has technically been out of recession for almost four quarters but the recovery in real retail sales growth lagged by six months and job creation is stagnant.

Group product inflation -0.4%
Food and Liquor 1.4%
Home Improvement 1.8%
General Merchandise -5.3%

The effect of the strengthening Rand dominated trading conditions and kept inflation low in all our product categories with Food and Liquor inflation at 1.4%, General Merchandise in deflation at 5.3% and Home Improvement inflation at 1.8%. Historically, Food and Liquor volumes do not respond significantly to lower prices and did not do so over the past year. General Merchandise and Home Improvement volumes however, usually do respond and this was particularly evident in the latter part of the financial year.

The 2010 FIFA World Cup was an exciting, once in a lifetime experience for the country and we could certainly see the increased spend in our stores over that four-week period. We estimate this to have been R200m – R300m of additional turnover, not significant in the year but welcome nevertheless.

Labour relations were unfortunately strained in Massdiscounters as management sought more labour flexibility from the labour union, SACCAWU, in order to extract productivity improvements from our three-year investment in the supply chain. Unfortunately, we were unable to reach resolution and had to resort to retrenchment, which was devastating for those employees. We have provided, and continue to provide, those retrenched employees with as much support as possible. As a result of these labour disputes, there were some isolated labour-related disruptions to trading. More significantly however, the Game Lakeside Mall store in Benoni was deliberately destroyed by fire. We continue to co-operate with the police as they progress their investigations and the store will re-open in November 2010.

OPERATING REVIEW

There were a few operating highlights this year: costs were tightly controlled increasing by only 2.8% on a comparable basis, working capital was well-managed releasing R292.6 million in cash, and capital of over R1 billion was spent in maintaining, improving and expanding the business.

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Operational Review

Overall we traded well and most measurements suggest we held or gained market share. In Food, the year began with wholesale volumes declining as deflation caused the system to destock and gross margins were lower as inflation profits turned into deflation losses. In General Merchandise, which was in deflation, sales volumes only responded in the second half and grew well. In Home Improvement, home owners spent confidently in our stores on what appeared to be mostly maintenance and home improvement categories, and spent less on the refurbishment and building categories.

From a retail perspective, we focused on relevant product ranges with lower price points, offered aggressive prices in promotions and trading, and cleared slow-selling products early as cost-prices declined.

Including acquisitions, this year we added 92,000m² of trading space, representing 8.5% more space. There were no new Makro stores in South Africa or new Game stores in Africa, but we expect to see progress on both those fronts in the 2011 financial year.

We did not make sufficient progress with improving customer service (advice and sales) in our retail businesses, although our in-stock service levels have improved. In Builders Warehouse we remain relatively poor in servicing the home improvement contractor.

We also made insufficient progress in re-positioning Builders Trade Depot with a completed range to properly service general and specialist residential and commercial building contractors. Of the 13 businesses acquired during the year, only one has underperformed.

SUSTAINABLE DEVELOPMENT

Last year I acknowledged self-critical concerns in this arena that included: the high percentage (31%) of HIV positive employees not registered on the Massmart treatment programme; our poorly structured approach to improving energy efficiency; indifferent implementation of our Eco-wise initiative; and our failure to invest 1% of profit after tax (PAT) in Corporate Social Investment (CSI) initiatives in our African operations.

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Corporate Accountability

Not all these concerns have been fully resolved in the 2010 financial year but I am encouraged by the progress that has been made. Changes to the way in which our HIV/Aids treatment programme is managed has led to closer monitoring by the business of our service provider, better information for divisional Human Resources Directors and more intensive follow-up protocols with HIV-positive employees. Early successes include the registration of 20 HIV-positive employees onto the programme in one month.

I am an electrical engineer by training and was concerned about our ad hoc approach to implementing the energy efficiency initiatives that are important to our objective to reduce Group carbon emissions. A review was conducted and it became clear that there was an urgent need to improve the accuracy of electricity consumption data. So we extended the scope of a project to install independent electricity metering in more stores across the Group. As a result, we are now able to evaluate and target energy-savings initiatives more effectively. Disappointingly this has revealed that our objective to reduce energy consumption by 12% by June 2011 is unlikely to be achieved. We are, in the context of more accurate consumption data, reviewing this target and will have a clearer perspective of the way forward in December 2010.

In 2008 Eco-wise was developed by the Group private label merchants to promote environmentally responsible merchandise. Last year I expressed concern that we had promoted only four Eco-wise lines during the year to June 2009. We have performed considerably better this year, having promoted approximately 34 Eco-wise products. A personal highlight was a profitable Builders Warehouse promotion that offered a comprehensive do-it-yourself range of energy-efficient solutions for the home. These included products such as wireless-controlled electricity consumption monitors, geyser blankets, solar geysers, occupancy sensors, compact fluorescent light bulbs and energy efficient wall heaters. Encouragingly, a similar Eco-wise promotion is being developed for launching a do-it-yourself range of water-wise products.

In the case of CSI spending in Africa, I am pleased that we met the 1% PAT policy threshold that is applied in South Africa. Equally important is that we have started working on achieving better alignment between our sustainability initiatives and African retail imperatives, for example advocating better labelling standards for traditional medicines.

Looking ahead, we have a full sustainability agenda that includes maintaining a Level 4 Broad-based Black Economic Empowerment (B-BBEE) rating, aggressively extending medical benefits coverage to more employees, developing a framework for reducing waste to landfill, understanding the challenges and opportunities of operating in water-scarce markets and re-launching our CSI initiatives so that they deliver more impactful social returns. I will continue to monitor the progress that we make in these areas, offering encouragement and advice where required.

I also detect the early signs that we may be trying to do too much, too quickly, without paying sufficient attention to the quality of implementation and the potential commercial benefit. So this year I would like to start consolidating and prioritising Group sustainability activities, moving toward developing a focused dashboard of performance indicators that enables Massmart to start optimising the commercial, social and environmental impact in areas where we as retailers can achieve high leverage; for example, by focusing on opportunities to reduce product packaging and increase recycling.

Controversially, I feel that a first step may require de-emphasising the significant effort and emphasis placed on activities to support reporting the myriad of Sustainability criteria advocated by well-intentioned codes and reporting competitions, and rather focusing on tracking only the essential data that drives sustainability performance in the areas where retailers like Massmart can achieve highest constructive impact.

STRATEGIC VISION 2013

Our Strategic Agenda has been reviewed and updated, focusing on Leadership and Transformation; Growth of the Core Business through investment in Supply Chain, Private Label and Financial Services; Organic Growth; New Formats and Categories; and Sustainability.

We continue to focus on format renewal across the Group. All stores opened this year took significant steps forward in their in-store look and feel, and this will continue for several years.

One new Strategic Agenda item has been added under the heading of Customer 2.0 which represents our desire to ensure all our trading formats are positioned to respond to continually changing customer demands and the trading opportunities created by the adoption of internet-based technologies.

Within the opportunities identified in New Formats and Categories, we are going to invest in our participation in the Fresh Category in the retail, wholesale and commercial areas. We are learning at a fast pace in Retail Cash and Carry and believe there is much we can do across our other formats.

In terms of delivery against the Strategic Agenda, we are proud to have made good progress across all fronts and have recruited an additional 39 graduates, hosted more than 231 senior leaders through our Corporate University, complied with all aspects of the Employment Equity Act and BEE Acts, achieved Level 4 B-BBEE status, achieved fourth place nationally in the external rating of our 2009 annual report, and opened our 70,000m² Gauteng RDC for Massdiscounters.

APPRECIATION

In tough times, there are more demands placed on our employees, service providers and suppliers. I am very grateful for the efforts of our 26,585 employees, and 8,541 product and service suppliers. Thank you for your support and efforts.

I would also like to thank our Board and Shareholders for their support and counsel through the year.

PROSPECTS

For the 14 weeks to 3 October 2010, total sales increased by 14.9% and comparable sales increased by 9.2%, continuing the trends experienced for most of the second half of the 2010 financial year, specifically strong General Merchandise and Home Improvement trading performances.

In the short term, we expect the Food and African businesses to continue to underperform due to food deflation and the strong Rand, respectively, but expect gradual improvement in both of these throughout the coming financial year.

Acknowledging the concerns and uncertainty permeating the global economy, if current South African economic and trading trends continue for the financial year, Massmart should achieve profit growth, before any foreign exchange translation adjustments, ahead of sales growth for the full year.

The financial information on which this outlook statement is based has not been reviewed or reported on by the Company’s external auditors.

CONCLUSION

On 27 September 2010, Massmart released an announcement describing a non-binding expression of interest received from Wal-Mart Stores, Inc, which could lead to Wal-Mart making a cash offer to acquire the entire issued share capital of our Company for a price of R148 per share. This has subsequently received extensive coverage in the local and international press.

Prospects

14 weeks to 3 October 2010

Total sales 14.9%
Comparable sales 9.2%

Wal-Mart is currently conducting due diligence on the Group and the first time that any further announcements may be made in this regard will be on or about 8 November 2010. In the event that a firm offer is received from Wal-Mart, the directors of Massmart will obtain an independent opinion and express a view on the firm offer at that time.

Difficult times present an opportunity to focus and learn. We have done both and are confident that the Group is in better shape than a year ago.

We believe we managed the business well through the crisis, and have established good momentum in implementing our growth plans across the entire Group. Should the current mild economic recovery be sustained, we should see net margins expand in the years ahead.

We can see areas of weakness too, but the opportunity to address or improve on these exceeds our capacity to respond. We have plenty to do.

Our decision to continue to invest through the economic cycle should bear fruit in the years ahead.

Grant Pattison

Grant Pattison
Chief Executive Officer

6 October 2010

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