Pepkor is a South African retail investment holding company whose most valuable assets are PEP and Ackermans, two of the country’s most successful clothing retailers. We take a deep dive into the operations of these retailers, unpacking the techniques employed to steadily expand their businesses and deliver value to customers.

Pepkor at a glance
Pepkor is structured into four operating segments: clothing and general merchandise (CGM); furniture, appliances and electronics (JD Group); FinTech; and The Building Company (TBC).

TBC is in the process of being sold to Cashbuild, a competitor within the building supplies sector, with final Competition Commission approval expected in March 2021. The charts that follow therefore exclude this segment.

The organisational chart below illustrates the brands that lie within each of the remaining three segments. The CGM segment is further divided into PEP and Ackermans (South African stores only), Speciality and PEP Africa (PEP stores outside of South Africa), with the Speciality division housing smaller clothing and footwear retail brands. Within FinTech, Flash provides point of sale (POS) technology enabling virtual products such as airtime and electricity to be sold in the informal market, and Capfin is a short-term unsecured credit provider.

The contribution charts below demonstrate that the CGM segment and, within that, Pep and Ackermans, is responsible for the bulk of Pepkor’s revenue and profits. Although the JD Group has been loss-making for several years, performance has been steadily improving as the store base has been reduced. This segment is expected to break even from the 2021 financial year and to have a marginally positive contribution thereafter.

Enduring brands
Ackermans opened its first store in 1916. Over a century later, there are 861 stores countrywide that primarily target women with children in their lives. Kids and baby clothing accounts for over 60% of sales, with roughly a 20% contribution from womenswear and the remainder from cellular devices, airtime and fast-moving consumer goods (FMCG) including essentials like basic toiletries and nappies.

PEP has been operating for 55 years and has expanded from clothing into homeware, cellular devices and airtime, FMCG, financial services and parcel delivery. The 2 384 stores countrywide include more than 250 PEPhome stores that offer a range of homeware items and over 500 PEPcell stores that sell airtime and cellular products (including PEP’s own exclusive brand of cellular handsets and accessories – Stylo). A new discount variety store format known as Dealz is also being trialled, with 15 stores at present. PEP clothing stores comprise the remaining outlets, selling a quarter of all kids clothing and almost a third of all baby clothing in South Africa¹.

¹_{According to June 2020 data from the Retail Liaison Committee (RLC).}

Strategic positioning
PEP primarily targets lower LSM² customers with very little disposable income. The store network has been designed around customer convenience, with the aim of lowering transport costs to reach stores, thus maximising potential spend. PEP prides itself on price leadership, with 97% of all products priced either the same or cheaper than at any other retailer. Ackermans’ price points are generally higher than those of PEP, however they are also classified as discount retailers. Store sizes range from 200 to 2 000 m² across both brands. The ability to profitably operate a wide range of store formats has led to a significantly larger network of stores than competitors, with room for further growth.

The clothing offering of PEP and Ackermans is centred on basics – items that can be worn from one season to the next, independent of current fashion trends. As the product has minimal risk of losing relevance, it is possible to buy in bulk with long lead times of up to nine months, thereby bringing down the unit cost of each item purchased. The longer shelf life of basics relative to fashionable clothing also reduces the need to rely on markdowns to clear stock, aiding ultimate profitability. Margins have remained relatively constant in this division, with efficiency gains in the supply chain invested back into price or improving quality to increase the attractiveness of the offering over time.

Leaders in schoolwear
PEP sells more than half of all school clothing sold in South Africa³. These garments are predominantly locally manufactured by Pepclo, a clothing manufacturer owned by the Pepkor group. Employing more than 2 000 people, it is the largest South African clothing manufacturing facility operating under one roof. Pepclo currently manufactures around 15 million units per year, including basic schoolwear (excluding school shoes), flip-flops, basic underwear and, more recently, masks and disposable isolation gowns.

Between 20% and 30% of school clothing sales occur in the “back-to-school” period, from just after Christmas until schools open. To capture the maximum amount of spend, store inventory is rapidly shifted from Christmas to back-to-school within a three-day period directly after Christmas. During this time, up to 30% of store space is allocated to schoolwear, compared to 3% to 4% over the remainder of the year.

The bulk of the schoolwear inventory required over this period is built up in distribution centres in the months leading up to Christmas, with a smaller proportion manufactured during the back-to-school period. Local production mitigates risks around lost sales due to inventory delays, reducing both the length of time and the amount of space needed to store this inventory. Again, the focus on basics proves to be an advantage as there is limited risk of inventory write-downs on the stock that is temporarily removed from stores to make room for a greater proportion of schoolwear.

Leveraging an extensive geographic footprint
Stores are generally replenished at least twice a week and, in some cases, more frequently depending on the size and popularity of the store. Regular store replenishment allows for smaller store formats as less inventory is required to be kept on hand. Moreover, it has enabled the group to leverage the store footprint and supply chain to create new business lines. In 2018, PEP launched a parcel delivery service called PAXI, whereby customers can send parcels from one PEP store to another. Competitive pricing and a store network that significantly outstrips the number of South African Post Office outlets has led to PAXI already delivering around 10 000 parcels daily.

The FinTech division of Pepkor has also benefitted from this extensive footprint. Customers can apply for Capfin loans in PEP and Ackermans stores. In addition, vendors in the informal market can buy Flash POS devices along with the tokens required to top up these devices. Other financial services offered in store, falling outside of the FinTech division, include account payments (eg DStv), funeral cover and money transfers. The select range of essential FMCG products on offer across both retailers encourages impulse buying that assists in increasing the average customer basket size. The net impact of all these offerings is a more profitable use of space and added incentives for customers to visit stores more frequently.

Resilient business model
Despite the impact of COVID-19, Pepkor was able to grow sales across all divisions apart from TBC in the financial year ended September 2020. Strong free cash flow generation and good working capital management assisted in paying down a substantial portion of their debt, reducing potential liquidity concerns. With the sale of TBC on the horizon and the rightsizing of the furniture and electronics store base essentially complete, the business is in a strong position to meaningfully grow earnings in 2021 and the years to follow.

Looking ahead, South Africa has weak economic fundamentals, with unemployment expected to remain high and consumer incomes under pressure. Most lockdown-related job losses occurred in the lower income segment, leading to reduced disposable income and consumer downtrading. Consumer spend has also shifted towards convenience, with customers choosing to shop closer to home. Though risks remain in this environment, Pepkor’s positioning as a discount retailer with stores located close to their customers appears well placed relative to competitors. As such, we view Pepkor as best positioned of the local clothing retailers to weather the current tough operating environment.

²_{Living Standards Measure (LSM) has become the most widely used market segmentation tool that cuts across race, gender, age or any other variable used to categorise people.}
³_{According to March 2020 data from the RLC.}