Furniture Retail
Insurance tail wags retail dog
Nick Higham
Research Analyst
(+27) 11 775-7286
nick.higham@db.com
Buy Lewis as attractive medium-term value play
Current valuations in the furniture retail sector appear inexpensive, but we expect
structural changes to separate fit from feeble business models. The ABIL/Ellerine
merger looks to be a decisive move positioning them for superior growth (we
highlight DB’s Buy on ABIL, TP 3900cps; covered by Voyt Krzychylkiewicz). We
believe Lewis is a more defensive play and offers attractive value (initiate with
Buy, TP 4900cps). JD Group is a geared interest rate play and is our least
preferred retailer given timing of the cycle (initiate with Hold, TP 2700cps).
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1

Table of Contents
Executive summary ............................................................................4
Outlook: de-misting the crystal ball ............................................................................................4
Valuation: LEW – Buy, TP 4900cps; JDG – Hold, TP 2700cps ...................................................4
Risks: Deteriorating macro drivers a risk for furniture retailers ..................................................5
Furniture retail in a nutshell ..............................................................6
Key themes addressed in the report ..........................................................................................6
LEW: Buy, TP 4900cps (40% upside potential)..........................................................................7
JDG: Hold, TP 2700cps ..............................................................................................................8
Defining the market............................................................................9
Market shares in the furniture retail industry..............................................................................9
Size and split of the consumer credit market ...........................................................................10
Overlap with the micro-lending industry...................................................................................11
New information to become available from the NCR...............................................................12
Strategic landscape evolving ..........................................................15
Depressed valuations not all deserved...........................................17
Valuation methodology: price-to-book is preferred ..................................................................18
Comparability to major banks and micro-lenders .....................................................................19
Retailer valuations.....................................................................................................................20
Peer valuations appear expensive ............................................................................................22
Earnings confusion ...........................................................................25
Weak volumes with NCA underpin...........................................................................................25
Macro driver analysis .......................................................................27
An overview of DB’s view and macro drivers for furniture retail .............................................27
Earnings highly interest-rate dependent, with LEW the exception ..........................................27
Durable volume momentum lags rates by six to nine months.................................................28
Inflation in furniture and impact on volumes ............................................................................31
Dissecting the insurance business model ......................................33
In a nutshell..............................................................................................................................33
Delving below skin-deep ..........................................................................................................34
A closer examination of the retailers’ micro-insurance model .................................................36
The launch of Zimele products could cause retailers headaches.............................................43
Flexing GAAP ............................................................................................................................45
The difficulties of comparative disclosure ................................................................................46
NCA: A final word .............................................................................50
We foresee limited further short-term impacts of the NCA.....................................................50
Retail rump unimpressive ................................................................52
Re-modelling of the business may return focus to core retail..................................................53
Financial analysis ..............................................................................56
Primary ROE drivers..................................................................................................................56
JD Group: Your uncle in the financial services business ..............58
Investment thesis .............................................................................60
Outlook ....................................................................................................................................60
Valuation ..................................................................................................................................60
Risks ........................................................................................................................................60
Historical share price performance...........................................................................................61

The future JDG operating structure..........................................................................................61
Corporate action underpin in the midst of changing landscape? .............................................63
Watershed years (2002 and 2007 comparison)........................................................................64
Tax contingencies could have an unpleasant bite ....................................................................65
Lewis: Is a premium for low-end exposure warranted? ...............66
A brief (listed) history................................................................................................................66
Investment thesis .............................................................................68
Outlook ....................................................................................................................................68
Valuation ..................................................................................................................................68
Risks ........................................................................................................................................68
Relative valuation on LEW appears inexpensive despite premium..........................................69
The pros and cons of exposure to a low-end consumer (LSM1-4) ..........................................70
Profile of a low-end consumer..................................................................................................71
A low-end consumer’s income and expenditure profile...........................................................72
Unemployment has been hailed as the biggest driver of volumes at the low-end..................76
Is the book better quality, therefore deserving of a premium? ................................................76
Appendix A: JDG acquisitive history ..............................................79
Appendix B: Primary research on credit application processes
post-NCA ...........................................................................................80
Synopsis of initial application of NCA across furniture retailers ...............................................80
NCA impact and concerns: temporary blip on the radar screen ..............................................80
Feedback from the retailers......................................................................................................81
Primary channel checks: credit application process testing.....................................................82
Extended telephonic sample covering other geographic regions ............................................86
Stance of the National Credit Regulator ...................................................................................90

Executive summary
Outlook: de-misting the crystal ball
The price collapse of the furniture sector begs the question of whether this correction has
been overdone and now presents compelling value, or whether there has indeed been a
fundamental shift in the landscape that justifies current ratings.
DB believes that interest rates will peak in August 2008 (one more 50bp hike from here) for
the current cycle, and although the first rate cut is only anticipated in the last quarter of 2009,
the bad news should be fully discounted in the price of interest-rate sensitive cyclical
retailers.
The consumer outlook remains negative in the near term with rising inflation and pressure on
real incomes and consistent messages from retail management teams that the next trading
year could be the toughest yet. This does not bode well for volumes of highly discretionary
durable goods, particularly due to the base effect of significant compound growth over the
last four years of consumer strength in a low rates and inflationary environment. Increased
competition and regulatory focus has created headwinds for the micro-finance and microinsurance
businesses of the furniture retailers that have been significant profit contributors
historically. In this report we scratch below the surface to determine whether this poor
outlook has already been discounted in the current stock ratings.
Valuation: LEW – Buy, TP 4900cps; JDG – Hold, TP 2700cps
We analyse the ‘retail rump’ of the furniture retailers and assess its value:
􀂄 We believe that c.100% of economic profit is generated from financial services in the
retailers (despite disclosed EBIT splits to the contrary; company figures are
understated due to intergroup transactions).
􀂄 We believe that the retail rump has been neglected (due to the superior margins
earned through ancillary financial services streams), leaving it uneconomical.
Current valuations in the furniture retail sector appear inexpensive, but we expect that
structural changes in the industry will separate the fit from the feeble business models.
Some players will likely be forced into a painful transformation process which, we believe,
will lead to market share losses and margin pressure.
We value both JDG and LEW using price-to-book methodology.
For JDG we incorporate a two-year average forecast ROE of 14.4% and COE of 14.8% (Rf
8.5%, beta 1.4x and ERP of 4.5%). We utilise a Tg of 4.5%, below the standard 6% utilised
across our domestic stock universe, to reflect the highly competitive nature of the industry
and exposure to currency on the imported component of product, resulting in historically
erratic pricing power. Our calculations result in a 12-month price target of 2700cps. Hold.
For LEW we incorporate two-year average ROE of 22.5%, COE of 14.4% (Rf 8.5%, ERP
4.5% and beta 1.3x) and Tg of 4.5%, in line with that applied for JDG to the price-to-book
methodology. This produces an exit multiple of 1.8x book and our 12-month price target of
4900cps. This implies an exit PE 12 months from now of c.6.8x for the stock. Buy.
In addition, as a sanity check, we valued LEW on a through-the-cycle DCF basis and obtained
a fair valuation of 6600cps. However, we do not feel that the implied exit multiple from the

DCF valuation would be warranted at this point in the cycle and revert to our price-to-book
multiple.
Risks: Deteriorating macro drivers a risk for furniture retailers
Sector-specific risks. Risks include competitive pressures, particularly with respect to the
micro-finance businesses and deteriorating macro drivers – further rate hikes and inflationary
pressure on the consumer.
Company-specific risks. Potential downside risks for JDG include unavoidable imported
product inflation resulting in weaker volumes than expected and operating cost inflationary
pressures impacting margins negatively. Upside risks for JDG include possible corporate
action given suppressed trading levels and successful execution on the rationalisation of their
business model to central collections and a single IT platform, resulting in greater-thanexpected
cost savings.
LEW, on the other hand, is susceptible to a spike in unemployment driven by corporate costcutting
and possible corporate failures in a tough inflationary environment, the knock-on
effect on bad debts and ABL/ELH merger-related risks (increased competition resulting in
downside pressure on the cost of credit and lower profitability in the micro-finance business).

Furniture retail in a nutshell
Key themes addressed in the report
‘Change is the law of life. And those who look only to the past or present are certain to miss
the future.’ John F Kennedy
DB believes that interest rates will peak in August 2008 (further 50 bps from here) for the
current cycle, and although the first rate cut is only anticipated that in the last quarter of 2009,
the bad news should be fully discounted in the price of interest-rate sensitive cyclical
retailers. In this report we scratch below the surface to determine whether this is indeed the
case, or whether there are structural problems in the sector that justify the current low
ratings. Below we summarise the key issues we explore in this context:
Market shares. We analyse the various shares of furniture players and micro-lenders in the
furniture and appliance space to gain an understanding of the players and the playing field:
􀂄 JDG has the biggest single share in furniture sales and by credit book size with microlenders
comprising a small share based on estimated overlaps.
􀂄 Low price-point discounters have grown their top lines faster than retailers over the
last seven years as retailers focused on financial services.
Credit markets. We further analyse the consumer credit market to determine who the
lenders are and whether it is retailers, banks or micro-lenders that have made the most
inroads into the consumer ‘credit wallet’:
􀂄 The overall micro-lending segment constitutes <5% of total consumer credit.
􀂄 Retailers have been making the biggest inroads into the consumer ‘credit wallet’
followed by micro-lenders and then major banks after 2003.
Strategic landscape. We assess the changes in the strategic landscape and who will stand
to lose or gain the most:
􀂄 In a sector context, the combined ABL and ELH entity looks to be best-positioned with
first-mover advantage in terms of introducing a micro-finance specialist to drive down
the cost of credit resulting in lower cost to the consumer and probable market share
gains in the furniture space.
Macro factors. We examine key macro factors and price sensitivities in order to understand
the primary macro drivers of the furniture stocks and cycles:
􀂄 ELH and JDG historical earnings are highly geared to interest rates, LEW much less
so.
􀂄 Quite surprisingly, there appears to be a lag of about nine months in changing
momentum of durable sales after rates peak. suggesting that we may only see a
recovery in volumes in early CY2010.
Micro-insurance industry. At the core of the report is a detailed analysis of the microinsurance
industry, retailers’ roles in the distribution channel and the sustainability of the
current business model:
􀂄 We believe that re-insurance has been utilised extensively to recognise revenue
upfront, causing revenue and debtors to be overstated.

We believe that economic profit margins in the insurance business are as high as 74%
and that almost 100% of economic profit generated on an annual basis comes from
financial services and the insurance business due to the neglect of the core retail
business.
􀂄 The credit life insurance business of the retailers faces substantial regulatory
interference in the form of LOA, FSB and NCR investigations, which could place
pressure on the above margins and impact the economic value of the company
significantly.
National Credit Act. We examine the economic impacts of the introduction of the NCA:
􀂄 We believe the NCA will have a net positive economic impact for the retailers as tougher
affordability criteria are more than offset by an increased yield on the post-NCA book due
to higher caps on interest rates (than previous usury rates) and new initiation and
monthly service fees chargeable on credit transactions.
For JDG’s acquisitive history and group structure, please see Appendix A. In Appendix B we
have included a discussion regarding the effect of the NCA, primary research undertaken at
the time of National Credit Act (NCA), implementation and guidance issued by retailers and
the NCR (National Credit Regulator) on the overall impact to date and ‘future monitoring’ of
consumer credit.
LEW: Buy, TP 4900cps (40% upside potential)
LEW’s premium rating. We assess whether LEW deserves a premium rating due to its
positioning in the low-end consumer segment:
􀂄 We believe that the LEW book differs fundamentally from those of its retail peers, as
it deals with lower-end consumers and the associated longer collection periods. We
do not believe that current reporting reflects this accurately, as we perceive
discrepancies in LEW’s provisioning policies (less conservative) relative to its peers.
􀂄 LEW’s earnings (bad debts) are negatively correlated with interest rates and far more
geared to reductions in unemployment levels, which we believe will drive higher
ROE’s (c.23%) during the changing credit cycle and are deserving of a higher exit
multiple (our TP represents an exit at 1.8x price-to-book 12 months out).
􀂄 Although the pressure on real incomes forecast for low-end households is greater
than for the middle-end segment, this bracket is significantly less exposed to interest
rates, while the forecast reduction in unemployment forms a positive underpin to
volumes.
We believe that despite possible higher arrears and less conservative provisioning, the LEW
book deserves a premium over that of JDG due to its low-end focus. While we expect
existing low-end consumers to experience pressure on their real income, a further reduction
in unemployment driven by government infrastructural spend is expected to more than offset
any squeeze (probable c.5% spending underpin at the low-end with upside risk to this
number) experienced by existing households and help ensure superior earnings growth
relative to peers (forecast three-year CAGR of 8.6% which is c.4.5% ahead of consensus
three-year CAGR).
􀂄 We expect JDG’s current premium relative to LEW (c.25% interpolated historical and
one-year forward on our earnings estimates) to reverse in the next 12 months as
LEW’s earnings growth exceeds market expectations and higher ROE’s (c.23%) are
generated over the next two years, assisted by the continued buyback program.
􀂄 We estimate that LEW’s insurance business contributes >50% of the economic profit
generated. Despite the headwinds facing the business, given the captive consumer at

the relatively uncontested low-end, we believe the business will continue to earn
superior margins off these services over the next couple of years.
􀂄 While these near-term concerns could squeeze the consumer short term, and softer
collection rates could cause an increase in the doubtful debt provisions, we do not
anticipate material bad debt write-offs (in line with LEW’s history in similar macro
conditions). Although there we see no imminent short-term catalyst, the inherent
value looks appealing, and underlined by a dividend yield in excess of 9.5%. Buy, TP
4900cps (40% upside potential).
JDG: Hold, TP 2700cps
JDG’s business model. We examine JDG’s current and future business model and
prospects in more detail (including further company-specific financial analysis):
􀂄 We believe the retail rump is over-stored and overstaffed, leading to poor productivity
and efficiency ratios compared to retail peers, rendering the business model subeconomic.
We believe this is due to significant cross-subsidisation by ancillary
financial services streams.
􀂄 We believe that FY2008 will be another watershed year for JDG, after which earnings
should bounce off a relatively undemanding base.
While JDG is undergoing significant restructuring, we do not believe that it currently has the
ability to respond decisively to the ABL/ELH merger. We expect earnings growth to
disappoint (DB forecasts three-year CAGR in earnings of c.-3.6%, which is 9% below
consensus three-year CAGR expectations). Despite the share price falling 25% in the last
month, we expect another watershed year in FY2008, after which earnings should rebound
strongly (the stock is on 6.7xPE on a historic and forward basis). Despite what we see as an
attractive dividend yield of c.7.8%, with near-term ROE’s declining to the COE, we believe
the stock will tread water at these levels for an extended period.
Key issues:
􀂄 The group has no specialist financial partner lined up for the micro-finance business.
􀂄 Due to excessive reliance on ancillary financial services revenue streams, we believe the
retail rump is over-stored and overstaffed, and requires significant restructuring.
􀂄 Slowing durable volumes and a deteriorating rates cycle (the full effect of which has yet
to be felt) is likely to cause further pain on the book; however, the level of provisioning at
c.80% of arrears is substantial.
􀂄 Continued negative headwinds in the press and deteriorating macro drivers (rising
inflation placing real income growth under pressure in the mass middle market).
Offsetting this, we believe the prospect of corporate action is high given the current
suppressed valuation and previous interest shown in acquiring the business at higher levels
(Steinhoff made an offer in March 2007, which fell away in May, followed by a 12-month
restriction on further pursuit, which has recently expired).
Despite our negative view, we believe current valuation levels already reflect most of the bad
news. With recent price action, our valuation suggests c.4.8% upside from these levels (exit
price-to-book of 0.96x) which together with the dividend yield produces a 12-month total
return expectation of low teens. Nevertheless, we highlight the significant tax contingencies
outstanding and uncertainty surrounding near-term earnings, which we believe supports our
neutral stance on the stock at these levels. Hold, TP 2700cps.