Uchumi Supermarkets’ expansion strategy has come under intense scrutiny following its Ksh262.3 million ($2.88 million) interim loss despite a cash injection of more than $26 million over two years.

The giant retail chain, which is Kenya’s oldest, blamed the loss for the six months ended December 31, 2014 on high operational costs, increasing competition and falling sales. Over a corresponding period in the previous year, it had recorded Ksh106.9 million ($1.17 million) net profit.

“This is due to committed rental escalations and the impact of rent for newly opened branches that have yet to mature, coupled with higher staff costs,” Uchumi chief executive officer Jonathan Ciano said in a telephone interview.

“The adverse effects of insecurity, among other things, contributed to dampening of the general propensity to spend.”

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An investor note from Dyer & Blair Investment Bank however questions the strategy, noting that the retailer has consistently lagged behind the competition in identifying prime locations as well as in generating income.

“Though an increase in the number of stores is a good direction to follow, we believe Uchumi will need to increase income generated per store in order to realise the full value of its expanding network,” the note reads. “Slow turnaround and breakeven times for newly opened stores remain a huge risk, driven mainly by stiff competition.”

Uchumi’s expansion drive last year resulted in an 11.70 per cent rise in operating expenses, to $19.3 million, over the $17.3 million spent in the previous period. Cumulatively, the retailer opened 24 branches, translating into higher staff costs and an increase in operating costs.

Operating expenses shot up by a tenth, driven mainly by higher finance costs, salaries and rent and a 15-month delay in its rights issue that led to working capital challenges.

Proceeds of the rights issue, which sought to raise $9.6 million late last year, were to go into expansion but this seems to have changed.

Chief finance officer Chadwick Okumu however says that in 2015 Uchumi has a strategy to manage the rising finance and operation costs.

“We have decided not to use the funds from the rights issue to fund growth and instead the board embraced asset leasing,” Mr Okumu said.

“This means that any new branch that Uchumi will open will not use funds from operations. If you win the tender to supply bakery equipment, Uchumi will not buy but will instead be renting the asset.”

Tax planning

Uchumi hopes that that will also help it in tax planning because, in the next two years, the tax credit that it has been enjoying will lapse.

“With lease rental financing, depreciation charged on the asset isn’t tax-allowable,” Mr Okumu explained.

“If we make $1 million in a year and depreciation is $534,485, it means that you will be required to add the two and pay tax on $1.6 million; but if it’s lease rental, which is allowable for tax purposes, if it’s $1 million after the $534,485 depreciation, we will only pay tax on that.”

Uchumi used to fund new branches with operations money, spending $22.6 million in capital expenditure from 2006 to June 2014.

“Had we used this money on operations, we would have posted very impressive results,” Mr Okumu said. “But we could not, because we were still under receivership and no bank in their due diligence would have liked to partner with us in the master rent agreement. We had to work the turnaround then start on this new arrangement.”

Kevin Tuitoek, a macroeconomic analyst at Genghis Capital, said that in the long run, Uchumi will face increased competition — especially from foreign investors.

Uchumi’s finance costs rose to $645,481 from $279,708 in 2013 due to the credit facilities that it had. The retailer has a $6.4 million debenture from Kenya Commercial Bank in addition to a $7.6 million overdraft facility from the same lender pegged at 18 per cent interest as compared with 14 per cent for corporate bonds in the secondary market. It is set to incur $1.2 million as finance costs over one year.

Uchumi is also servicing a $3.2 million credit facility from the Industrial and Commercial Development Corporation at the current base rate of 16 per cent. Granted last year, the ICDC loan is to be repaid quarterly over three years. 

“Uchumi might care to innovate by issuing convertible bonds to expand its war chest, because the margin of error is very slim,” said Ally Khan Satchu, a financial analyst.

The retailer plans to open 13 branches in Kenya, Uganda, Tanzania and Rwanda through the new business model that will see it lease premises and equipment in a bid to reduce capital expenditure.

Cash position healthy

Mr Okumu however said the retailer’s cash position is healthy and that the over-subscription in its rights issue was a vote of confidence on its strategy.

“We believe that the story on growth will be positive this year,” he said. “Branches take time to mature and we expect them to break even.

“As at June 30, 2014, our free cash flow was very healthy. Our cash flow last year was at 5.1 per cent, which is higher than our competitors and even listed retailers in South Africa, who were not going even beyond 2.5 per cent.

He added: “When you are faced with negative information in the markets, suppliers are bound to be jittery because of the receivership memories. That was the reason for the negative outlook that we were receiving.”

Despite the operations cost going up in the second half due to the new branches, Uchumi says it received $6.6 million from a sale and lease-back arrangement in preparation for the expansion and growth it envisages.

But increased competition from major players targeting developed towns in Kenya, Uganda and Tanzania, coupled with the possible entry of newer retail chains, will continue to put pressure on Uchumi’s line.