Chairman's report

Challenging economic climate

The 2011 financial year started on a positive note in an environment of buoyant consumer sentiment in the wake of South Africa’s successful hosting of the FIFA 2010 World Cup. This mood of optimism was supported by an expectation of a continued economic recovery both locally and internationally.

Low and stable interest rates, with a further 100 basis point reduction in rates in the first half of the year, and higher real wage increases across most sectors proved positive for consumer spending and sustained the economic momentum through the festive season trading period.

However, economic and trading conditions became increasingly challenging as the financial year progressed as these positive factors were negated by consumers coming under pressure from higher fuel, electricity, utilities and food costs. Confidence was further eroded by the renewed global uncertainty arising out of the USA and the Euro zone.

The impact of the tougher trading conditions are reflected in the slowdown in economic growth in the country, with gross domestic product slowing to 1.3% in the second quarter of 2011 following two consecutive quarters of growth measuring 4.5%.

Consumer confidence has also declined during the course of 2011 and fell sharply in the third quarter of the year to the lowest level recorded since mid-2009. This reflects a growing concern among South Africans about the state of the economy and sentiment is being negatively impacted by global economic instability. Domestically, rising household costs, high debt levels and a lack of job creation are weighing down confidence levels.

There is a close correlation between consumer spending and consumer confidence; and the declining levels of confidence indicate a deteriorating retail environment in the months ahead.

Sustained financial performance

In this tightening economic environment it is pleasing that the group delivered a strong financial performance and continues to generate sustained returns for shareholders. Headline earnings increased by 13.9% to R655 million through robust trading in Clicks and efficient margin management. Diluted headline earnings per share (HEPS) again benefited from the earnings-enhancing effect of the share buy-back programme and increased by 18.1% to 249.7 cents per share. Diluted HEPS has grown at an annual compound rate of 28.6% over the past five years.

A final distribution of 88.0 cents per share was declared, bringing the total distribution for the year to 125.0 cents, an increase of 17.7%. Distributions have shown a five-year annual compound growth of 30.4%.

The group continues to be highly cash generative and remains committed to returning excess capital to shareholders. During the year R848 million was returned to shareholders through distributions and share buy-backs. Over the past five years the group has generated over R4 billion in cash, utilised R1 billion for capital expenditure and returned R3.4 billion to shareholders in distributions and share buy-backs.

The return on shareholders’ equity (ROE) was boosted by the share buy-backs and increased strongly from 50.8% to 62.2% for the year, more than trebling since 2006.

Owing to the continued strong cash generation, the board has shown its confidence in the group’s prospects and resolved to reduce the distribution cover from 2.0 to 1.8 times HEPS from the 2012 financial year, which will further enhance returns to our shareholders.

The group’s trading and financial performance is covered in the Chief Executive’s Report and in the Chief Financial Officer’s Report.

Changing governance landscape

South Africa’s corporate governance landscape has undergone fundamental change in the past year following the introduction of King lll and the enactment of the Companies Act (No. 71 of 2008, as amended). Governance processes and practices in the group have been aligned and enhanced as part of the implementation of this ground-breaking governance code and far-reaching new legislation. A detailed review of governance developments over the past year is contained in the Corporate Governance Report.

The board committee structure has been streamlined to enable committees to function more efficiently. Following the amalgamation of the audit and risk committees last year, the remuneration and nominations committees have been combined. In line with the requirements of the Companies Act the board has established a social and ethics committee. The transformation committee has been incorporated into the social and ethics committee and the combined committee has oversight for ethics management, stakeholder engagement, empowerment and transformation.

The independence of all non-executive directors was reviewed during the year. After an intensive evaluation the nominations committee concluded that all six non-executive directors, including myself as chairman, are appropriately classified as being independent in terms of both the King lll definition and the JSE Listings Requirements. This review of director independence is undertaken annually.

King lll has also introduced the concept of integrated reporting to enable stakeholders to assess a company’s ability to create and sustain value in the short, medium and long term. The group supports the concept of integrated reporting in the interests of enhancing disclosure to allow investors to make more informed investment decisions.

Integrated reporting presents another first for South Africa, which is already highly regarded internationally for reporting, regulation and governance standards.

The group qualified for inclusion in the JSE Socially Responsible Investment (SRI) Index for the second consecutive year, based on an independent evaluation of environmental, social, governance and sustainability practices.

The SRI Index has become the benchmark for sustainabilty among listed companies and applies both global SRI standards and issues specific to South Africa, such as transformation and black economic empowerment. The group showed a pleasing overall improvement in its rating in the index, achieving over 90% of the governance and related sustainability indicators.

Board of directors

The group’s chief financial officer, Keith Warburton, resigned to take a well-deserved sabbatical from corporate life. We echo the tribute paid to Keith in last year’s annual report and on behalf of the group wish him every success for the future. Michael Fleming succeeded Keith as chief financial officer and was appointed to the board as group financial director in March 2011. Michael has strong credentials as a financial director in a listed environment and we are already benefiting from his wealth of experience.

Outlook

Consumer spending is expected to remain muted in the current uncertain economic climate. Selling price inflation is anticipated to remain low and no medicine single exit price increase is expected to be granted by the Department of Health for 2012. The group will also face increasing cost pressures in employment, property, transport and utilities.

The focus for the year ahead will therefore be on driving sales volumes and containing costs.

The group remains well positioned in the medium term through the continued expansion of the Clicks store and pharmacy footprint and the opportunity to capitalise on UPD’s national presence to secure additional distribution agency contracts.

Acknowledgements

Challenging times call for strong and decisive leadership and I thank David Kneale and his executive team of Michael Fleming, Michael Harvey and Bertina Engelbrecht for their contribution over the past year. Thank you also to my fellow non-executive directors for sharing their wisdom and expertise.

Once again I thank our more than 8 300 employees at our stores, distribution centres and at head office for their commitment to ensuring our group remains the market leader. I also welcome our staff who became shareholders for the first time this year through the employee share ownership programme.

Thank you to all our external stakeholders, including our customers, shareholders and investment analysts, suppliers, industry regulators and business partners for your continued support.

David Nurek 
Independent non-executive chairman