All the eggs in one basket

There is nothing wrong with being a credit-retailer.
Just don’t pretend that you are not one

Keith McLachlan

I previously wrote about Kaap Agri when it listed,

The Problem with Kaap Agri. To be fair, I interacted with management and raised several concerns. Their responses were fair and I stood back to watch it play out. This article is an update and a simple, short piece on why I just cannot bring myself to invest in the group.

The first point to make is that Kaap Agri is ultimately a credit-retailer. The interest income earned, the debtors book on its balance sheet and its weak cash conversion all indicate that it is a credit-based retailer.

There is nothing wrong with being a credit retailer. Truworths and Foschini have both built large, impressive and highly-profitable businesses on the credit-retail model. Likewise, smaller, but equally profitable businesses like Lewis exist, built on this model too. Even Cashbuild – predominantly a cash-based retailer – has some credit-based sales and a small retail book.

There is nothing wrong with being a credit-retailer. Just don’t pretend that you are not one. Hence, I am going to look at Kaap Agri through the lens of credit retail.

TFG has built a successful business on the credit retail model.

Source: Supplied

Truworths too, has a successful credit book.

Source: Supplied

Given the fact that there is scant disclosure on their retail book, I have built two graphs with two ratios:

Firstly, here is a comparison between the book sizes of each of the main credit-retailers as well as Cashbuild and Kaap Agri.

I have taken the net book exposure (i.e. after security) and expressed it as a percentage of each groups’ market cap.

Source: Various company reports, Iress, & AlphaWealth workings and assumptions

It is clear as day that Kaap Agri is more exposed to its book than the other credit-retailers. Once again, this is fine if the book is high-quality, diversified and well-provided for. But how do we know if the book is high quality? Well, we only really know that in hindsight. So, let’s focus on the other two characteristics.

Kaap Agri has branches across South Africa and a joint venture in Namibia, but it is pretty much a Western Cape-focused business. The group was formed out of a co-op from that

province, around 68% of its branches are there and, logically, I would expect that the majority of its credit book is exposed there.

Not just is there a geographical bias, but Kaap Agri’s book is also likely to be almost entirely agriculture-related. This is, after all, the focus of their business.

And then, to make matters even more concentrated, Kaap Agri has collateral against this credit in its book.

Kaap Agri is largely a Western Cape-focused business.

Source: Shutterstock

This collateral tends to be land, machinery or harvests of the farmers to whom they have sold products. In other words, the same events that could conspire to make a farmer default on his debt – such as a drought or a collapse in soft commodity prices – could conspire to reduce the value of the collateral.

This is risky. Correlated collateral is not great security for a lender to rely on….

Compare this to Truworths and Foschini’s books.

Both books have zero collateral, but they are spread across all walks of life, across all provinces in all regions and both urban and rural – both books are diversified.

Kaap Agri’s book fails my diversification test. This is fine, but only if Kaap Agri adequately provides for this.

So, here is the second graph. This shows the implied percentage of bad debts provided for against the net debtors books (after collateral).

Source: Various company reports, Iress, & AlphaWealth workings and assumptions

Once again, it is as clear as day that Kaap Agri’s book is not just relatively bigger and more concentrated than the other credit retailers, but it also appears to be materially less provided for by the group.

On all accounts, I find this is terrifying and it is the sole reason I just cannot invest in Kaap Agri.

For many reasons, I hope I’m wrong. But I am not going to take a chance. The size, concentration and apparent provisioning of the Kaap Agri’s book means that if the Western Cape misses another rainy season or two, this group could be in serious trouble.■

Keith McLachlan is an equity analyst and small-cap specialist with AlphaWealth.