Zara investment could significantly alter PG’s financial dynamics

Financial Article 555 by Edward Rizzo - Sep 13, 2018

On 28 August, PG plc published its annual financial statements as at 30 April 2018 and on the same day the Directors declared a second interim dividend of €0.0236 per share net of tax which was subsequently paid on 5 September.

The declaration and immediate payment of a second interim dividend may have surprised many investors since the customary procedure is for Directors to recommend the payment of a final dividend on the day of the publication of the annual financial statements and this dividend is then paid following approval by shareholders during the Annual General Meeting.

During a meeting convened with financial analysts the day after the publication of the annual financial statements, PG’s Chairman John Zarb explained that since the company’s AGM is scheduled for October and the company distributes an interim dividend in December, PG will start paying two interim dividends to ensure an appropriate lead time between the first dividend and the second.

PG’s Chairman gave a detailed overview of the company’s operations and its financial performance. It is important to highlight that the April 2018 annual financial results are not directly comparable with those of the previous financial year (reflecting the period from May 2016 to April 2017) as the retail mall within the PAMA Shopping Village was inaugurated in October 2016. As such, the financial year ended 30 April 2018 is the first one to include the operation and contribution of all three business units of PG – namely the PAVI and PAMA supermarkets, as well as the franchise operations related to the Zara retail stores.

Overall group revenue during the 12 months ended 30 April 2018 was just below €100 million representing an increase of 8.9% from the previous financial year. Both the supermarket outlets as well as the Zara franchise operations registered strong growth. Revenue from the PAMA and PAVI supermarkets increased by 8.3% to €83.4 million on the back of the increased maturity of the PAMA supermarket operations (footfall increased by 13.5%) as well as the impact of a full twelve-month period of the PAMA retail mall while the Zara franchise registered a growth of 12.3% to €16.5 million.

At the time of the Initial Public Offering in March 2017, the company had published financial projections for the year ended 30 April 2018. Actual revenue for the past financial year of €99.8 million was 3.6% above projections.

On the other hand, however, costs increased by more than expected as a result of higher employment costs within the various outlets (reflecting local economic dynamics) and a significant investment in the group’s management structure which was necessary following the strong rate of growth within a short timeframe. Overall operating costs increased by €7.9 million (9.7%) to €88.2 million compared to the IPO projections of €83.4 million. In the recently published 2017/18 Annual Report, it was stated that “with the possible exception of IT, the group expects that such costs will now stabilize”.

In view of the steeper rise in costs, earnings before interest, tax, depreciation and amortization (EBITDA) of €12.9 million was only 2% above the previous year’s level and 10% below projections. Likewise, the actual net profit of €7.66 million improved by 4% over the previous year but was almost 9% lower than originally anticipated.

Notwithstanding the fact that overall profits were below expectations, the total dividend in respect of the 2017/18 financial year amounting to €0.0393 per share (the first interim dividend of €0.01574 per share paid in December 2017 and the second interim dividend of €0.0236 paid on 5 September 2018) is in line with the indication given at the time of the IPO. The Prospectus had stated that the company’s dividend policy will amount to at least 50% of annual profits after tax. Had the company achieved its projected profit of €7.66 million (equivalent to earnings per share of €0.078), a 50% payout would have resulted in a total net dividend of €0.039 per share. The actual dividend distribution of €0.0393 is therefore exactly in line with expectations since the dividend payout ratio was increased to 55%.

PG’s business remains highly cash generative and during the past financial year, free cash flow amounted to €6.6 million or €0.0611 per share which is significantly higher than the net dividend of €0.0393 per share. Mr Zarb explained that the strong cash flow and the low level of loan repayment commitments enables the company to easily support the semi-annual dividend stream and finance new growth opportunities.

The current financial year ending 30 April 2019 will be largely characterised by the extension and refurbishment of the Zara outlet located in Sliema at a cost of around €9.1 million. The Zara outlet in Sliema was closed on 9 July 2018 and it is anticipated to reopen for business in November 2018. Accordingly, the interim financial statements as at 31 October 2018 will be negatively impacted by the lost income pertaining to the five-month period during which Zara Sliema is closed.

The major surprise from the recent analyst meeting was that despite the closure of Zara Sliema for five months during the current financial year, PG hopes to maintain a stable level of profits this year. This would be a remarkable achievement. According to the company this would be possible since during the first two months of the 2018/19 financial year (May and June 2018), supermarket sales have grown by 8% over last year while Zara Sliema should see a sizeable increase in revenue once it opens in November 2018 since the floor area is almost doubling to 3,300 sqm.

PG’s Chairman explained that the Zara development “could have a material impact on the group’s performance and margins”. In fact, during the last financial year, the Zara franchise operations accounted for 16.5% of total revenues but generated nearly 26% of the group’s operating profits. This is a clear indication that although the Zara and Zara Home operations are smaller than that of PAVI and PAMA from a revenue perspective, they generate higher margins and are thus more important contributors to PG’s overall profitability.

During the recent analyst meeting, PG’s Chairman also spoke about the recent property acquisition. Both the Chairman as well as the CEO Mr Charles Borg highlighted that the purchase of the ‘United Macaroni’ factory was not part of the company’s overall strategic plan but was mainly an opportunistic deal given the attractive consideration of €3.5 million as well as the advantageous payment terms. The company’s officials claimed that they do not intend to enter into any speculative property development and will proceed with the development of circa 13,000 sqm of rentable area once an anchor tenant is signed up. The timing of the potential redevelopment of the old factory is therefore still undecided.

Moreover, PG indicated that it continues to maintain a close eye on potential growth opportunities including the possibility of further enhancing or extending its present facilities within PAVI and PAMA as well as acquiring alternative sites to convert or develop these into a new supermarket and shopping village.

PG’s officials again confirmed that any new growth initiatives would not come at the expense of excessive leverage and/or a reduction in the dividend as the company aims to continue to reward shareholders with consistent and sustainable dividends.

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