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AGM Annexure 1 Analysis of Shareholders Shareholders' Diary Definitions

 

Chief Financial Officer's Report

Introduction

Clicks Group has again delivered strong earnings growth and achieved or exceeded all financial targets in a period characterised by continued pressure on consumer spending.

Headline earnings for the period increased by 19.7% to R478 million, with diluted headline earnings per share (HEPS) increasing 26.2% to 165.9 cents per share.

Return on shareholders’ interest (ROE), the over-arching indicator of the group’s financial performance, rose strongly from 32.8% to 42.3%.

The 37.5% increase in the total distribution to shareholders for the year is testament to the board’s confidence in the group’s performance and longer term prospects. Distribution cover was reduced to two times undiluted headline earnings per share.

The group has remained strongly cash generative during the period, returning R529 million to shareholders through distributions and share repurchases while investing R225 million for the maintenance and growth of the business.

Financial performance

The review of the group’s financial performance for the year ended 31 August 2009 should be read in conjunction with the annual financial statements, as well as the business unit trading analysis.

Growth momentum

Income statement

Turnover

Group turnover increased by 8.8% to R12.2 billion (2008: R11.2 billion). Turnover across the retail businesses of Clicks, Musica and The Body Shop increased by 15.4% and showed high real growth as selling price inflation measured 8.6%.

Clicks produced another strong performance and increased turnover by 17.7%, with second half sales growing by 20.1%. Comparable store sales rose by 15.3%. This performance was largely driven by the 30.5% growth in sales in the health category as dispensary sales continued to gain momentum, supported by solid growth in front shop health products.

The slowdown in discretionary spending continued to impact Musica and turnover increased by 0.8%, although the business gained market share over the period. CD sales, which account for 53% of turnover, declined marginally, with DVD sales growing 2.2% and gaming software and consoles by 6.0%.

The Body Shop benefited from new store openings and increased turnover by 8.7%.

Turnover growth of 4.4% in UPD was in line with management’s expectations as the business was repositioned during the year to focus on customer profitability and improving operating efficiencies (refer to UPD for further detail). Price inflation of 9.2% was largely as a result of the increases in the single exit price (SEP) of medicines granted to manufacturers by the Department of Health in April 2008 and December 2008.

Intragroup turnover from UPD to Clicks grew by 39.4% and reflects the growth in the dispensary business of Clicks.

The trading performance of the business units is covered in the operational reviews.

Total income

Total income, comprising gross profit and other income, grew by 13.8% to R3.1 billion. The total income margin, expressing total income as a percentage of sales, improved to 25.3% from 24.2% in 2008.

The retail total income margin was constant at 32.0% owing to improved buying margins and well-managed shrinkage and wastage.

UPD’s total income margin was stable at 8.4% despite an increasing proportion of ethical drug products in the sales mix. UPD benefited from the SEP increases referred to above.

Operating expenditure

Group operating expenditure increased by 12.0% and was again contained below the level of growth in total income.

Retail operating expenses increased by 13.8% and includes the increased investment in new stores and pharmacies of R141 million (2008: R40 million) and performance incentive costs of R134 million (2008: R103 million). Excluding these costs, the underlying growth in costs was only 10.3%.

Operating costs in UPD declined by 0.7%. When the costs relating to the consolidation of Clicks Direct Medicines are excluded, UPD’s costs reduced by 14.9% as the benefits of the repositioning strategy were reflected in cost savings across the business, particularly in transport and employment costs.

Operating profit
The group’s operating margin improved to 5.8%, continuing to show an improving trend from 3.9% in 2006, 4.8% in 2007 and 5.3% in 2008.

Clicks lifted operating margin to 6.5% from 6.1% in 2008 through improved efficiencies. This was achieved despite the increasing proportion of lower margin dispensary turnover in the sales mix as Clicks continues to apply the R26/26% pricing model. Dispensary turnover accounted for 20.6% (2008: 17.3%) of Clicks’ turnover.

Musica produced a creditable performance and maintained its operating margin and operating profit through good management of buying margins and tight cost control, despite the limited growth in turnover.

UPD increased its margin to 3.4%, also realising further operating efficiencies through the repositioning. While management believes that a more sustainable wholesale margin is between 2.7% and 3%, it should be noted that this targeted margin does not take into account any trading benefit from an increase in SEP as was the case in the past two years or the business gaining significant third party distribution contracts in the forthcoming financial year.

The enhanced margin translated into growth of 20.1% in group operating profit to R709 million, with Clicks and UPD contributing 91%.

Interest
Net interest paid for the period was R55 million (2008: R51 million). Cash interest servicing costs reduced by 31% from R62 million in 2008 to R43 million in 2009, mainly due to lower levels of funding required through expedient working capital management. The R9 million charge for the second half of the year was significantly lower than the first half cost of R34 million.

The interest charge for structured finance loans, which attract a higher rate of interest, reduced to R4 million (2008: R18 million). The group’s remaining structured finance loans will be retired by August 2010.

Balance sheet

Inventory
Inventory continued to be well managed and increased by only 3.7%, comfortably below the rate of turnover growth. Inventory days cover improved from 56 to 54 days.

Clicks contained inventory growth to a modest 2.9% compared to turnover growth of 17.7%, while the days cost of sales in inventory reduced from 72 to 62 days. This improvement was aided by the changing sales mix with an increasing proportion of dispensary sales which have a higher inventory turn. UPD’s inventory days cover was constant at 28 days.

Inventories have been consistently tightly controlled in recent years as management sought to improve working capital management, showing a four-year compound growth rate of -0.3% per annum, while turnover has increased by 8.7% per annum over the same period.

Cash utilisation
Cash flow from operating activities of R1.1 billion showed a significant increase on the R264 million generated in 2008.

Following capital expenditure of R225 million, distributions to shareholders of R191 million and share buy-backs of R338 million, the group generated net cash of R309 million.

Cash flow was positively impacted by timing differences in the working capital funding from trade payables in UPD totalling R359 million. Accounting for these differences to UPD’s trade payables, the normalised cash flow for 2009 was R698 million (2008: R643 million) which is a more representative level for the year.

Shareholder distribution

A final distribution of 59.5 cents per share was declared to shareholders, bringing the total distribution for the year to 84.0 cents, an increase of 37.5% over the previous financial year. The distribution will again be paid as a capital reduction out of share premium.

Distribution cover has been reduced from 2.2 to 2.0 times cover on undiluted headline earnings per share from the 2009 financial year.

Acquisition

In line with the strategy of creating pre-eminence in healthcare retailing, the group expanded its national pharmacy offering with the acquisition of a 60% stake in leading courier pharmacy business, Direct Medicines, for R13.2 million.

The business has been renamed Clicks Direct Medicines and integrated into the retail pharmacy offer to complement the in-store dispensary network of Clicks, with UPD supplying the majority of the medication for distribution through the courier business nationally. Turnover has increased by 25% since the business was acquired by the group.

The acquisition was effective from 1 December 2008 and the group has the option to acquire the remaining 40% of the business after three years.

Return on total assets and inventory days

Capital management

The group strives for efficient management of cash and capital to enhance returns to shareholders while maintaining an optimal capital structure. Management utilises various mechanisms to maintain the ratio of shareholders’ interests to total assets in the range of 30% to 35%, including the management of working capital, share buy-backs and distributions to shareholders.

Over the past year the group repurchased shares totalling R338 million at an average price of R17.50. Since the share buy-back programme was initiated in May 2006 the group has acquired R1 550 million in shares at an average price of R14.56. This represents 31% of the issued shares at the commencement of the programme.

Excellence in Corporate Reporting

The 2008 annual report was ranked in the “Excellent” category in the prestigious Ernst & Young Excellence in Corporate Reporting awards, placing the report among the most highly rated in the country and recognising our efforts to continually improve financial reporting and disclosure. These awards rank the annual reports of the 100 largest companies on the JSE and have become the benchmark for recognising the quality of financial reporting by listed companies.

Financial targets

Financial targets are reviewed each year based on performance and the outlook for the next three-year period. Following the achievement of all targets for the 2009 financial year, the medium-term targets for 2010 to 2012 have been adjusted to reflect the improved performance and prospects, as well as the expected improvement in the trading environment beyond 2010. The targets for ROE, return on total assets and operating margin have been revised upwards and the targets are as follows:

	Performance in 2009	Target 2010 – 2012
Return on shareholders’ interests (%)	42.3	40 – 50
Shareholders’ interest to total assets (%)	26.9	30 – 35
Return on total assets (%)	12.3	13 – 16
Inventory days	54	55 – 60
Operating margin (%)	5.8	5.5 – 6.5

Plans for 2010

Capital expenditure will be maintained at R225 million for 2010. This includes R137 million for investment in new stores, dispensaries and store refurbishments and R46 million for information communication and technology. Over 70% of the expenditure has been allocated to the Clicks chain.

Total retail trading space is anticipated to increase by between 5% and 6% through the opening of 23 to 33 new stores.

Further detail on capital expenditure and store development for 2010 is contained here.

Product inflation is expected to slow to the mid-single-digit level into the second half of the financial year owing mainly to the strengthening in the average value of the Rand. However, cost pressures in the local economy such as rising energy prices and higher real wage increases remain a risk to inflation.

The group plans to continue to repurchase shares as part of the ongoing capital management programme at price levels that remain earnings enhancing, although the level of buy-backs will be at a more moderate level than in 2009.

Acknowledgements

Thank you to our shareholders for their vote of confidence in the Clicks Group and we welcome those institutions and individuals who invested for the first time during the year. We value our relationships with the investment community and thank analysts and fund managers for their interest in the group, and welcome the increasing interest from offshore investors as our shareholder base is further diversified. In closing I extend my thanks to the finance staff across the group for their commitment and ongoing effort to enhance the standard of financial reporting.