Retail trading conditions in South Africa proved challenging against the backdrop of slowing economic growth, heightened socio-political tensions and instability, rising interest rates and a weakening labour market. The Rand continued to lose ground and impacted on retailers exposed to the currency weakness through imported goods.
Credit retailers faced further headwinds following the introduction of new affordability assessment regulations by the National Credit Regulator (NCR) which have had a marked impact on credit sales in the country.
Consumer spending came under further pressure from rising living costs, driven by higher food, fuel and utility costs. Overall consumer confidence is at a lower level than during the global financial crisis of 2008/2009.
Volatile and depreciating currency
As approximately 60% of Truworths' merchandise is imported and US dollar denominated, the business is vulnerable to exchange rate volatility and the depreciation of the Rand. While the Rand devalued by 23% against the US dollar over the reporting period, the currency was highly volatile and fell as much as 38% in the aftermath of the dismissal of South Africa's finance minister in December 2015.
Truworths partially mitigated the currency impact by improving procurement processes, identifying new sources of supply and adjusting product ranges, thereby limiting product inflation to an average of 9% for the reporting period. However the full impact of the devaluing Rand will only be evident in the summer 2016 season, when product inflation is expected to peak in the low to mid-teen levels.
The acquisition of Office in the UK has diversified the Group's currency exposure and can provide a hedge against what has historically and generally been a volatile and depreciating Rand, although the Pound Sterling has weakened in the short-term against the Rand in the aftermath of the recent Brexit vote.
Burdensome affordability regulations
The introduction of new affordability assessment regulations in September 2015 has had a widespread impact on credit retailers. Besides the extensive system and process changes required to be implemented to comply with the regulations, one of the main requirements is for retailers to validate an applicant's declared income with documented proof of income. This would typically need to be the three most recent salary advices or bank statements.
The impact of this proof of income requirement has been significant among Truworths' mass middle-market customers. Many customers are either self-employed or work in the informal sector and cannot provide formal proof of income. Others have found the process too onerous to comply. The new regulations have resulted in approximately 30% fewer accounts being opened each month, translating into an estimated loss of at least R200 million in sales for the reporting period.
Together with two other listed retailers, Truworths instituted legal proceedings against the NCR and the Minister of Trade and Industry in June 2016, seeking an order to have the new affordability assessment regulations reviewed.
After showing signs of stabilising in the first half, the consumer credit environment in South Africa has deteriorated in the second half of the reporting period in line with slowing economic conditions and rising interest rates.
South Africa's benchmark interest rate, the repurchase (repo) rate (being the rate at which commercial banks borrow from the SA Reserve Bank), increased by 125 basis points to 7% over the past 12 months. Market consensus currently indicates the likelihood of a further 25 basis point increase in the second half of the 2016 calendar year.
While higher lending rates will increase consumers' debt servicing costs and reduce their disposable incomes, Truworths is not an interest rate sensitive business as account customers generally have limited exposure to mortgage bonds, vehicle finance and bank credit cards, and are reliant on in-store credit. Higher interest rates are therefore not expected to have a material impact on the spending patterns or debt repayment ability of the Truworths customer base.
Retail trading in the rest of Africa
Trading conditions across the African continent were impacted by lower commodity prices and weakening currencies in most countries in which Truworths trades. This was particularly evident in Ghana and Zambia where the economies are highly dependent on commodities. Regulatory limitations preventing clothing imports into Nigeria resulted in trading no longer being viable and the four stores in the country were closed in the second half of the reporting period. Notwithstanding these factors, retail sales in the rest of Africa reflected pleasing year-on-year growth.
Retail trading in the United Kingdom
Conditions in the UK have also proved challenging during the reporting period, with declining footfall and spend being experienced across the retail sector. This has been largely driven by a general slowing of the economy, the tightening job market and uncertainty in the latter stages of the reporting period ahead of the Brexit vote in June.
The BDO monthly high street tracker reflected an 8.1% decline in retail sales for June 2016 over the prior year, with fashion retail sales being down for 10 of the past 12 months to June 2016.
However, online sales continued to grow strongly with industry sales for June 2016 reflecting growth of 15.8%. This trend favours Office as 24% of total sales are generated from e-commerce.
Consumers have shown a growing appetite for discount and promotional shopping and a reluctance to buy at full prices. As a fashion retailer Office was also affected by unseasonal and unpredictable weather patterns in both summer and winter.