2013 04 Great Mall of China

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PREPARED BY BNP PARIBAS SECURITIES ASIA

THIS MATERIAL HAS BEEN APPROVED FOR U.S DISTRIBUTION. IMPORTANT DISCLOSURES CAN BE FOUND IN THE DISCLOSURES APPENDIX

EQUITIES RESEARCH

THE GREAT MALL OF CHINA

IN SOUTH AFRICA

Catalyst

There has been dramatic growth in the number of independent Chinese retail shops in South Africa inrecent years. In this note we analyse the potential impact of these new stores, and determine which listedretailers are most at risk from the high growth of these Chinese entrants.

Key findings

We estimate there could be c5,000 of these stores in South Africa, generating annual sales of ZAR20b. Sucha figure would rank this format collectively as the largest retailer by store numbers in SA, and the 8

th

largest in terms of merchandise sales. The stores have relatively low gross margins (about 29% in clothing),but with their low operating costs they are able to generate double-digit operating margins for their owner-operators.

Impact

In the listed retail universe, we believe Massmart (MSM SJ) may be impacted most by the rapid growth ofthe Chinese retail shops. General merchandise and home improvement accounts for c45% of MSM sales,and these categories are very prominent in the Chinese shops.

Likely impact on formal retailers within our coverage universe

High impact Moderate impact Low impact

Massmart (MSM SJ) JD Group (JDG SJ) Pick n Pay (PIK SJ)

Lewis (LEW SJ) Shoprite (SHP SJ)

Mr Price (MPC SJ) Spar (SPP SJ)

Truworths (TRU SJ)

Foschini (TFG SJ)

Woolworths (WHL SJ)

Clicks (CLS SJ)

Source: BNP Paribas Cadiz Securities

Shamil Ismail, [email protected]

+27 21 834 3656

Jasmine [email protected]

+27 21 834 3657

BNP Paribas Securities (Asia) Ltd. research is available on Thomson One, Bloomberg, TheMarkets.com, Factset and on http://eqresearch.bnpparibas.com/index. Please contactour salesperson for authorisation. Please see the important notice on the back page.

9 APRIL 2013
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The Great Mall of China Shamil Ismail, CFA

2 BNP PARIBAS 9 APRIL 2013

Impact of Chinese shops in SA

Over the past six years there has been dramatic growth in the number of independent Chinese shops inSouth Africa. Their store locations vary from concentrated large malls in urban areas, housing in excess of50 stores in one location, to single stores in small, rural towns. The spread of this retail format isimpressive and has surpassed the footprint of the large listed retailers.

EXHIBIT 1: Large mall format --- China Mall Johannesburg EXHIBIT 2: Standalone store format

Source: China Mall Source: BNP Paribas Cadiz store visits

While the large listed retailers have increased their market share over the past decade with increasedconsolidation, we believe recent growth in the number of Chinese shops could lead to a resurgence ofindependent retail in SA, with some implications for the larger listed retailers.

How many stores are there?

A recent article in the Noseweekmagazine (November 2012) estimated there could be about 6,000 of thesestores in SA. We tested this assertion in two ways. First, we obtained a list of 230 municipalities in SouthAfrica detailing their population. Assuming a ratio of 1 Chinese store per 10,000 population (this ratio was

established based on known store numbers for small towns like Clanwilliam and Citrusdal), we estimatethere may be 5,177 Chinese stores in SA.

EXHIBIT 3: Selection of municipalities with estimated number of Chinese stores

Municipality Province Population 2011 Population density (per km) Est number of Chinese stores

City of Johannesburg Metropolitan Municipality Gauteng 4 434 827 2,695.9 443

City of Cape Town Metropolitan Municipality Western Cape 3 740 026 1,520.3 374

eThekwini Metropolitan Municipality KwaZulu-Natal 3 442 361 1,501.9 344

Ekurhuleni Metropolitan Municipality Gauteng 3 178 470 1,652.0 318

City of Tshwane Metropolitan Municipality Gauteng 2 921 488 460.4 292

Nelson Mandela Bay Metropolitan Municipality Eastern Cape 1 152 115 588.1 115

Cederberg Local Municipality Western Cape 49 768 6.2 5

Swellendam Local Municipality Western Cape 35 916 9.4 4

Prince Albert Local Municipality Western Cape 13 136 1.6 1

Total for 230 municipalities 51 770 565 230 5 177

Source: BNP Paribas Cadiz Securities estimates

A second approach was to obtain a list of 596 populated places in South Africa, and categorise them ascities, large towns or small towns. Assuming an average number of stores for each category, we estimatethe number of Chinese stores could be c5,440.


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EXHIBIT 4: Estimate based on size of cities and towns

Cities Large towns Small towns Total

Number 6 120 470 596

Assumed number of Chinese shops per location 350 20 2 322

Estimated number of Chinese shops 2 100 2 400 940 5 440

Sources: BNP Paribas Cadiz Securities estimates

These estimates confirm that the number of Chinese shops in South Africa could be substantial, with afootprint of c5,000 stores. Compared with the store numbers of the large retailers listed below, we believethe collective footprint of the independent Chinese shops may represent the largest retailer in the country.

EXHIBIT 5: Store footprint of large retailers in South Africa

Sales Number of stores Sales/store

(ZAR m) (nos) (ZAR m p.a.)

Pepkor (division of Brait - BAT SJ) 19,800 2,457 8.1

Foschini (TFG SJ) 11,629 1,727 6.7

Spar (SPP SJ) 43,166 1,629 26.5

Edcon (unlisted) 24,664 1,228 20.1

JD Group (JDG SJ) 20,446 1,227 16.7

Mr Price (MPC SJ) 11,767 962 12.2

Pick n Pay (PIK SJ) 55,331 915 60.5

Shoprite (SHP SJ) 73,556 816 90.1

Lewis (LEW SJ) 2,365 602 3.9

Clicks (CLS SJ) 15,437 594 26.0

Truworths (TRU SJ) 8,830 569 15.5

Woolworths (WHL SJ) 25,231 448 56.3

Massmart (MSM SJ) 56,924 313 181.9

Total SA Sales 369,146 13,487 27.4

Stats SA Retail sales (2012) 666,171% large retailer concentration 55.4

Source: Company disclosure, Stats SA

The store footprint of the Chinese stores in SA may be double that of the largest formal retailer, Pepkor, andremarkably most of this store expansion is said to have occurred over the past six years (source: Noseweekmagazine, Nov 2012).

Impact of stores

In order to assess the sales impact of the Chinese stores, we use a range of store numbers and apply anaverage annual store turnover to these. Feedback from some urban store owners revealed that annualturnover could range from ZAR6m to ZAR8m per store. These were, however, larger stores located close to

high traffic areas. We test the scenarios below assuming an average annual turnover per store of ZAR4m(which would compare to the most recent annual turnover of the smallest listed retailer, LEW SJ, above).

EXHIBIT 6: Sales generated by Chinese stores

Number of Chinese stores 3,000 4,000 5,000 6,000 7,000 8,000

Sales pa per store (ZAR 000) 4,000 4,000 4,000 4,000 4,000 4,000

Total sales pa (ZAR m) 12,000 16,000 20,000 24,000 28,000 32,000

% Clothing, est.* 40 40 40 40 40 40

% General merchandise (GM), est. 60 60 60 60 60 60

Clothing sales (ZARm) 4,800 6,400 8,000 9,600 11,200 12,800

GM sales (ZARm) 7,200 9,600 12,000 14,400 16,800 19,200

Sources: BNP Paribas Cadiz Securities scenarios. *Estimate based on the findings of our store visits.


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In our base case of 5,000 stores, we estimate the sales generated by these retailers could amount to ZAR20bpa (3% of Stats SA retail sales). This would place this collective retail format as the 8th largest retailer bysales in SA, ahead of such well-known brands as Mr Price, Foschini and Truworths.

EXHIBIT 7: Ranking by annual turnover

Sales rank Retailer Sales pa (ZAR m)

1 Shoprite (SHP SJ) 73,556

2 Massmart (MSM SJ) 56,924

3 Pick n Pay (PIK SJ) 55,331

4 Spar (SPP SJ) 43,166

5 Woolworths (WHL SJ) 25,231

6 Edcon (unlisted) 24,664

7 JD Group (JDG SJ) 20,446

8 Chinese stores 20,000

9 Pepkor (division of Brait - BAT SJ) 19,800

10 Clicks (CLS SJ) 15,437

11 Mr Price (MPC SJ) 11,767

12 Foschini (TFG SJ) 11,629

13 Truworths (TRU SJ) 8,830

14 Lewis (LEW SJ) 2,365

Sources: Company disclosure; BNP Paribas Cadiz Securities calculations for Chinese stores

We calculate that products currently sold through these formats are mostly general merchandise, andestimate that with a 60:40 split between GM and clothing, clothing sales would be cZAR8b (on a par withTRU SJ).

Understanding the format

We conducted a survey of c100 of these stores and interviewed some store owners and other industrysources. These discussions shed some light onto the operations of the stores. Key points from these

discussions include:

The profitability of the R5 stores, which are primarily general merchandise, is quite high. Stores operate on a cash-only basis, with no credit or credit card facilities available. All products are no-name brands. Target market for the stores is mostly lower LSM customers, although some formats (e.g. party goods)

do attract higher LSM consumers.

The Chinese shops dont see themselves as competing with the large retailers. They believe theycompete with the other informal retailers. We believe this is the case in clothing retail, while in generalmerchandise these stores could compete effectively with the larger retailers.

Supply Chain --- the stores source from larger wholesalers who import directly from China. The storeowner would travel to the wholesaler (often located in Johannesburg) and select the merchandise. Thewholesaler therefore makes the import merchandising decision, and would need a good understandingof local product demand.

Store stock in most cases ranges from ZAR250k (in a small rural store) to ZAR500k (in urban stores). The stores have very low set-up costs, with limited shop fittings and product often stacked on the floor. In small stores products are often not price-marked, but the operators easily know the price as they

only have about nine price points. Each product falls into one of these price groups. This system is quiteefficient in its simplicity.

In rural areas, the model is to open a store close to a Pep store.


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Profitability of the Chinese shops

Some clothing store owners gave insights into the margins of these stores. The retail stores appear totypically generate GP margins of 28%, with wholesale margins at 14%.

EXHIBIT 8: Typical price composition (clothing)

Mark-up % ZAR % to selling price

Cost at source (China) 40 47.6

Wholesale profit 30 12 14.3

Shipping 20 8 9.5

Cost in South Africa 60 71.4

Retail profit 40 24 28.6

Selling price 84 100.0

Source: Store owners

We assess individual store profitability below, noting the stores can generate a generous return for thestore owner of c11.3% (before owner salaries and tax).

EXHIBIT 9: Store profitability (clothing)

MonthlyZAR 000

AnnualZAR000

Sales 333 4 000

GP % 29 29

Markdown % (very low, as goods are generally displayed until sold) 2 2

GP margin 90 1,080

Costs 52 628

Rent 30 360

Staff 9 108

Electricity and other 3 36

Transport costs 8 100

Communication 2 24

Store profit, before owner salaries and tax 38 452

Operating margin for owner (%) 11.3

Sources: Store owners; BNP Paribas Cadiz Securities calculations

Is this a franchise model?

The Noseweekarticle noted that in many cases the rural Chinese stores are typically operated by peoplefrom the Fujian province in China. A key question then is how these operators become aware of a smallretail opportunity in a Western Cape rural town like Citrusdal, for example. One theory is there may be amaster franchisor recruiting people to operate these stores, potentially on a profit share basis. We were

unable to confirm such a theory with the store owners. A 2008 study1

also rebutted the notion of acollective China Inc effort, pointing out a high level of competition between individual stores.

What it means

The independent Chinese retail stores rapid expansion may limit the market consolidation of largerretailers in SA.

This retail format is mainly price-driven, and would therefore appeal to a lower LSM, value seekingconsumer. However, in the large mall formats, there appears to be a sizable middle to higher incomeconsumer group.

1 The China Shop Phenomenon: Trade Supply within the Chinese Diaspora in South Africa, Rachel Laribee, 2008 GIGAInstitute of African Affairs, Hamburg


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In the clothing category, we believe the format will mainly impact entry level retailers. The stores oftendo not offer an appealing shopping environment, and no claims are made of good quality (althoughsome stores are making an effort to improve presentation --- see Exhibit 10 below).

We believe clothing retailers like TRU, WHL, TFG and MPC may be relatively unaffected by the fastgrowth of the Chinese retail stores in the near term.

In the general merchandise category, the customers appear to be across the entire LSM spectrum. Inthis category, we believe chains like Game and Makro (MSM SJ) are most likely to be impacted. The

pricing of substitute product in Chinese shops is substantially lower than Massmart's Game, as theindependent retailers often add lower mark-ups and have lower running costs.

Food retailers should be largely unaffected by this retail trend (except for their general merchandisecategory, which typically contribute less than 20% of overall sales). While we have noted a smallnumber of food stores, these tend to be focused on niche Oriental food products. A change on this frontis unlikely, in our view, as the short shelf life of most food product requires local supply sources.

While there is evidence of more furniture being sold in these formats, we believe the credit offering ofthe local furniture retailers should safeguard their market in the short term.

Overall, we believe the establishment of this formidable footprint and supply chain could signal new retailchallenges in the years ahead. Basic changes like improving the in-store shopping experience and offering

better quality product could be a game-changer for large retailers in SA, in our view.

EXHIBIT 10: Improved presentation in some stores EXHIBIT 11: Expanding categories - Furniture offering

Source: BNP Paribas Cadiz Securities store visits Source: BNP Paribas Cadiz Securities store visits

Summary impact

In the listed retail universe, we believe Massmart (MSM SJ) may be impacted most by the rapid growth ofChinese retail shops. General merchandise and home improvement accounts for c45% of MSM sales, andthese categories are very prominent in the Chinese shops.

EXHIBIT 12: Likely impact on formal retailers

High impact Moderate impact Low impact

Massmart (MSM SJ) JD Group (JDG SJ) Pick n Pay (PIK SJ)

Lewis (LEW SJ) Shoprite (SHP SJ)

Mr Price (MPC SJ) Spar (SPP SJ)

Truworths (TRU SJ)

Truworths (TFG SJ)

Woolworths (WHL SJ)Clicks (CLS SJ)

Source: BNP Paribas Cadiz Securities


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Disclaimers and Disclosures

ANALYST(S) CERTIFICATIONShamil Ismail, CFA, BNP Paribas Cadiz Securities (Pty) Ltd, +27 21 834 3656, [email protected] Lin, BNP Paribas Cadiz Securities (Pty) Ltd, +27 21 834 3657, [email protected].

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RECOMMENDATION STRUCTURE

Stock RatingsStock ratings are based on absolute upside or downside, which we define as (target price* - current price) / current price.BUY (B). The upside is 10% or more.HOLD (H). The upside or downside is less than 10%.REDUCE (R). The downside is 10% or more.

Unless otherwise specified, these recommendations are set with a 12-month horizon. Thus, it is possible that future price volatility may cause atemporary mismatch between upside/downside for a stock based on market price and the formal recommendation.

* In most cases, the target price will equal the analyst's assessment of the current fair value of the stock. However, if the analyst doesn't think the market willreassess the stock over the specified time horizon due to a lack of events or catalysts, then the target price may differ from fair value. In most cases, therefore, ourrecommendation is an assessment of the mismatch between current market price and our assessment of current fair value.

Industry RecommendationsImproving(): The analyst expects the fundamental conditions of the sector to be positive over the next 12 months.Neutral(): The analyst expects the fundamental conditions of the sector to be maintained over the next 12 months.Deteriorating(): The analyst expects the fundamental conditions of the sector to be negative over the next 12 months.

Country (Strategy) RecommendationsOverweight (O). Over the next 12 months, the analyst expects the market to score positively on two or more of the criteria used to determinemarket recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and indexreturns relative to the market cost of equity.

Neutral (N). Over the next 12 months, the analyst expects the market to score positively on one of the criteria used to determine marketrecommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and index returnsrelative to the market cost of equity.

Underweight (U). Over the next 12 months, the analyst does not expect the market to score positively on any of the criteria used to determinemarket recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and indexreturns relative to the market cost of equity.

RATING DISTRIBUTION (as at 9 April 2013)Total BNP Paribas coverage universe 644 Investment Banking Relationship (%)

Buy 343 Buy 7.0

Hold 202 Hold 2.0

Reduce 99 Reduce 4.0

Should you require additional information concerning this report please contact the relevant BNP Paribas research team or the author(s) of this report.

2013 BNP Paribas Group

2013 04 Great Mall of China

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