Chief Executive’s Report

Trading performance

2012 proved to be a challenging year as middle income consumers in the Clicks target market faced increasing economic pressures. Selling price inflation remained low as we had expected and averaged only 0.5% for the period.

The group anticipated these headwinds and in this trading environment we have focused on staying competitive and maintaining tight expense control while continuing to invest for long-term growth.

Group turnover for the year increased by 9.2% to pass R15 billion for the first time, with all our businesses showing real sales volume growth.

The Clicks chain increased turnover by 9.2%. The health and beauty markets in which we operate have been reliant on promotional activity to sustain sales volumes and attract value-conscious consumers into stores.

The gross margin came under pressure owing to our decision to invest in offering customers better value through investment in more promotional activity. Clicks increased operating profit by 4.9% and the operating margin of 7.4% remains within the medium-term target range of 7% to 8%.

The appeal of the Clicks brand, however, remains strong, evidenced by the chain gaining market share in all key product categories. The Clicks ClubCard loyalty base has grown by over 500 000 to 3.9 million active members, and accounted for 77.1% of the chain’s sales.

Musica performed well and increased market share in CDs, DVDs and gaming. The ongoing right-sizing of the brand, which resulted in the net closure of a further 14 stores, contributed to operating profit increasing by 36.3%.

The Body Shop also had a good year and increased turnover by 14.1%, with operating profit up by 15.9%.

UPD, the group’s pharmaceutical wholesaler, reported an improved performance and trebled the notional turnover of the distribution agency business to R1.7 billion. While the business faces pressures from increased genericisation and from manufacturers seeking to reduce supply chain costs, UPD is on track for sustained growth.

The group’s financial and operating performance is covered in the Chief Financial Officer’s Report and in the Operational Reviews.

Group strategy

The integrated healthcare retail and supply model provides a unique competitive positioning for the Clicks Group in South Africa. The group’s strategy is driven by two key objectives, notably to achieve pre-eminence in health and beauty retailing, and in healthcare supply management. The strategy has been consistently applied during the year.

Clicks has again been independently rated by customers as South Africa’s leading health and beauty retailer. Health and beauty collectively accounts for 80% of the chain’s sales. Clicks has the largest retail pharmacy footprint and opened its 300th pharmacy, with the network being extended to 306 with the opening of 23 dispensaries during the year. Retail pharmacy market share has increased to 16.2%.

The Clicks store footprint was extended to 420 following the opening of a net 20 new outlets, and is on track to expand to 500 stores in the medium term. Clicks increased front shop healthcare market share to 38.7%. In the beauty category, skincare and haircare market share increased to 33.8% and 30.4% respectively, while continued innovation saw over 4 300 new beauty products introduced.

Private label and exclusive brands are core to the Clicks growth strategy and accounted for 18.4% of total Clicks sales and 24.2% of front shop sales.

In healthcare supply management, UPD has entrenched its market-leading position and increased its share of the private pharmaceutical wholesale market from 23.1% to 24.3%.

Ten new agency distribution contracts were awarded during the year, including Pfizer, one of the largest global pharmaceutical manufacturers. UPD was also appointed as the preferred supply chain partner to Aspen Pharmacare, South Africa’s largest pharmaceutical manufacturer.

The group’s strategic objectives are supported by two strategic enablers: enhancing organisational capability to deliver sustained performance, and the efficient management of cash and capital. Medium-term financial targets are published to guide investors on the performance objectives of the group, and these targets are reviewed annually. Targets are also disclosed for the strategic enablers to demonstrate the sustainability of the business. The detailed review of the group’s performance against the strategic objectives and enablers is covered in the Group Strategy and Targets report.

Material risks that could impact on performance and the delivery of the strategy are reviewed annually and mitigation plans developed. The biggest challenges facing the group are the current economic and trading environment, the increasing level of competition in the retail and corporate pharmacy sectors, and the increasing cost of attracting and retaining pharmacy professionals. The group’s material sustainability issues and risks are outlined here.

The directors believe the strategy remains relevant in the current environment, gives the group competitive advantage, and should ensure sustainable growth in the health and beauty retailing and supply markets. The strategy therefore remains unchanged for the year ahead.

Addressing pharmacy challenges

Clicks is the largest employer of pharmacy professionals in the private sector with over 2 370 permanent and locum pharmacists. In the past year the pharmacy business generated turnover of R2.8 billion while processing more than 22 million prescriptions.

In the current trading environment the group has focused on containing costs. One of the consequences has been that Clicks has managed the pharmacy business too tightly, which has impacted on the chain’s ability to retain pharmacy staff in some stores, resulting in the pharmacy staff turnover increasing to 37%. Our ability to fill the consequent vacancies is then hampered by the shortage of healthcare professionals, which is already an industry challenge.

This has also affected service levels as customers have experienced longer queues in pharmacies that have staff shortages, while the morale of pharmacy teams has also been negatively impacted by increased workload.

Decisive action is being taken to improve customer service in our dispensaries.

The Clicks operations have been restructured, with the retail and pharmacy regional management being integrated into one team to provide greater management support to pharmacies.

The pharmacy recruitment process has been streamlined and the recruitment team strengthened to enable Clicks to fill vacancies faster.

During the year the group commissioned an independent benchmarking survey of the pharmacy industry, which showed that salaries for our pharmacists are competitive. The only area we lagged the market was for pharmacist assistants, and pay bands and salaries have been adjusted accordingly.

An additional 200 pharmacist assistants are being trained through the in-house Pharmacy Healthcare Academy to improve staffing levels in dispensaries.

The cost of implementing this corrective action in Clicks is approximately R40 million. We will endeavour to fund this investment by creating efficiencies in the rest of the chain in the year ahead.

Healthcare regulation

The group continues to engage constructively with the Department of Health (DoH) on proposed regulatory and legislative changes affecting Clicks and UPD.

The DoH has issued a second draft proposal on regulations to cap the logistics fees that can be earned by pharmaceutical wholesalers. The group has consistently supported the introduction of a maximum logistics fee to manage costs along the pharmaceutical supply chain.

While the new proposals are an improvement on the initial draft regulations released in 2011, the proposals are flawed in a number of respects and we are raising our concerns with the DoH.

The fees remain inappropriately low to allow wholesalers to earn a reasonable return, and at this level would dilute UPD’s margin and erode profit. The definition of a logistics service provider needs to be clarified in the regulations so the industry can determine the services covered by the fee. We believe the proposed monitoring mechanisms are administratively burdensome and will increase costs to manufacturers. The proposals also do not address the licensing and policing of quasi-wholesalers who currently earn fees without providing a full wholesaling service.

The capping of logistics fees will accelerate consolidation of the pharmaceutical supply chain, which will be to the benefit of UPD as the industry leader.

Attracting, retaining and training people

Attracting and retaining talent is key to our ongoing success, while growing and developing our people is critical to the sustainability of the business.

Employee turnover increased to 21.7% from 19.4% in the previous year and is outside the target range of 18% to 20%. The group’s turnover has been impacted by the turnover in pharmacy staff.

A broad-based employee share ownership plan (ESOP) was implemented in 2011 to attract, retain and incentivise staff, and to allow them to share in the long-term growth and success of the group. Shares have been allocated to 7 855 permanent employees, with black staff accounting for 86% and women 63% of the recipients. Pharmacists comprise 5% of the ESOP beneficiaries. The first dividend of R2.8 million was paid to scheme participants this year.

A group retention scheme was implemented in 2009 to retain talented employees by providing them with a long-term financial incentive linked to growth in the group’s earnings. This includes high-potential employees, black staff and employees with scarce and critical skills. There are currently 39 employees participating in the scheme, of which 33% are black and 44% are women.

The group invested R40 million in learning and development in the past year, with over 4 600 employees participating in training programmes. Black employees accounted for 82% of the employees trained.

Attracting and retaining scarce skills remains a challenge, particularly in general management, and in merchandise and planning in the retail businesses. A leadership development programme was introduced during the year and 20 managers are currently participating in the three-year programme. A merchant academy was launched to train new and existing buyers and planners.

The Clicks chain has identified the need to strengthen management in its large stores. A new training and development programme will be introduced for the managers of the top 40 stores.

The Pharmacy Healthcare Academy, which is registered with the SA Pharmacy Council, and is SETA accredited, continues to be instrumental in developing pharmacy talent to address the skills shortage. At year-end, 360 pharmacist assistants were registered on training programmes with the academy. An annual pharmacy conference provides continuing professional development for both pharmacists and nursing practitioners in the group.

Transformation

Clicks Group was rated as the most empowered company in the retail sector in the Financial Mail Top Empowerment Companies 2012 survey, underlying our commitment to sustainable transformation.

The group has maintained its level 3 BBBEE rating despite more onerous targets for employment equity and preferential procurement on the DTI scorecard. Improved scores were recorded in the ownership, management control and preferential procurement categories.

Over 6 700 black staff are shareholders through the ESOP, which has accelerated transformation at ownership level. An independent analysis was also conducted on the group’s shareholding to determine the level of beneficial black ownership.

Employment equity continues to improve, with black staff representing 85.0% (2011: 84.8%) and women 63.3% (2011: 63.0%) of all employees. Attracting and retaining senior black talent remains a challenge, and black staff represent 20.0% (2011: 20.4%) of senior and top management. Women comprise 36.0% (2011: 35.5%) of the group’s senior leadership.

In the past year R40 million was invested in skills development, R90 million was committed to enterprise development and R7 million invested in social development projects.

Prospects

Growth in consumer spending is expected to remain muted in the year ahead, and the health and beauty markets will continue to be promotionally driven. Selling price inflation is currently anticipated to remain at low single-digit levels.

The group’s focus in this trading environment will therefore continue to be on growing sales volumes and containing costs.

Capital expenditure of R356 million has been committed for 2013 for new stores, new pharmacies, store revamps, IT systems and the expansion of UPD’s distribution infrastructure. Trading space is planned to increase by 4% to 5%.

The group’s brands are all leaders in their respective markets and have proven track records of gaining market share. Based on the growth potential of Clicks and UPD, together with the group’s strong cash-generating ability, management is confident of achieving its medium-term financial targets.

Appreciation

Thank you to our chairman, David Nurek, for his support and decisive leadership, and our non-executive directors for their active participation in the group. Thank you to my colleagues on the group executive, management across the group and our people at head office, stores and distribution centres throughout the country for your contribution.

Thank you to our customers for making us their first choice in health and beauty retailing.

David Kneale

David Kneale
Chief Executive Officer