CHIEF EXECUTIVE OFFICER’S REVIEW


GRANT PATTISON
CHIEF EXECUTIVE OFFICER

The past year has been one of the busiest in Massmart’s history. We have been simultaneously implementing our organic growth strategy, re-engineering our supply chain, establishing ourselves as a food retailer, integrating with Walmart and completing the remaining legal aspects of the Walmart transaction.

We have made good progress on all fronts and, perhaps most importantly, we can now put the Walmart transaction and its related stresses and distractions behind us. Whilst we still have much to do and learn, we are “integrated” with Walmart and the transaction has been approved by all the required authorities.

The financial year ended much as expected – a mixed performance. The core business performed well, while the investments in supply chain and Food Retail were a drag on the Group’s financial performance, with investments in skills and assets happening in advance of value generation.

Towards the end of the June 2012 financial year we restructured the management team. We appointed our previous Chief Financial Officer, Guy Hayward, as Chief Operating Officer and his second-in-charge, Ilan Zwarenstein, as Financial Director. Early in the new financial year we re-assigned responsibilities within the Group executive team.

While we have been “transacting” and “integrating” since late 2010, our competitors have been responding to Walmart’s investment in the South African retail sector and so we have now turned our full focus back to serving customers and responding to competitors, informed with new perspectives, skills and assets.

Financial performance

For the 52 weeks to June 2012, Massmart’s total sales increased by 15.6%, operating profit by 21.0% and headline earnings by 38.0%. Excluding the costs relating to the Walmart integration and transaction however, operating profit increased by 3.7% and headline earnings by 8.9%.

The underlying trading was resilient with comparable sales increasing by 9.6% while product inflation remained low at only 1.8%. The derived 7.8% increase in comparable sales volumes was material and put pressure on operating costs, the impact of which was somewhat mitigated by supply chain efficiencies.

Although the South African Rand weakened against the US Dollar and our basket of African currencies during the financial year, the Group incurred a foreign exchange translation loss on its foreign businesses of R72.5 million. This was due mainly to the unrealised translation loss caused by the significant currency devaluation in Malawi in May 2012.

As with the disposal of the Makro Zimbabwe business last year, we continued to clean up some of our smaller poor-performing businesses resulting in some once-off costs and inefficiencies of similar magnitude in both financial periods.

Underlying cost pressures remain a challenge. The Group’s significant investment in new stores, the Food Retail conversions (Foodco) and the new Regional Distribution Centres (RDCs) caused both occupancy costs and depreciation to increase ahead of sales growth. A secondary effect is the above-inflation increases in local government taxes and services.

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OPERATIONAL REVIEW

More detail on the operational performance can be found in:

At a Divisional level, Massbuild and Masswarehouse both performed well and increased trading profit before tax by 22.7% and 12.8%, respectively. Massdiscounters struggled somewhat in South Africa but performed well outside of South Africa, increasing overall trading profit before tax by 4.0%. Masscash had a difficult year with trading profit before tax declining by 22.8% with the accelerated investment in skills and assets, and one or two own-goals, hampering financial performance.

Cash generated by operations increased by 62.8% to R2.7 billion, supported by a solid working capital performance, which financed a record R1.7 billion in capital spending on maintaining and growing operations, and acquisitions.

Walmart relationship

An important area of management focus has been the development of our relationship with Walmart as our majority shareholder.

The impact of having Walmart as a majority shareholder is fundamental and affects almost every part of Massmart’s operations. In summary, management’s objective has been to align with Walmart where necessary and appropriate and to extract value from its significant global capabilities, to the benefit of all key stakeholders, in general, and to both majority and minority shareholders, specifically.

We achieved the bulk of the objectives around alignment between the two organisations and the first signs of value were evident in the income statement towards the end of the 2012 financial year, although not significant enough to cover the costs of integration. Value is expected to exceed costs for the 12 months ending December 2013.

Overall, relationships with all key stakeholders are in good shape. Importantly, management relationships with the broader Walmart Group continue to be warm and effective, bringing stability to the management team.

In addition, a concerted effort has resulted in the return of relations with the South African Government to the same levels as before the Walmart transaction, and in improving relationships with the Departments of Agriculture and Trade and Industry, both of whom are important to the ongoing operations of the Group.

Environment

Whilst South African GDP growth estimates declined throughout the June 2012 financial year, Massmart’s high comparable sales growth suggests a healthy overall consumer environment for the period. We sense that within the South African consumer-base however, middle-income consumers, particularly those that rely on unsecured credit to fund their purchases, came under increasing financial pressure. The large growth in new consumer credit accounts at our consumer credit partner, RCS, also points towards a trend of increasing use of unsecured credit.

Competition in most product categories increased as the battle for market share intensified, indicative of a healthy competitive environment. Most major retailers are being innovative in the search for growth by focusing on new categories, whilst the independent retailers remain nimble, exploiting opportunities in the market.

Wage settlements remain above inflation, requiring management to seek productivity gains. This puts downward pressure on employment figures in the comparable business whilst total employment will increase from organic store growth. The proposed amendments to the South African labour regulations will require us to manage flexi-time workers differently, although the regulations will not affect the balance between full-time and flexi-time employment. They will however, increase the costs of managing the flexi-time employees, which will again require management to look for productivity gains.

Massmart’s labour relations remain sound and our wage agreements have, almost without exception, been concluded earlier than we experienced a year ago and, in some instances, with two-year agreements.

Our participation in the affairs of government and industry are of growing importance and we will increase our contribution to the policy debates on matters affecting business, trade and the economy at large.

Corporate Accountability review

In line with the Accountability framework that we introduced in our 2011 report, we continue to focus on three Accountability themes of: enabling sustainable supply and consumerism; minimising the Group’s environmental footprint; and championing social equality issues.

The Accountability initiatives associated with each theme remain largely unchanged, although we have developed a clearer sense of prioritisation through an assessment of each initiative in terms of the following five criteria:

  • What is the legislative/regulatory driver for this initiative?
  • What direct commercial benefit will flow from this initiative?
  • What resonance does this initiative have with government and civil society-driven public discourse?
  • What relevance does this initiative have for Walmart’s global sustainability commitments?
  • What positive leverage does this initiative present for Massmart-Walmart’s reputation in Africa?

This is an important refinement that further addresses the concern we raised in our 2010 and 2011 annual reports, that our Corporate Accountability agenda had become too “cluttered”. You can read more about our Accountability prioritisation matrix in the Corporate Accountability section of this report.

A major highlight has been the positive and tangible impact that Walmart has had on our way of thinking about Accountability. Walmart is deservedly acknowledged as a global leader in this field. We have enjoyed the benefit of their experience, specifically in the areas of small-scale farmer development (direct-to-farm), energy efficiency, primary packaging rationalisation and supplier advocacy. Benefits to Massmart have included exposure to new ideas and innovations, sharing of intellectual capital and lessons learned, and access to materials and business case guidelines. You will notice further reference to Walmart’s impact in the Corporate Accountability progress update.

Finally, I want to pay tribute to the various Broad-Based Black Economic Empowerment practitioners across the Group, who contributed toward Massmart achieving a BBBEE score of 72.8%, Level 4, even after a 7.2% decline in the Ownership element of the scorecard as the result of the vesting of shares held by Massmart’s Thuthukani Staff Empowerment Trust. Massdiscounters’ verified score of 77.4%, which was higher than the score of the top ranked retailer in Financial Mail Top Empowerment Companies 2012 survey, was remarkable.

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CORPORATE ACCOUNTABILITY

More detail on Walmart's ethical sourcing framework

Looking forward, I am especially enthusiastic about the introduction of Walmart’s ethical sourcing framework and believe that overall we have consolidated a solid base on which to further develop our Corporate Accountability agenda.

Strategy

We have made good progress on our four priorities of: completing the Walmart transaction; Walmart integration; maintaining trading momentum; and being a good corporate citizen.

Legally, the Walmart transaction is complete, save for the anticipated final ruling from the Competition Appeal Court on the amount, purpose and governance of the Supplier Development Fund. The three other conditions from the Competition Tribunal have been implemented; 222 of the 503 previously retrenched Massdiscounters’ employees have been re-employed across the Group. We began implementing the Supplier Development Fund in terms of our existing commitments but, pending the Appeal Court ruling, have put any new commitments on hold.

About 368 Massmart employees attended the annual Walmart shareholders' conference in May 2012..."

The formal Walmart Integration project is complete. Governance, control, risk and reporting dimensions have been aligned and the basic processes to continually extract value from the transaction are now in place. The formal Integration process will wind down over the period to June 2013 whilst processes are handed over to Massmart line-management. About 368 Massmart employees attended the annual Walmart shareholders’ conference in May 2012, completing the process of welcoming Massmart into the Walmart family.

On Maintaining Trading Momentum, all strategic agenda projects have progressed well. We completed the Massdiscounters RDC network with the opening of the third and final RDC in Durban in July 2012; opened our first Food DC; improved our competence in Food Retail; increased Private Label and Financial Services penetration; and continued with our roll-out of Food Retail.

On Corporate Citizenry, we maintained our Level 4 BBBEE status; continue to drive advocacy on environmental sustainability with our suppliers; reduced our Group’s environmental footprint through investment in waste management and energy efficiency; and maintained our private – public partnerships with various South African government departments and services including Basic Education; Agriculture, Forestry & Fisheries; the South African Police Services; Treasury; the SABS and the SANDF.

Prospects

PROSPECTS

14 weeks to 30 September 2012
Total stores’ sales growth 16.6%
Comparable stores’ sales growth 7.8%

For the 14 weeks to 30 September 2012, total stores’ sales increased by 16.6% and comparable stores’ sales increased by 7.8%, continuing the trends experienced at the close of the last financial period.

With the coming change in Massmart’s financial year-end, the next reporting period will be the 26-week “financial year” to December 2012. Sales and gross margins are expected to grow satisfactorily, although cost pressures will remain. Currently we expect no improvement in the Group’s net trading margin for either the 26-weeks to December 2012 or for the year to December 2013.

Beyond the next 18 months, we believe the Group is well positioned for strong growth, in both sales and profits.

Appreciation

In a year as busy as this one, we are particularly grateful for the support we received from all colleagues employed in the Group, our suppliers, our advisors, our new colleagues in Walmart and our colleagues in civil society and government.

We are also appreciative of the support from our Board and shareholders.

Thank you all.

GM PATTISON

Chief Executive Officer

5 October 2012