commentary

Keith Warburton
Chief financial officer

“Inventory management was one of the highlights of 2007. The group reduced inventory levels by 2.8%, despite a 12% increase in turnover.”





chief financial officer's report

Review of the year

New Clicks delivered a strong trading, operational and financial performance during the 2007 financial year as the group continued to make encouraging progress towards achieving its medium-term performance targets.

  • The focus on working capital management saw the group generate cash of R420 million after repurchasing shares of R558 million and continuing to invest for long-term growth across its businesses.
  • The group’s return on equity (ROE) continued its strong growth trend, improving from 16.7% to 24.7%.
  • Group turnover increased by 12.0% to R11.2 billion (2006: R10.0 billion). As selling price inflation for the period averaged only 2.3%, the group recorded real turnover growth of 9.7%.
  • Retail turnover rose 13.1% and by 13.2% on a comparable store basis, with inflation of 2.5%. UPD increased turnover by 11.2% and experienced inflation of 2.0% for the year.
  • Headline earnings grew by 41.9% to R356.9 million (2006: R251.6 million). Diluted headline earnings per share increased 45.1% to 103.0 cents per share. During the year the group sold properties at a capital profit of R28.4 million (after tax), resulting in diluted basic earnings per share growing by 58.4% to 109.9 cents per share.

Disposal of businesses

The group has sold retail businesses Discom and Style Studio, with both transactions effective from September 2007. As a major line of business, Discom is reflected as a discontinued operation in the annual financial statements.

Income statement

Turnover

Clicks increased turnover by 14.3% and by the same amount on a comparable store basis, showing double digit real growth with inflation at 2.8%.

Musica experienced a slower second half sales performance and recorded growth of 12.1%, with same store sales at 10.0%. The business continued to experience price deflation largely in the entertainment product categories of DVD and gaming.

The Body Shop has continued its sales momentum built up in 2006 and increased turnover by 26.3%, with same store sales of 19.3%.

UPD’s turnover growth of 11.2% was in line with expectations and reflects the benefits of the supply contracts for two major private hospital groups.

Intragroup turnover increased by 17.4% as a result of higher volumes of ethical product from UPD to Clicks. It should also be noted that during the year the distribution of certain front shop products was relocated from UPD to the Clicks distribution centres.

The group’s trading performance is covered in more detail in the operational reviews.

turnover       same  
      % store % %
R’m 2007 2006 change growth inflation
Clicks 5 562 4 865 14.3 14.3 2.8
Musica 873 779 12.1 10.0 (1.3)
The Body Shop 83 65 26.3 19.3 5.3
continuing retail ops 6 518 5 709 14.2 13.8 2.3
UPD 4 295 3 863 11.2   2.0
intragroup turnover (770) (656) 17.4    
total continuing ops 10 043 8 916 12.6   2.1
Discom & Style Studio 1 162 1 085 7.1 10.1 4.1
total group 11 205 10 001 12.0 13.2 2.3

Gross profit margin

Retail gross margins improved to 27.3% (2006: 27.1%). This is a pleasing performance considering the increasing influence of lower margin dispensary sales where Clicks continues to apply the R26/26% pricing model.

UPD’s gross income, which includes gross profit and other income (primarily distribution fees), improved to 8.5% of turnover (2006: 8.3%). Income benefited from the increase in single exit pricing afforded to selected manufacturers in January 2007 and the transfer of the Musica distribution to UPD. However, this was partially offset by the higher proportion of sales of ethical products (78.9% in 2007 against 77.3% in 2006) which are at a lower gross income than front shop products.

Operating expenditure

Operating expense growth was contained at 9.7%, with all businesses maintaining expenditure below the level of turnover growth.

Employment costs, which account for 48% of group expenses, increased by 10.6%. Employment costs were impacted by the higher short-term and long-term incentive scheme expenses which relate to the improved performance of the group as well as the appointment of further professionals in Clicks as the pharmacy business expands.

Depreciation and amortisation costs reduced by 2.4%. This reflects a 5.5% decline in retail owing to certain IT equipment being fully amortised. Depreciation in UPD increased by 57.7% following the commissioning of the new automated pharmaceutical distribution facility.

Occupancy costs remained well managed and rose by 8.7%, despite an increase in the number of Clicks stores. Overall retail trading space increased by 3.4%.

The increase of 10.8% in other operating expenses includes the growth in volume related costs such as credit card commissions, the move of the Musica distribution to UPD with associated transport costs and the introduction of the store Blueprint programme in Clicks.

Operating profit

Operating profit increased 35.8% to R533.8 million, reflecting the improved turnover, margin and operating efficiencies.

The 43.2% increase in Clicks is particularly noteworthy given the size of the contribution of the business to total group profit. Clicks benefited from buoyant turnover, good gross margin management, improved inventory management and reasonable expense control.

Musica’s operating profit increase of 67.7% is inflated by an inventory shortfall of R5 million which was reported in the previous financial year. However, when the impact of this loss is excluded, Musica still showed strong growth of 40%.

operating profit      
R’m 2007 2006 % change
Clicks 296 207 43.2
Musica 43 26 67.7
The Body Shop 14 11 24.7
UPD 139 114 21.0
intragroup 2  
total continuing operations 494 358 37.8
Discom & Style Studio 40 35 15.3
total group 534 393 35.8

Interest

Net interest paid declined 32.1% from R57 million to R39 million, reflecting the improved cash generation of the business which is detailed under “Cash utilisation”.

Taxation

The increase in the tax charge from R84 million in 2006 to R141 million can be attributed mainly to the higher proportion of exempt income to total taxable income in 2006, the maturing of structured finance schemes during the year and the provision of secondary tax on companies (STC) and capital gains tax (CGT) on certain transactions.

It is anticipated that the group’s effective tax rate will continue to increase in 2008 and move to a corporate rate of 29% by the 2009 financial year.

Balance sheet

Inventory

Inventory management was one of the highlights of 2007. The group continued to build on the strategies implemented in 2006 and reduced inventory levels by 2.8%, despite a 12% increase in group turnover. The days cost of sales in inventory declined from 66 to 57 days.

All continuing businesses reduced inventory levels while Discom stock levels were increased over the year-end period in anticipation of the transfer of the business to Edcon in early September 2007.

The improvement in the UPD inventory level from 29 to 22 days is not considered to be sustainable and a more realistic level for 2008 would be around 27 days.

inventory days in stock* inventory (R’m)  
          %
  2007 2006 2007 2006 change
Clicks 71 83 802 817 (1.9)
Musica 77 88 128 131 (2.1)
The Body Shop 88 122 8 9 (6.7)
total retail 72 84 938 957 (1.9)
UPD 22 29 255 297 (14.3)
intragroup inventory     (2) (3)  
total continuing ops 53 63 1 191 1 251 (4.8)
Discom & Style Studio 93 90 212 192 10.2
total group 57 66 1 403 1 443 (2.8)

* at cost price

Cash utilisation

An increased focus on working capital management enabled the group to generate cash from operations of R1 254 million (2006: R252 million).

The group invested R155 million in capital expenditure for the growth of the business, paid R121 million in distributions to shareholders and repurchased shares of R558 million. Cash equivalents amounted to R413 million (2006: -R7 million) at year end.

However, following the strong performance in 2007, off a relatively high working capital base in 2006, the group does not expect to generate the same levels of cash in the new financial year.

Capital management

In the 2007 financial year the group repurchased shares totalling R558 million on the open market while a further R125 million were acquired by forward agreement. The repurchases enhanced earnings for the period by 1.7%.

The repurchase programme has also facilitated the delivery of 18 million share options during the year, with the outstanding options standing at 16.2 million compared to 57.6 million at the end of 2004.

The group has now acquired R879 million in shares at an average price of R13.62 since the inception of the repurchase programme in May 2006. This represents 18.1% of the issued share capital prior to the cancellation of 20 million shares in August 2007.

The average shareholders’ funds to total assets has improved from 40.9% in 2006 to 36.0%.

The group plans to continue the share repurchase programme in the 2008 financial year, utilising the net proceeds of the sale of Discom of approximately R210 million for this purpose.

Return on equity

The group has a medium-term target of achieving a return on equity (ROE) of 30% to 35%.

In the past year the group’s ROE increased from 16.7% to 24.7%, driven by increased profitability, enhanced asset turn and the improved gearing resulting from the share repurchase programme.

Financial priorities for 2008

  • Cash generation through a continued focus on working capital;
  • Capital expenditure of R176 million has been committed to invest mainly in the aggressive store opening and refurbishment programme; and
  • Balance sheet restructuring through continued share repurchases.

Shareholder distribution

The group has maintained its distribution cover ratio at 2.2 times earnings. The directors approved a total distribution of 48.2 cents per share (2006: 33.2 cents) to shareholders. This will be paid partly as a cash dividend from retained income and the balance out of share premium. The group expects to continue making distributions out of share premium in the medium term.

Financial targets

As a means of enhancing the quality of reporting and providing shareholders with a greater understanding of the group’s anticipated performance, management has disclosed medium-term financial targets for the first time. These targets are detailed on in the section on Strategy, Objectives and Targets.

Keith Warburton
Chief financial officer