Integrated Annual Report 2014

The style. The passion
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An array of improvements were made in the core areas of the business, serving to achieve increased customer satisfaction and deliver pleasing double digit growth.

Review of operations

Overview

At the end of the prior financial year, management's stated goal was to intensify the best practice programmes implemented in the business to continue to capitalise on growth opportunities. A range of key focus areas were identified, including investment in people and processes, innovation in products and technology, and enhancement of efficiencies and cost containment, to ensure that the Group improved profitability and gained and retained market share.

In this regard, management believes that good progress has been achieved, although it has set challenging new goals to attain even higher benchmarks in the forthcoming year.

Through interventions such as CTM's 9 Key Disciplines and Italtile Retail's The Italtile Way, the Group entrenched its focus on fundamental retail principles, aimed at standardising and promoting performance consistency of the offering – across the brands, in all stores, across the regions – to ensure in-store satisfaction for customers.

An array of improvements were made in the core areas of the business, including range management (fashion and pricing); merchandising, display and marketing (focused on promoting complete product solutions depicted through design lifestyles, which improved the average basket size); stock management (centred on procurement processes, improved warehousing and cooperation between stores); cost containment (in logistics, administration and stock control); training; and technology (further development of the CTM webstore, and point-of-sale and handheld scanner technology in store).

As a result of these enhancements and the unwavering commitment to improvement by the people who are integral to the success of the Group, pleasing double digit growth was reported, including in previously under-performing regions.

Financial review
Trading conditions

During the review period, the ratio of household debt to disposable income continued to rise, serving to constrain consumer discretionary spend further in an economy which has recorded deteriorating growth over several years. In the construction sector the renovations market was slightly more buoyant than the new-build market, which remained subdued in the context of negative sentiment and restrained public and private sector investment.

Whilst the middle income market appeared less resilient than the top and bottom-end earners, consumers across the spectrum were price sensitive and acutely conscious of value-for-money offerings.

The devaluation of the currency over the period had a significant impact on industry participants and trading behaviour. The weak exchange rate served to squeeze retailers' working capital reserves and margins, and independent opportunistic traders with unsustainable business models were particularly hard hit. Whilst further rationalisation occurred, these trading conditions also served to restrict access to the industry to new entrants.

Other consequences of this currency volatility and aggressive price competition were stock shortages, and range gaps both in price and fashion, as operators attempted to cut costs further.

The strength of the Group's well-established business model, underpinned by its integrated supply chain and strong cash reserves were critical to its continued growth in this testing environment. The stated policy of ensuring the right stock at the right time, place and price, together with an uncompromising focus on quality, ensured that Italtile entrenched its position as a leading retailer in the sector.

Results
Continuing operations

Following the disposal of non-core businesses, the results of these entities have been recorded as discontinued operations for the period. Accordingly, the financial information presented below refers to continuing operations only.

System-wide turnover for the period rose 17% to R4,46 billion (2013: R3,82 billion), with turnover growing at a higher rate year-on-year in the second six months than the first six months. Operating margins were also firmer in the latter half of the period attributable to intensified cost containment and increased average selling prices. Trading profit grew 23% to R751 million (2013: R611 million) as a result of improved store profitability including the contribution of nine franchised stores converted to Group-owned stores.

Earnings per share and headline earnings per share which grew 19% and 24% respectively were impacted by a R17 million IFRS 2 charge, of which R11 million is a once-off charge, related to an equity-settled staff share incentive scheme implemented in the prior comparative period. In addition, an impairment of R20 million (2013: R5 million) was recorded for the Group's property portfolio in Australia, a reflection of continued adverse economic conditions in that country. This has been excluded from headline earnings.

Due to its deliberate strategy to capture costs in the supply chain in order to support competitive pricing in the stores, the Group succeeded in containing average selling price increases in line with inflation.

Inventory levels increased to R408 million (2013: R335 million), primarily due to stockholdings of new stores which were added to the network. One of the Group's key competitive advantages is the consistent availability of an extensive range of fashionable merchandise. Stock control is therefore a priority challenge for management to ensure that stock turn continuously improves to enhance product life cycles and provides for the addition of new ranges. Inventory management has been identified as a key focus area in the forthcoming period and unrelenting attention will be paid to improving on this discipline across the business.

Capital expenditure of R166 million (2013: R168 million) was incurred primarily to enhance the Group's property investment portfolio through the acquisition of four new properties and an ongoing store upgrade programme across the network. This investment, together with the net special dividend of R467 million paid during the period, resulted in net cash reserves of R249 million at the end of the period.

The Group's net asset value was 242 cents (2013: 251 cents).

Investment in associates
Ceramic Industries Limited (Ceramic)

The 20% strategic investment in its largest supplier of tiles, sanitaryware and baths once again delivered tactical advantages in supporting the Group's growth programme. In the context of the weaker Rand and Italtile's stated goal to promote an 'always in stock' policy for customer convenience, this relationship with Ceramic served to enable consistent supply of local high quality, affordable products.

During the period, increased production volumes were achieved across Ceramic's tile and sanitaryware factories. Improved sales and profitability were also attained, attributable to the decision to produce narrower ranges which ensured continuous availability of higher volumes of in-demand product; the currency devaluation which favoured local producers; and an increase in average selling prices.

Ceramic's Australian manufacturing operation also delivered improved results, trading profitably in the last quarter of the review period.

This all-round improved performance across the business resulted in a 70% growth in profitability and an increase in contribution to Group profit of R24 million for the full year (2013: R9 million).

Ezeetile

The Group holds an effective 46% strategic stake in this business, a national manufacturer of grout, adhesive and related products.

Wide-ranging enhanced business processes and systems were implemented in the operation over the past year, and whilst improved efficiencies have resulted, the restructuring remains to be completely bedded down before the full benefits of the programme will be realised. Whilst increased imported raw material costs and higher fuel charges also had a negative impact on results, the business reported growth for the period, contributing R5 million (2013: R3 million) to Group profits.

Italtile Australia

The Group's seven store CTM retail operation was disposed of via a facilitated management buyout in October 2013. Italtile has retained and continues to manage the five Group-owned properties out of which the stores traded. This business has contributed to income from July 2014, although the sum is immaterial. Management's longer-term strategy is to dispose of these properties once the market recovers.