Cashbuild has established a strong platform and brand equity in the fragmented retail building supplies industry, providing a range of basic building materials at competitive prices. It is this platform, together with its operational consistency, that has enabled the group to grow sales ahead of its peers and to achieve a compound growth in earnings of almost 16% p.a. over the past two decades.
However, times are changing and a confluence of factors have seen Cashbuild’s recent sales growth lag that of the overall Building & Hardware retail segment. We believe that this is a result of the group’s core lower-income, peri-urban customer base, which is particularly vulnerable to economic downturns and has borne the brunt of the economic collapse since 2014...the 'state capture', and then the COVID-19 pandemics. Cashbuild’s core market bias is reflected in this, essentially a non-metro store base (30% rural, 34% town, 27% township and 9% metro).
With hindsight, the 2016 acquisition of the P&L Hardware chain to ‘fill in’ stores in smaller peri-urban markets that lack the addressable market required of a full-size Cashbuild store, was unfortunately timed, coinciding with the economic growth slide accelerated by the mis-management of the Zuma presidency. And regrettably, the Competition Commission-blocked proposed acquisition of The Building Company from Pepkor, as it would have provided Cashbuild with more balanced customer diversification by augmenting its relatively low exposure to higher income customers.
While Cashbuild does have exposure to the private independent building contractor and middle and upper income retail markets, its core market has experienced a large-scale loss of employment, especially in unskilled categories. Total employment declined by 0.7% p.a. from 2014 to 2021, versus the average population growth rate of 1.6% p.a. during the same period.
Furthermore, a key demand driver for Cashbuild, that of government low-cost or ‘RDP’ housing delivery, has also slowed (2.4% p.a. from 2014 to 2020 versus growth of 8% p.a. in the decade up to 2014). While not the only driver, government low-cost housing delivery is an important demand driver for the company because members of its core market are typically government housing recipients and research shows that historically most (>85%) basic units delivered are upgraded or extended by the recipients within two years.
The group’s peri-urban bias also resulted in an out-sized impact from the July 2021 unrest.
With a poor medium term economic outlook and the failure to replace lost pandemic employment to date, the group’s sales outlook appears muted.
This bleak outlook follows the unprecedented pandemic-fuelled housing upgrade boost as consumers positioned for home-based employment, which Cashbuild also benefitted from, albeit to a lesser extent than higher-income market focused peers.
Having said all that, one would be foolish to overlook this critical factor: The lagging recent sales growth trend (briefly interrupted by the pandemic blip), has been juxtaposed by management’s masterful operational execution and as a consequence, financial performance.
The group has benefited from, among others, re-platformed IT system (to SAP) enabling significantly enhanced stock and operational control, which have meaningfully raised the sustainable margin level of close to 8% versus around 5% historically. As a result, the compound growth rate of headline earnings per share has far exceeded the sales growth in the last decade (16% p.a. versus 8% p.a.), in our opinion, raised the sustainable earnings trajectory.
Furthermore, the group’s financial risk has been reduced by selling predominantly for cash and maintaining an ungeared balance sheet to date. The resulting strong free cash flow is also supportive of ongoing dividends.
In conclusion, while we have downgraded our earnings expectations and valuation in the context of recent macro developments and the weak economic outlook, we believe the counter offers value at current levels.
