Sales exceed forecasts by 63%.Truworths released a very impressive set of results

beating prior forecasts of $600,000/month to turn over $5,9m (Monthly average of

$975,230). At a gross margin of 49%, they posted a gross profit of $2,9m. Expenses,

which were 43% of revenue, pulled pretax profits to $348,480, while a tax credit of

$74,005 pushed them to post attributable earnings of $422,485 implying an

annualized PER of 6,2x. Their balance sheet grew by 128% to $5,8m as they increased

their current assets (inventory, receivables and cash) from 5 July 2009’s $1,4m to

$4,6m. Their NAV closed the half year at $1,6m, but as they were struggling to

stabilize their working capital cycle, they closed the period overdrawn by $904,039.

Raw materials to come straight from China. Truworths, after realizing that part of

their costs of sales could be reduced by importing directly from China, decided to act

to that effect. This should increase their EBITDA margins from 49% to 60% and

increase beyond that when they import finished goods. This, they intend on rolling

out on their lower income stores.

Graceful shift towards importing finished goods on the table. The group sees little

hope in continuing clothes manufacturing for long because they are not as

competitive as in other countries. For example, it costs the average local

manufacturer $12 to make a pair of denim jeans whilst it costs Lesotho

manufacturers only $6,60. The disparity is even worse when compared to countries

like China, with whom they are competing for local customers.

Controlled growth of credit customers to boost sales. Having witnessed a surge in

credit customers from November’s 6,3k to 24,9k at the end of the period (against

2007 highs of 93k customers) they are fast increasing their sales pool and we should

witness good revenue figures continuing to be reported. However, they cannot

spontaneously grow their book given the risk of defaulters and their possible effect

on cash flows. As at 3 January, average sales per active customer stood at $106-00

for Truworths and $91-00 for Topics, while average balance per customer was $105-

00 with a collections rate of 36% (of the opening book). Against a norm of 33%, the

group is therefore deemed safe within its cash flow cycle.

Sales forecasts revised upwards. Truworths upgraded their annual sales forecasts

from $7,2m in November to $14m at a gross margin of 49%. They have also revised

their 2011F gross margins to 60% as a result of their strategy to import fabric and

finished goods from China. Operating expenses should see a marked improvement as

utility suppliers normalize their billing systems and landlords adjust rentals to match

the current economic situation. However, for the sake of our analysis, we will

assume that costs will remain constant.

Value and Recommendation. Based on the new sales forecasts of $14m for the year,

they should make a pretax profit of $1,9m and attributable earnings of $1,4m.

Applying the discounted regional PER of 7,8x (13x discounted by 40%), we get a value

of $10,9m (2,9c per share). At 1c, there is a 290% upside potential. Given they

exceeded our forecasts in H1; we have every reason to maintain our STRONG BUY