Smiths City goes up without the ‘market’

Press, 16 September 1987, Page 36

Smiths City goes up without the ‘market’

By

DAVID HAY

I have always wondered about Smiths City Market Did Smith have a market in the city, or did the name refer to a market in Smith’s city? The company have now resolved the question — the name is "Smiths City Group, Ltd.”

The merger with Smith and Brown (no relation) could lead to a new change in the group’s over-all identity. The group is accustomed to having its operating divisions keep a variety of names, such as Noel Leeming’s Appliance Centres, Paterson and Barr (Dunedin), Tucker’s (Ashburton), and Irvin and Stern (Auckland). The group general manager, Mr Peter Leeming, says a new national identity will be established. But "management structure will be similar to now — we intend to maintain decentralisation.” For instance, general management of Smith and Brown will be in Auckland, as it is now, and will report to the group office, which will remain in Christchurch. (If a really fashionable new identity is needed, a subsidiary already exists with a logical and trendy name: Smithcorp, Ltd.)

Group management is highly regarded and the fact that during the year the company won the “Theory K” award for management “ek-sel-lence” was not a surprise. As you would expect, the company’s annual report (produced before the merger announcement) is suitably excellent. It is a well-stocked store of information, and it gives financial reporting equal "display space” with directors’ reports and other information.

Some interesting information came from the report, the recent announcement (plus some research), and an interview I had with Mr Kevin Smith, chairman of the company and with Mr Peter Leeming, group general manager. The financial report is very interesting reading. Since last year the company has had a complete overhaul of all its accounting policies. Properties are now revalued; goodwill is assigned to the fair value of assets and the balance written off to reserves; depreciation is now carried out on the diminishing-value method; and the provisions previously deducted from stock and debtors are converted into a general reserve under shareholders’

funds. The exercise has been done thoroughly, including making prior-year adjustments and restating the comparative figures in the accounts. It could be confusing for analysts, but it is the' most complete way to make adjustments, and follows the procedure recommended by the Society of Accountants for changes in accounting policy. And if it helps to bring the financial statements to a form in which they are more useful, who can disagree? The annual report shows group sales of 5199 million, and tells us that the directors believe potential sales of 5500 M can be reached. (And the two top executives suggested that after that, a billion dollars would be the target) The merger with Smith and Brown will add 5150 M to group sales, so the company is well on its way to that target. Amounts like that are not easy to comprehend. How much is it really? I looked at the statistics of New Zealand furniture and home-appliance sales and compared them with those of Smiths. For the year ended April 30, New Zealand furniture and home-appliance sales were 51882 M (in the previous year 51654 M). Smiths City Group sales were SI99M and 5140 M respectively. The statistics include a small effect due to GST; and the Smiths group sales include the effect of the merger with Irvin and Stem halfway through 1985. But we can clearly see that the group is doing well and getting better. As Peter Leeming says: “The big are becoming bigger and the small becoming fewer.” This is part of a long term trend. To keep up strong growth in the long term, management appear to be considering extending the business into other products. The Smith and Brown merger announcement included the news

that: "We hope that some time in the future our group will also include clothing and footwear.” The group general manager, Peter Leeming, agreed that this could seem to be a move outside management’s expertise. But, “We would say the reality is that all retail products involve: stock control; location; staff training and motivation; and effective promotion. We have proved our expertise in those areas. The only thing added is expert choice in selection of goods, and that is something you can acquire.” The other important feature of a retail business is its properties. Most of the other major retail groups have recently gone through some form of restructuring, based on the increasing value of the land and buildings of the businesses.

Smiths City Group’s properties are very significant. This year, property revaluations have been recorded (but not through the profit and loss account, of course). The increase in value for the year was 54.3 M, which is a substantial increase in reserves to add to the profit of 56.3 M. The property valuations are on a conservative “empty shell” basis (a value for the properties as if they were untenanted). There are different types of valuation that an independent valuer can produce, and it would be useful if more companies explained their revaluations in more detail like this one does.

“Smithcorp” does not intend to float its properties as a separate company. I asked Kevin Smith that question, and he said: “We have been down the path of reviewing our options. We see three integral parts of being a retailer — trading, finance, and property. Location is essential — you can not be a retailer without it.”

And the directors felt

that, eventually, the sharemarket would recognise that retail companies have the extra attraction of growth in property values. This factor is recognised in some other countries in a higher-than-average price-earn-ings ratio for retailers.

Peter Leeming was proud to announce that the company’s shares still rate in the top nine performers (in terms of returns to shareholders over the last five years). There are dramatic plans for continuing the sales growth of the company. That would not necessarily mean growth in profits or returns to shareholders — improved returns depend on the cost of expansion.

But the directors believe the Smith and Brown acquisition was bought on “an attractive price-earnings ratio relative to its retail worth,” as Peter Leeming put it Looking up Feltex’s last annual report we see that the Smith and Brown chain had a net profit of 52.2 M on shareholders’ funds of 512.2 M. But that is not why Smiths City see it as such good vaue for S2OM.

“There is a lot to be done to fully capitalise on the enormous potential the merger has for our group,” Mr Leeming said. That potential shows from the relationship of profit to sales. Smiths City Group has consistently managed a net profit after tax of 3.2 per cent of sales. If Smith and Brown can be run to achieve this level of over-all profitability it would return earnings of S4.BM.

One of the main differences, I understand, lies in the finance part of the business. Smiths City has kept its hire-purchase business within the company, and found doing so very profitable. Smith and Brown on the other hand finances its transactions through another group company. These financing arrangements will now gradually be brought within the group over the next three years.' ■ The purchase is probably to be funded by a share placement rather than from borrowing. Issuing shares at the price before the “don’t sell” notice of last week of 150 c, would mean about 13.3 million new shares. Adding these figures to the existing group shows that even if the Smith and Brown profit stays at the 52.2 M level, the shareholders would get a small increase in earnings per share.

We can see why Peter Leeming is so enthusiastic. He said: “We have proven capacity. This gives us real scope to do something quite spectacular.”

A rambling old department store at the wrong end of central Christchurch does not at first seem likely to be the centre of an organisation that wins management awards, gives shareholders top returns, and looks to be the leader in a major retail area. The company was audacious enough to include a picture in its financial report of metropolitan Auckland. Is this the town they will soon be renaming “Smiths City”?

David Hay is the manager at Price Waterhouse, chartered accountants, Christchurch, and a lecturer in auditing at Lincoln University College.