The Uchumi meltdown

It took 30 years to build Uchumi Supermarkets into a regional retailing powerhouse and less than 365 days to bring it down to its knees.

Over the next few months, as 12,000 long suffering shareholders, suppliers and employees come to terms with their loss, the closure of Uchumi is expected to significantly undermine the public confidence in the stock market.

While Uchumi’s troubles have been heavily documented in the media in the last two years, there are still many questions that remain unanswered. 

First, no independent forensic audit has been done so far to establish the real causes of the deterioration of the retailer’s finances in the five-year period that businessman Mr Chris Kirubi and Mr Kennedy Thairu chaired the board and managed the company respectively. 

The issues range from how Uchumi under the Kirubi/Thairu reign could have bought such low quality and overpriced slow-moving inventory — which was sold at throwaway prices to raise cash — that has so far resulted in losses amounting to more than Sh2 billion in just three years and why auditors PricewaterhouseCoopers (PWC) never caught a whiff or mentioned it to shareholders.

Then there were the controversial real estate deals that the company got involved in its Sh2.5 billion branch expansion and uncontrolled growth in branch operating expenses.

For instance, Uchumi advanced a wholly-owned non-trading subsidiary, Kasarani Malls, Sh110 million to buy land on Thika Road for store development, yet this investment only seems to have yielded little gains for the company. 

Yet, in auditing, for retailers like Uchumi nothing is as important as watching closely the valuation and movement of inventory. Other than the expensive branch network expansion that did not pay off, the biggest cause of Uchumi’s failure stems from the way its inventory was managed. 

At one point, confidential internal documents showed that Uchumi was holding inventory worth more than Sh1 billion and was expected to make a stock write-off of more than Sh100 million. In the last two years, much of Uchumi’s losses have stemmed from management selling inventory that the company spent millions of shillings to acquire for fire-sale prices (Great sales!).

Yet, these details do not feature clearly or are not easy to tell by merely looking at Uchumi’s annual reports, and particularly the August 2005 prospectus that helped raise Sh1.2 billion. Indeed, despite Uchumi paying Sh60 million for advice for the rights issue — which included Sh6 million for transaction advisers, Sh3.9 million for auditors and Sh12 million for brokerage fees — the prospectus was lacking in both substance and quality of accounting disclosures.  It seemed to have been prepared in a hurry to the extent that crucial accounting information that routinely appears in footnotes was missing. Yet, the same teams that acted as brokers and transaction advisers in the KenGen initial share offer saw it fit to make adequate disclosures to investors than it did in the Uchumi rights issue.

Though PriceWaterhouseCoopers warned of Uchumi’s precarious financial situation, without qualifying its opinion, in its 2004 report, it gave the retailer a clean bill of health in its October 25, 2005, report.

Two months earlier, as Uchumi tapped its shareholders to raise Sh1.2 billion through a rights issue, the auditors had clearly warned that the retailer stood no chance of surviving if it did not raise this cash. 

“The group incurred a net loss of Sh632 million during the six months ended December 2004, and as of that date, the group’s current liabilities exceeded its current assets by Sh1.7 billion,” warned PWC in the prospectus last year.

In addition to the rights issue, the auditors warned that Uchumi’s continued survival was dependent on raising a further Sh600 million from the sale of surplus assets, obtaining Sh500 million long-term loan and being able to borrow Sh200 million for a short-term by June 2008. None of these facilities had been negotiated by then.

Since the exit of Mr Kirubi and Mr Thairu, the new management team led by Mr John Masterten-Smith has been grappling with how to lift the company out of this financial mess.

Clearly, the role of the Capital Markets Authority (CMA) as a securities regulator will come into sharp focus.

As Uchumi lies on its deathbed, the second big issue in shareholders’ minds is whether anything can be salvaged from this mess. Can Uchumi survive from receivership it has been placed by KCB? Judging by the current state of its finances, many analysts are sceptical that it will.

 “With a historical cost and reported negative asset value position of Sh558 million as at December 31, 2005, the implications for equity shareholders are severe,” warned African Alliance Kenya security analyst Anthony Schroen last week. “Indeed the only hope of even achieving a zero net asset value position are highly contingent on Uchumi receiving fair market value for their real estate portfolio, valued at Sh709 million in the balance sheet, but said to be worth at least Sh1 billion, given the recent substantial appreciation in Kenyan real estate.”

Foreign link

In a report titled “Pulling the Rag” released last week, Mr Schroen said that it is believed that a group of shareholders is rallying to either take control of the company and try and turn it around or sell it to a foreign supermarket chain. 

“We believe these efforts will face tremendous challenges as they will be trying to succeed where an experienced management team has failed,” says Mr Schroen.

“A foreign new owner will have to take on the group’s debt, but it is unlikely to pay more than this. This means there will be nothing extra for equity holders.” From a KCB perspective, the implications are far less severe if any at all, he says. 

“We understand that KCB’s exposure to Uchumi is just under Sh500 million and that is fully secured over Uchumi’s assets. As KCB has been involved in helping Uchumi dispose of its real estate portfolio, we believe that they will continue to do so and importantly in an orderly manner that will achieve the highest possible return. Combined with inventory and movable assets, we believe KCB should recover the majority of their debt. Assuming worst case scenario, we believe KCB’s maximum exposure could be Sh200 million,” says Mr Schroen, 

The analyst says that the implications for this exposure are minor and will barely shake off the bank’s share price. He estimates that the net exposure represents 0.4 per cent of KCB’s gross loan book and a full after-tax write-off would represent 7.4 per cent of KCB’s forecast income this financial year. 

“However, we do note that KCB has a substantial non-performing loan provision of approximately Sh13 billion, which would comfortably cover such a write-off,” Mr Schroen says. Under a worst case scenario, where the full Sh200 million would be written off through the income statement, the analyst says that the impact on valuation would be to reduce KCB’s share price of Sh154 by Sh13.5 per share.