Company Name Wetherlys Target Price 384c Sector Retail - Small

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Company Name Wetherlys Target Price 384c Sector Retail - Small Powered By Docstoc
					PLJ Financial Services Limited, Member of the JSE, BME Reg No.69/13227/06 2 Hogsback Road Constantia View Office Estate Quellerina Ext 4, 1709 P O Box 418, Bergbron, 1712 16th September 2002

Johannesburg: 011 375 1000 Bellville: 021 914 7444 Bloemfontein: 051 448 2429 Pretoria: 012 342 6700 Westville: 031 266 1311 Email: Web:

Company Name: Wetherlys Sector: Retail - Small Caps Recommendation: BUY
JSE Code: Market Capitalisation ZAR USD WET R342m $32m Summary

Target Price: 384c Price: 268c

All Share Index


Current PE 3 Year Average PE PE Relative

8.62 10.45 0.76

? Wetherlys targets the more resilient, affluent and upwardly mobile ? sector of the furniture market. This gives the counter a defensive stance in adverse retail market conditions, but does not limit the upside in improving markets. ? The company is in a strong financial position with an excess of ? R 45 m in cash on the balance sheet at year-end and a long-term debt to equity ratio of 13%. ? Great growth potential locally and, particularly, offshore ? ? We are forecasting 25% growth in earnings for the 6 months to ? Aug 2002 ? Wetherlys is a financially strong company with good growth ? prospects and the stock is trading at a deep discount to its fair value. We therefore recommend buying the stock, particularly at these levels.

FY’01Actual HY’02Actual FY’02Actual HY’03Forecasted

HEPS (Cents) 25.4 11.4 31.1 13.9

Dividend (Cents) 6c N/A 7c N/A

Net Asset Value (Cents) 121.1 126.7 145.3 FY174

Interest Cover 168 49 75 13

Dividend Cover 4.2 N/A 4.4 N/A

Effective Tax Rate (%) 31% 33% 30% 30%

Performance (%) YTD 1 Month 3 Months 13% 3% 7%

12 Month High 12 Month Low Shares in Issue Average Monthly Trade

Cents Cents Million R Million

280c 175c 127 703 000 3 630 000

Research Analyst: Natalie Kolbe Tel: (011) 375-1117 Fax: (011) 375-1300 E-mail:
This report is confidential and for the information of clients only. Information and opinions in this document are from sources believed to be reliable, but cannot be guaranteed due to the nature thereof. PLJ Financial Services Limited accepts no liability as a result of any action based on the information or opinions expressed in this report. The company, directors and staff may from time to time have interest in the shares mentioned in this report.

You don’t have to travel far before coming across the instantly recognizable style that is Wetherlys. Whether traveling on business or holiday, or just visiting the neighbour next door, it is clear that Wetherlys is making substantial inroads into the affluent South African furniture market. Their furniture is classical and unique and their lifestyle accessories stylish and exclusive, but, although this may be good news for the housewives of Sandton, what does it mean for the ‘armchair’ investor? Wetherlys has been in the furniture market for almost 30 years and was born when brothers, Nick and Steve Davies, started selling handmade pieces out of their garage in 1973. Their first retail outlet was opened in Craighall Park, Johannesburg and demand soon saw additional stores being opened. To take full advantage of the proposed future growth opportunities, management took Wetherlys to the market in November 1997, raising R40 m on the JSE. Wetherlys now enjoys a presence in all major centres around South Africa and has recently opened a store in Spain.




Melville Decor

Subsequent to their 2000 year-end, Wetherlys acquired the niche cane importing business of Osiers. Additional products where added to the Osiers range, including bedding and bathroom products, and the first store opened in November 2000 in Kya Sands. The company now has 8 Wetherlys and 5 Osiers stores, with the latest addition being the Nelspruit branches that opened in August 2002. They also opened a store in Spain that sells a combination of Osiers and Wetherlys products. Earlier this year Wetherlys acquired Melville Décor, a small furniture business in the Eastern Cape. The company has three stores situated in Knysna, George and Plettenberg Bay and this growing region is expected to contribute adequately to future revenues. Mellville Décor are much smaller stores that sell a combination of Osiers and Wetherlys products. THE SOUTH AFRICAN FURNITURE INDUSTRY Sales growth The South African furniture sector has been in disarray over the past year, following international trends towards consolidation. Declining real furniture sales and increasing interest rates put pressure on the industry and the past year saw 2 of the 5 listed furniture retailers on the JSE being rescued from financial


distress. Real growth in furniture sales has been steadily decelerating over the last 3 years and the June retail sales figures showed a 4.3% YOY decline in real furniture sales. Although Wetherlys’ furniture sales growth is decelerating, their sales have been growing in excess of that of the market and their market share has been steadily climbing since their listing, tapering off last year. At their financial year-end they had 2.16% of the local retail furniture market compared with 1.2% at their listing date. Total furniture sales in South Africa were just under R10 bn for 2001, with average sales of R800 m per month. The graph below only takes into account Wetherlys’ furniture sales and does not include the revenue received from Osiers or Melville Décor.
Furniture Sales Growth: Total Market vs Wetherlys 40% 30% 20% 10% 0% Feb 97 Feb 98 Feb 99 Feb 00 Feb 01 - 98 - 99 - 00 - 01 - 02 South Africa Wetherlys

Besides expansive growth, Wetherlys has experienced stable organic growth and increased market share and they have produced solid results in the toughest of retail and financial environments. We believe that their success can be attributed to the following factors: ? Target market – Wetherlys targets the affluent sector of the market that is less sensitive to adverse ? retail and economic conditions. This market is also less inclined to purchase goods on credit. ? Cash only - One feature that clearly distinguishes Wetherlys from their listed peers is their ‘cash ? only’ sales basis. They issue very little credit; with strict terms and their receivables to sales ratio is only 5%. This is considerably less than the JD Group (85%), Ellerines (72%), Profurn (80%) and Relyant (52%). This has ensured that they have not had to cope with the crippling bad debts experienced by some of the other furniture retailers. ? Wetherlys have pursued a sustainable model of slow but consistent growth. They have refrained ? from raising huge amounts of debt or issuing equity to fund expansion and have therefore reduced their inherent risk substantially. Emerging Trends As indicated in the graph above, real furniture sales in South Africa are declining, but we believe that organic growth in revenue is achievable – specifically for Wetherlys, as the following trends in the furniture industry emerge: ? Home Entertainment - Computers, the Internet, and related technologies are transforming daily ? life and the emergence and growth of entertainment-centric home networks has seen a move towards entertaining at home. Wetherlys “lifestyle” offerings are poised to reap the rewards from this change in consumer behaviour. ? The Home Office - Secondly, there is also a global trend towards working from home and ? Wetherlys newly introduced office furniture range is targeted directly at this market. ? Black Elite - Wetherlys has neglected to target the emerging, ‘black elite’ market and have not ? made any commitments to do so going forward. This is South Africa’s fastest growing target market and retailers may find themselves left behind if they do not make inroads into this


segment. This presents a major opportunity for Wetherlys but it will require a huge shift in promotional and marketing strategy. We believe that if Wetherlys continues to ignore this very lucrative sector of the market, they may find the decision detrimental to future growth and profits Peer Group comparisons ? Financial Analysis - When comparing Wetherlys with it’s listed peers, the most comparable in ? terms of target market and product lines would be Furniture City, which is part of the Relyant Group. However, given the financial state of Relyant and the controversy surrounding the ‘bail out’, a direct comparison to this group would be imprudent. Listed companies JD Group, Profurn and Ellerines are also not directly comparable to Wetherlys, neither in business strategy nor in financial analysis. Although these companies are furniture retailers, they generally target the lower and middleincome groups and they sell to them on credit. This makes them more vulnerable to adverse retail conditions, particularly with rising interest rates. Focus in these groups tends to be split between revenue generation and debtors’ management. Credit granting criteria and bad debts provisions and write offs have to be managed very carefully, particularly in the lower end of the market, to ensure sustainability. Secondly, the effect of AIDS and rising unemployment on the lower end of the market is likely to have a detrimental impact on future sales and consumer spending behaviour. Furthermore, margins are strongly affected by finance charges earned on credit sales. Receivables, bad debts and provisions are also important variables to be considered when analysing credit-granting companies. Wetherlys cash only sales limits the effectiveness of financial comparison. The impact of AIDS on Wetherlys’ target market will not be material and the cash nature of their business ensures that ‘bad debts’ are negligible, thus making the company less risky compared to its counterparts.
Wetherlys 342m 8.62 269,788 50,988 19% 75 15% 31.1 9 22% 13% JD Group 1781m 6.15 3,788,000 608,800 16% 5.6 10% 351.2 106 22% 77% Ellerines 1072m 5.19 1,944,643 292,622 15% 7.5 11% 280.9 53 17% 23% Profurn 156m N/A 4347070 -400953 -9% 7.8 -8% -671.8 0 -20% 64% Relyant 55m N/A 2480589 -323902 -13% -759 -21% -759 0 -61% 161%

Mkt Cap P/E Sales R'000 Operating Profit GP Margin Interest Cover Net Profit Mgn EPS DPS ROE Gearing Ratio

? Economy per square meter - Sales per square meter is often employed when analysing the ? relative performance of retailers, however, this statistic should be utilized with caution as, although Wetherlys is a furniture retailer, they sell out of warehouses and additional square meterage will not necessarily translate into increased sales. We have, nonetheless, compared the sales per square meter and the graph below clearly highlights the distinction between the costs of Wetherlys’ goods versus that of other furniture retailers. Wetherlys targets the upper end of the market and it only makes sense that the sales per square meter should be higher than its peers. However, Wetherlys also has the added advantage of selling their products out of warehouses instead of positioning themselves in expensive shopping centres. Wetherlys pays on average R20


a square meter for their ‘retail space’ compared to rentals in shopping centres, which are upward of R100 per square meter depending on the location.
Sales per square meter 12000 10000 8000 6000 4000 2000 0 Morkels Russels Joshua Doore Bradlows Wetherlys

Competition Wetherlys main competitors are Furniture City, Weylandts, Coricraft and many of the smaller, private businesses. These are generally family businesses that have one or two stores that are regionally based. Weylandts in Cape Town is probably the most comparable to Wetherlys in product offering and concept. Weylandts has 3000 square meter stores featuring realistic room settings and added services like a coffee shop, a free décor-consulting service and a professionally managed crèche. Besides Furniture City, no other competitor rivals Wetherlys in size, product offering and, arguably, customer service. Osiers competes mainly in the linen and home accessories market and competitors include, Loads of Linen, @Home, Stutterfords etc.

Wetherlys generates income from 4 sources: Retail outlets, manufacturing activities, property letting and investments. The estimated proportion of consolidated net income attributable to the various businesses has historically been as follows:
Profit / Net Income distribution
40000 30000 R'000 20000 10000 0 -10000 1997 1998 1999 2000 2001 2002 Manufacturing Activities Propery letting Retail Outlets Investment

Manufacturing Activities Wetherlys is essentially an upmarket furniture and household accessories retailer. The group does, however, have a small manufacturing arm called Roodefurn, which manufactures furniture almost exclusively for Wetherlys. Roodefurn is one of Wetherlys biggest suppliers supplying 17% of Wetherlys furniture. Roodefurn plays an integral part as it has the ability to adapt quickly to design changes and product innovation, ensuring that Wetherlys always displays the latest trends and styles.


Although Roodefurn is wholly owned by Wetherlys, the businesses are run separately and all transactions are conducted at arms length. Roodefurn has been a steady contributor to the group’s profits, but its percentage contribution has declined as a result of the growth in Wetherlys’ product offering and the acquisition of Osiers. As the Rand depreciates and the offshore market becomes more attractive, the role of this manufacturer is expected to become more important and although Wetherlys are committed to the sustainability and growth of Roodefurn they do not e xpect to grow this side of their business through acquisitions. Retail Outlets Wetherlys sells furniture and household accessories to the public through its nationwide warehouses and has recently opened a warehouse in Spain. Wetherlys first introduced the very unique concept of ‘warehousing’ in 1985 when they opened the first retail warehouse in South Africa in Wendywood, Johannesburg. This ‘warehousing’ concept has become synonymys with the group and has ensured that Wetherlys has avoided the exorbitant cost of retail space and the risks involved therein. This gives Wetherlys more freedom to price goods competitively. Group revenue for the year ended February 2002 came in just under R270m. As discussed above, 17% of merchandise is sourced from Roodefurn. 10% of goods are imported, mainly from Italy, Thailand, Philippines, China and Indonesia (specifically the cane products). The remainder of their goods are sourced from local agents with whom they have strict exclusivity and service-level agreements. (Margins are not affected by the imports as Wetherlys applies standard mark-ups on their goods regardless of the source. Their mark-ups range between 80% and 100%.) Wetherlys obtain 10% of their revenue from 850 interior decorators that are currently registered with them. Registered decorators are given rebates on furniture that their clients purchase from Wetherlys. These decorators are generally loyal to two or three furniture suppliers only, as the suppliers will only register a decorator if he/she generates sufficient business with them. Decorators have been invaluable in sourcing a significant amount of business from the travel and tourism sector resulting in many lodges, guesthouses and B&B’s being kitted out with Wetherlys merchandise. Recently acquired Osiers contributed 13% to revenue last year – significantly better than the budgeted 8%. The group’s strategy is to have an Osiers store adjacent to every Wetherlys store. The Osiers acquisition has given Wetherlys exclusive access to a wide variety of high quality; imported cane products that significantly enhanced the existing cane furniture range. Osiers’ enhanced product offering is substantially different from Wetherlys’ but it provides a broader choice of exciting, value-added products which compliment Wetherlys’ furniture. Wetherlys have decided to keep the Wetherlys, Osiers and Melville Décor brands separate as their product offerings, although being complementary, are very different. In addition, the Osiers and Melville Décor brands have a significant amount of goodwill attached to them and Wetherlys continue to capitalise on this. Property Letting While the majority of floor space is rented, Wetherlys own the Cape Town and Kya Sands properties. May 2002 saw the opening of the “Lifestyle Centre” in Cape Town. Wetherlys purchased a 24 000 square meter property and has adopted the new and very innovative concept of developing the property as a “Lifestyle Centre’. This centre houses a Wetherlys and Osiers store and other complementing diverse lifestyle retailers. Wetherlys and Osiers occupy about 7000 m sq in total and the rest is rented out. Wetherlys spent R27 m on the property and currently generates between R150 000 and R200 000 per month in rental revenues - equating to a 12,5% yield on rented property. Not only does this generate additional income for Wetherlys in the form of rentals, but attracts customers to enjoy a one-stop “lifestyle” shopping experience. Examples of the retailers that are currently housed in the Cape Town centre are @Home, Knob and Knocker, a florist etc.


Wetherlys’ head office and operational activities have very recently moved to Longdale, Johannesburg. This move will free up additional space at their flagship store in Kya Sands and, based on the success of the Cape Town ‘Lifestyle’ centre, Wetherlys plans to implement this model in Johannesburg as well. Income from the property letting business has grown substantially over the past 2 years and 2001 saw R1.8m generated from net rental income compared to a net outflow of R1 m the year before. The net inflow was due to the opening of “Lifestyle Centre” in Cape Town.
Net Rental Income 3000000 2000000 1000000 0 -1000000 -2000000 1997 1998 1999 2000 2001 2002

Although property letting now contributes over 5% to Wetherlys’ bottom line, management have stated that it is not their long-term strategy to actively develop this business further and they will stay focussed on their core competencies. In the absence of appropriate rental properties and the restrictions placed on renovations, it was necessary for Wetherlys to purchase the property in Cape Town. They have effectively developed the ‘Lifestyle Centre’ and strong cross-selling opportunities between retailers have become evident. Rental income going forward is not expected to grow in excess of annual escalations. Future rental income from the Kya Sands Lifestyles centre will be offset by the rentals being paid at the new Longdale premises. Investments Wetherlys had R36 m invested in the unlisted preference shares of Brait, Sechold Finance Services and KWJ Investments (Pty) Ltd at year-end. These preference shares are cumulative redeemable preference shares and were yielding a 7.8% at the 2002 year-end. The yield on these preference shares would have subsequently improved as interest rates increased. The rationale behind investing in these preference shares is that they have generated a better return than cash, are tax efficient and are relatively liquid. Last year the preference shares generated R3.1m in dividend income. The preference shares have been used as an alternative ‘house’ for any excess cash but should cash investments become more attractive then these will be liquidated. Certain preference shares also act as collateral against certain debt obligations. FINANCIAL REVIEW Revenue We are expecting a 28% increase in revenue for the full financial year 2003. This is largely attributable to the additional revenue received from Wetherlys Spain, Melville Decor and the new branches that where recently opened in Nelspruit. Osiers in Durban (opened November 2001) and Wendywood (opened April 2002) will also start to contribute significantly to revenue. If no further expansion were to be pursued, growth in revenue will start to taper off. New stores generally enjoy sales growth of between 13 – 20% for the first 3 years. This gradually decreases over the years and full maturity is reached after about 7 years. Pure organic growth is maintained at between 10 and 12 % per annum. Outside of the proposed East Rand and Pretoria stores, we have assumed no further expansive growth in the absence of any commitments from management. East Rand and Pretoria’s revenue will enhance revenue growth in 2004 and 2005, however we expect growth to taper off to about 13% after that in the absence of further expansion. It should be noted that should Wetherlys embark on any further expansions, whether it be the


development of the Melville Décor brand or expansion offshore, then revenue should continue to grow in excess of 20% per annum. Profit Margins New stores generally operate at margins of between 15 – 20% while mature stores have considerably better operating margins of between 20 – 25%. The group has maintained operating margins of between 18 – 19% historically so significant improvement will come through at revenue growth maturity. We expect margins to remain between 17% and 18% till 2005. Although eventual sales growth may begin to decelerate post 2006, operating margins should continue to improve as stores reach growth maturity and start-up costs decline and head office costs are more easily absorbed. Other Income Wetherlys derives income from dividends received on the preference share investments and also from rental payments received from the retailers housed in their “Lifestyle Centres”. Total rental income from the Cape Town Lifestyle Centre ranges between R150 000 and R200 000 per month and we do not expect this line item to grow in excess of annual escalations. Taxation Wetherlys effective tax rate is currently in line with legislation and we do not expect this to change materially going forward. Debt Wetherlys currently has R23.6 m in interest bearing debt on the balance sheet. Convertible debentures were issued against R22.6 m and this structured finance deal ensures that the capital repayments are tax deductible. The majority of the debt in issue was raised to purchase the Cape Town property. We do not believe that Wetherlys will be raising substantial amounts of debt in the near future. They have ample cash resources (R45.5m at year end) should t ey require funding for further expansion. This should h ensure that their debt to equity ratio would gradually decrease over the coming years. Their long-term debt to equity ratio is currently 13% and we expect this to decline to 3% in 2007.
Long-term debt to equity ratio 14% 12% 10% 8% 6% 4% 2% 0% 2001A 2002A 2003F 2004F 2005F 2006F 2007F

Working Capital As the majority of Wetherlys’ sales are cash based, their receivables/sales ratio has remained static at 5% and we expect this to continue. Accounts payable has historically been 13% of sales but last year this increased to 16% - this was as a result of favourable negotiated terms with certain suppliers last year. We have maintained this ratio going forward. Inventory has historically been about 20% of sales, however, Wetherlys have increased their inventory by an additional R15 m to stock the dispatch centre in Longdale. Wetherlys goal is to do away with ‘delivery time’ and the dispatch centre will provide operational capacity for all the domestic dispatch and possible future export growth. High levels of stock are maintained to ensure speedy delivery and customer satisfaction. Incorporating the stock in the dispatch centre, we have assumed that inventory will average 25% of sales going forward. Wetherlys cash generating abilities should ensure that they have sufficient capital for any working capital requirements.


PROSPECTS Expansion Wetherlys Group has 3 new stores planned for next year – a Wetherlys and Osiers store in the East Rand and an Osiers store in Pretoria. The large Wetherlys and Osiers warehouses require a large, affluent regional customer base to ensure sustainability and management have stated that these proposed stores will probably be their saturation point in South Africa as far as these two brands go. However, they are continually looking at new ways of revitalising their older stores and putting strategies in place to more effectively penetrate the regional market. These successes have recently been witnessed in the newly relocated and revamped Wendywood and Cape Town stores and the Kya Sands store is the next line – to be developed as a lifestyle centre. Wetherlys are also currently looking into expanding the Mellville Décor brand into the smaller regions. These stores, which sell a combination of Wetherlys and Osiers products, will operate out of smaller stores in metropolitan area’s that do not currently have a Wetherlys and Osiers store in the area. Wetherlys have currently not made any concrete plans as to the roll out of these stores as their attention is currently focussed on the East Rand and Pretoria stores and on setting up the distribution centre in Longdale. Acquisitions Wetherlys have not ruled out the possibility of acquisitions should the fit be right. There flexibility in this matter has been proven in the recent acquisitions of Osiers and Mellville Décor. At present, none of the listed furniture companies hold any attraction to Wetherlys so any future acquisitions locally will be made into the unlisted sector. The finance of future acquisitions or expansions will not be a problem for Wetherlys as they currently have ample cash on the balance sheet and this is expected to grow substantially in the absence of major capital expenditure. In addition, at a long-term debt to equity ratio of a very undemanding 13%, Wetherlys has sufficient balance sheet potential to raise more cash. A rights issue will also be beneficial. Although it may dilute earnings initially, it increases the tradability of the stock. Marketing Strategy We believe that if Wetherlys is to capitalise on the previously mentioned three emerging trends in the local furniture market, a paradigm shift in their marketing strategy will be required. Although Wetherlys ‘customer service’ levels may rival competitors, their marketing needs to be greatly improved. Until recently, Wetherlys advertising was reserved for the back pages of magazines. Going forward, management have identified this as an area of improvement and have employed the services of a marketing company to aid them in this regard. Their larger national presence will facilitate the roll-out of a national marketing campaign and we believe that substantial benefit can be reaped from this opportunity – many customers still don’t know that Osiers is part of the group, let alone what their product offering is! Investec Tie-up A relatively recent tie-up with leading financial services provider, Investec, has proven to be very successful. Investec Private Bank credit card holders earn double points when they spend at Wetherlys and Wetherlys funds the second set of points. This gives Wetherlys access to a 25 000 person database and the venture generates about R350 000 per month in revenue. The cost to Wetherlys equates to 1% of the sales price – a small price to pay for access to a very lucrative, niche client base with great growth potential. Offshore expansion The group’s strategy towards offshore expansion has been a cautious one, and they have preferred to adopt the “wait and see” attitude as opposed to rushing into the uncertain offshore markets. Wetherlys employs several agents overseas and goods are sold to them at a substantial discount, so the current revenues that are generated are relatively inconsequential. The main aim of these operations is, however, not necessarily to generate large amounts of revenue, but rather to test the foreign appetite for Wetherlys goods.


This strategy has proven to be successful and May saw the first offshore Wetherlys store opening in Estepona, Spain. Estepona is situated on the western Costa del Sol in the South West of the province of Malaga. The town's present renaissance as a leisure centre ensures Estepona a prosperous future. Estepona has become a fashionable place for both foreign and Northern Spanish residents to acquire a holiday home. The Costa del Sol offers a great deal of potential with a large number of golfing estates and residential units being developed – prime potential clients for Wetherlys. The store is 51% owned by Wetherlys and already generates in excess of 100 000 Euros per month in sales. Wetherlys currently has agents in Ireland, Canada, France and Cyprus who are tied into 18 – 24 month renewable contracts. If these agents show promising growth, then Wetherlys may look at broadening their offshore base. The store in Spain has offered huge learning opportunities for Wetherlys and this experience will be carried forward into other potential foreign stores. One change that Wetherlys will make should they continue with their offshore drive; is to take a significantly larger stake in the respective stores. Currency Effects The effect that the depreciating Rand has on South African companies has become very pertinent. The depreciating Rand has a net positive effect on Wetherlys. The direct benefit will be come from profits generated by their offshore store in Spain. We expect the Rand to depreciate by between 5 – 7% year-onyear against the Euro, which will boost Wetherlys offshore revenues. Secondly, a depreciating Rand renders overseas travel very expensive for South Africans and would-be holiday money is spent alternatively – like refurbishing the home. Only 10% of Wetherlys goods are imported ensuring that the positive aspects outweigh the negative. CONCERNS Cash usage Wetherlys generates strong cash flow and in the absence of significant capital expenditure or acquisitions; the cash balances continue to grow. Our models are conservative in assuming no further expansion outside of the East Rand and Pretoria stores as management have indicated that they do not currently have any other concrete plans in the pipeline. We are expecting free cash flows to increase at an average 40% per annum over the next 5 years and the subsequently increasing cash balances will consistently drive the ROE down. We forecast a ROE of 19.89% in 2007 as opposed to the 21.29% investors currently enjoy.
Return on Equity 24.00% 22.00% 20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 2001A 2002A 2003F 2004F 2005F 2006F 2007F

Wetherlys management are currently not prepared to make any commitments or statements concerning the future utilization of their cash reserves but have assured investors that they are actively looking at ways for the cash to be employed constructively.


The following cash utilization options are available to management: ? Acquisitions / Expansion - Wetherlys management have shown their ability to make successful ? acquisitions in the past so we may see the group make some small acquisitions locally or extend their Melville Décor brand, but we believe that future growth will more than likely come from abroad. Furniture manufacturer, Steinhoff International Holdings, reported their results for 30 June 2002 on 10 September. The results stated that R925 m of their African operations revenue represent exports to the USA and the European Community – representing a 33% increase in exports from last year. The company also stated that growth in exports would be a major contributor to future earnings growth. This reaffirms the international appetite for locally made, inexpensive, quality furniture. Wetherlys currently have a very successful operation in Spain and, given their experience in this market, we believe that future expansion, along the lines of the South African operations, would be beneficial. Their careful strategy of appointing agents in different countries may present future opportunities in these countries as well. ? Share buy-backs - Although share buy-backs will have the desired effect of boosting HEPS ? share and the ROE, it has the adverse effect of decreasing the liquidity of the share ? Increased Dividends – Wetherlys may return excess cash to shareholders in the form of ? dividends. Wetherlys stated dividend policy is to maintain a dividend cover that will not be less than 3 times, however, we have seen their dividend cover steadily increasing over the past few years. Management stated that they do not plan to change their current policy so we have assumed a dividend payout ratio of 4.3 – which has been the average for the last 3 years. In the absence of the any of the above 2 scenarios, we would expect this to decrease substantially going forward or the declaration of special dividends.
Dividend Cover 5 4.5 4 3.5 3 2.5 1997 1998 1999 2000 2001 2002

Investors should seek some clarity from Wetherlys as to what their future strategy is; as the absence of sustained growth or increased dividends may see investors seek growth opportunities elsewhere. Liquidity Small cap stocks are notorious for their lack of tradability and Wetherlys is no exception. The tradability of the shares is a concern for management and last year saw the Davies brothers sell a 10% stake to SCMB in the hope that it would improve the stocks liquidity. Wetherlys has a free float of 50% and has an average monthly trade of R8.2 m (3.1 m shares at today’s share price). Although the shares are relatively illiquid, it is not impossible to obtain stock – investors looking for large volumes will just have to be patient. One option to increase the tradability would be to issue stock in lieu of dividends but this would have the negative effect of diluting earnings and management do not believe that this will create sufficient liquidity in the stock.


Market share Wetherlys current market share is relatively small and their niche focus will limit future growth within their targeted segment. They currently dominate their market and a change in marketing strategy or target market may be required to ensure future extraordinary growth locally. A change in target market will mean that they may have to start offering credit, which increases the risks. Wetherlys’ organic growth has been largely generated from word-of-mouth and they have t emendous opportunity to develop their r promotional strategy to capitalise on emerging lifestyle trends. Offshore expansion has its own inherent risks and many retailers, such as Woolworths or Pick ‘n Pay, have seen their foreign operations flounder. However, Wetherlys’ cautious approach to offshore expansion and their strategy of testing the market first gives us confidence in their ability to successfully exploit foreign markets. VALUATION On a relative PE basis we value Wetherlys at 379c – based on the assumption that Wetherlys has traded at .97x to the Alsi. Our DCF analysis values the stock at 432.c, based on a beta of 0.73, a risk free rate of 12, a discount factor of 17.43% and a debt ratio of 3%. Assuming a 10% liquidity discount, gives us a share price of 389c. Taking an average of the two valuations we arrive at a fair value for the stock of 384c. Based on today’s share price of 268c – this represents an upside of 43%.
PE Ratio: Alsi vs WET
25 20 15 10 5 0 8/2/1998 4/2/1999 8/2/1999 4/2/2000 8/2/2000 4/2/2001 8/2/2001 4/2/2002 12/2/1998 12/2/1999 12/2/2000 12/2/2001 8/2/2002

Asli WET

RECOMMENDATION Wetherlys targets the affluent and upwardly mobile sector of the furniture market and is therefore more resilient to unfavourable retail factors, such as increasing interest rates. This gives the counter a defensive stance in adverse retail market conditions, but does not limit the upside in improving markets. Secondly, changing lifestyle trends and potential to expand their target market in South Africa bodes well for future organic growth locally. Wetherlys are also financially well positioned to pursue expansive growth, whether they were to acquire businesses locally or expand into the offshore markets. Their very low level of debt and their large and growing cash balances ensures that they would be able to grow acquisitively should the opportunity arise. The relatively ow cost of Wetherlys goods and their upmarket style will ensure that their goods are l favourably received in the foreign market. Wetherlys has reported solid results since it’s listing in November 1997. Both turnover and headline earnings have grown in excess of 20% per annum since the listing. Unfortunately, the share price has not enjoyed the same success. Wetherlys listed at a price of 200c and currently trades at 268c – a banal 30% return over 5 years, equating to 6.03% compound return per annum. The only apparent reason for this being the scepticism investors have towards the small cap market after this sector lost almost 50% in less then 4 months in 1998. Another extenuating factor may be the illiquidity of the share, which keeps the big institutional investors at bay.


When evaluating small caps, investors are always particularly concerned about the company’s cash flow and debt levels. Wetherlys is in a strong position in both these aspects with an excess of R 45 m in cash on the balance sheet at year-end and a long-term debt to equity ratio of 13%. Wetherlys is a financially strong company with good growth prospects and the stock is trading at a deep discount to its fair value. We therefore recommend buying the stock, particularly at these levels.

Forecasted Income Statement
2001A Turnover Operating Expenses Operating Profit Operating Profit Margin Other Income EBITDA Depreciation EBIT Net Interest Income Net Income before taxation Taxation Net Profit Net Profit Margin Weighted # of shares in issue HEPS (cents) Div per share 220,644 180,058 40,586 18.39% 4,388 44,974 3,084 41,890 4,515 46,405 14,352 32,053 14.53% 1264 25.4 6.0 2002A 269,788 218,960 50,828 18.84% 7,214 58,042 3,912 54,130 2,271 56,401 16,897 39,504 14.64% 1270 31.1 7.0 2003F 345,837 284,041 61,796 17.87% 6,000 67,796 4,939 66,770 1,736 68,506 20,197 48,309 13.97% 1277 37.8 8.6 2004F 425,262 349,275 75,988 17.87% 6,600 82,588 5,799 81,601 3,264 84,865 25,049 59,816 14.07% 1277 46.8 10.8 2005F 507,872 417,123 90,749 17.87% 7,260 98,009 6,543 97,213 5,735 102,948 30,409 72,539 14.28% 1277 56.8 13.0 2006F 569,716 464,370 105,346 18.49% 7,986 113,332 7,250 108,982 10,152 119,134 35,190 83,944 14.73% 1277 65.7 15.0 2007F 643,779 517,424 126,355 19.63% 8,785 135,139 7,929 123,174 15,487 138,661 40,961 97,700 15.18% 1277 76.5 17.4


Forecasted Cash Flow Statement
2001A Net operating income Less: Depreciation Other non-cash items Dividends Received P/L on disposal of Fxd Assets In/Decrease in Inventory In/Decrease in Acc Rec In/Decrease in Payables Bad Debt & discount allowed 41890 3084 300 -2508 72 -9127 -677 5048 4244 2002A 54130 3912 -3142 -104 -8617 -4554 12826 2003F 68506 4939 -3500 -26033 -2193 7518 2004F 84866 5799 -3200 -25118 -3574 11517 2005F 102948 6543 -3200 -20652 -3717 11978 2006F 119134 7250 -3200 -15461 -2783 8967 2007F 138661 7929 -3200 -18516 -3333 10739

Cash Generated from Operations 42326 Net Interest Received Dividends Received Dividends Paid Tax Paid 4515 2508 -6314 -13260 -12551

54451 2271 3142 -7624 -20881 -23092

49238 553 3500 -11111 -19500 -26559

70289 1895 3200 -13758 -27000 -35663

93899 4150 3200 -16684 -30000 -39334

113907 8317 3200 -19307 -35000 -42790

132281 13364 3200 -22471 -42000 -47907

CF from Operating Activities CF from Investing Activities

29775 -61916

31359 -23962 -29999 8405 -2368

22679 -8800 -8800

34626 -9450 -9450

54565 -9350 -9350

71117 -9750 -9750

84374 -10150 -10150

Net Property, Plant and Equipment -32646 Investment in Financial assets -29270 Loan Advancement

CF from Financing Activities In/Decrease in L-T borrowings Proceeds of share issue

7353 6529 824

14584 12591 1993

-2213 -2213

-1370 -1370

-1585 -1585

-1835 -1835

-2123 -2123

Net movement in Cash Cash in bank at beginning of year Cash in bank at end of year

-24788 52182 27394

21981 23485 45466

11666 45466 57132

23806 57132 80938

43630 80938 124568

59533 124568 184101

72100 184101 256201


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Description: Company Name Wetherlys Target Price 384c Sector Retail - Small