Spar offers significant upside – Foord

Dhersan Chetty, an equity analyst at Foord Asset Management, said Spar is a good investment amidst high food inflation and rising interest rates in South Africa.

He said in periods of high food inflation, you want to be invested in food retailers over food producers.

“Within the Foord portfolios, we hold a big overweight position in food retailer Spar and have a low weight to food producers,” he said.

“We believe Spar offers significant upside from these levels with its defensiveness, high cashflow generation, consistent earnings growth and strong divisional management.”

Explaining his position, Chetty said that the net effect of rising food, transport and borrowing costs is the reduction of consumer’s discretionary — or non-essential — spending.

Higher inflation disproportionately impacts lower-income consumers, given the contribution of food and transport costs to their total expenses.

It is compounded by this consumer cohort tending to have lower savings.

Middle-income consumers with mortgages, car loans and credit card debt are also squeezed because of their exposure to rising interest rates.

A higher interest burden eats into budgets, causing consumers to be more conscious of their spending.

Unlike other consumer products such as clothing, entertainment and cars, food is an essential expenditure item.

However, a consumption squeeze still affects food expenditures. Consumers reduce their monthly basket sizes by eating less, reducing non-essential foods such as sweets and snacks, switching to cheaper proteins, and trading down to cheaper products.

Food companies with strong brands can better retain their customers and pass on these high price increases.

In comparison, those with weak brands or in highly competitive segments are more likely to be impacted by lower volumes, lower price increases, and input costs.

Food retailers versus food manufacturers

Chetty said food retailers tend to outperform food manufacturers in periods of high food inflation.

The big retailers’ market dominance and bargaining power end up squeezing the margins of the more competitive food manufacturers.

The retailers also benefit from switching to their better-priced private-label products and eat-in trends.

However, food retailers are not immune to the consequences of food inflation despite generally being able to pass it on to consumers.

Higher till prices result in lower volumes for retailers as consumers reduce their basket size.

Food retail sales growth has been positive every year since records began in 1980, but volume growth was negative in ten of the last forty-two years.

However, the average volume decline in these years was just 1.6%, which is not material.

This defensiveness has enabled food retailers to outperform cyclical sectors during periods of high food inflation.

Stiff competition for market share in the retail food segment will likely stimulate more promotional activity to offset some of this inflation.

With this in mind, Chetty said Spar stands out as a good investment in South Africa’s food industry.