Jumia Technologies & The Great A&P
A number of years ago, I read a wonderful book about the Atlantic & Pacific Tea Company: The Great A&P and the Struggle for Small Business in America by Marc Levinson. Younger generations may not realize this, but at one point during its 156-year history (in 1920), A&P was the world’s largest retailer. But before its growth truly took off, excessive inventory and unprofitable sales almost bankrupted them.
“[A&P’s management] responded to the tea and coffee crisis in the only sensible way: by broadening the product line [to foods] …
[But A&P] faced a serious disadvantage: it was poorly structured to be a grocery chain. Its 198 stores were strewn over twenty-eight states. In many towns it operated only one or two fixed locations, along with wagon routes. This was fine for a tea and coffee retailer, as tea stores didn’t require frequent resupply. The food business was different. Grocery stores needed new merchandise every day or two...[Therefore], A&P’s stores carried inventory equal to two months sales, roughly twice as much as the most efficient grocery chains.”
To survive, A&P’s legendary executives, George & John Hartford, drastically cut back the number of items which each location offered to only those with the greatest margin contribution. The initial impact from the decision was a reduction in sales, but this accompanied a decrease in working capital and an increase in net profits. Then, A&P utilized those profits to reinvest in the business by expanding its logistics infrastructure and opening new stores. These new stores were more working capital efficient, which led to faster growth, which led to more profits to reinvest, etc. etc. etc.:
“Over the next nine years, they opened an average of one story every two weeks, six times the pace of the 1890s. The network of wagon routes was expanded to over five thousand, and commissioned salespeople driving [A&P] horse carts were to be seen all over the East, Midwest and South.”
Critically, with this scale came powerful economics:
“With geographic concentrations of stores, the company could run its own warehouses and delivery trucks, which in turn let it manage inventory more efficiently. On average, grocery products took more than four months to get from factory to consumer in the early 1920s, and the financing charges and storage costs had to be built into the retail price. A&P, in contrast, turned its inventory once every five weeks. With comparatively few goods sitting in storage at any given time, it enjoyed much lower costs than independent grocers.”
In 2011, the New York Times wrote that George & John Hartford “were among the 20th century’s most accomplished and visionary businessmen”:
“In 1920, two years after the end of World War I, the Great Atlantic and Pacific Tea Company sold $235 million of groceries from 4,588 stores. It had become the largest retailer in the world.”
Recently, I came across Andrew Left / Citron Research’s long report on Jumia Technologies, and started to look into the company. The story reminds me a bit of the Great A&P in its early days, as Jumia recently de-emphasized lower margin products to focus its growth on more profitable opportunities. The initial impact was a reduction in sales, but the underlying fundamentals are much stronger now, and growth has resumed. Reinvestment in the more profitable underlying business could stimulate growth even further.
So the saying goes – “history may not repeat itself, but it often rhymes.”
I. Ecommerce in Africa
Jumia (Nasdaq: JMIA) is the leading e-commerce platform in Africa and currently has a market cap of ~US$2.0 billion.
E-commerce in Africa operates differently than in the US and elsewhere because a large percentage of the African population doesn’t have a bank account and / or lives in an area without proper or clear addresses. For example, here’s an excerpt from a Financial Times article this week with a great description of these challenges, and the opportunity, in one of Jumia’s key markets, Nigeria:
“70 percent of Nigerians [are] aged under 30, a cohort that is increasingly online and mobile first. Yet the informal economy represents more than half of GDP and 95 percent of transactions are still done in cash.”
When the average consumer places an order online at Jumia’s website, he / she pays cash upon delivery to a Jumia-hired courier with local geographical knowledge. This system creates all sorts of issues – for example, if the courier commits fraud and steals the cash or goes insolvent, then Jumia never gets paid. If the address cannot be found after a few attempts, the goods are returned and no revenue is generated to cover the logistic / delivery expenses.
To help counter these risks, Jumia has (i) installed numerous centralized pick-up stations for consumers, and (ii) launched JumiaPay, an online payment service, which has expanded to become a much more material percentage of revenues. The best credit management system for Jumia is payment in advance (through JumiaPay).
II. Jumia’s Brand & Market Position
Put simply, Jumia is the #1 e-commerce player and has the strongest brand in the most strategically relevant African markets.
Brand
The Jumia brand is very strong across Africa. For example, in Egypt, its brand has been identified as a prince among kings (even stronger that Souq, which was acquired by Amazon in 2017 for $580 million):
Market Penetration
In the markets where it operates, there’s just Jumia as the defacto leader by an extremely wide margin.
For example, see the following table about African e-commerce penetration:
Strategically Relevant Markets
The markets where Jumia currently operates were intentionally chosen, as they cover >70% of the continent’s GDP and internet users:
However, the markets Jumia operates in compare to others as follows:
III. History of Financial Results and Metrics
Jumia operates an asset light model, mainly delivering goods from leased warehouses on behalf of third party sellers; in 2020, more than 90% of the items sold on Jumia’s platform were from third party sellers. This results in ~70% of JMIA’s revenues being from commissions, fulfillment, and value-added services, etc. (rather than sales of goods). Less than 5% of the balance sheet is tied up in fixed assets.
In 2019, JMIA began a process to rebalance its revenue away from lower margin, higher ticket items such as phones and electronics and towards everyday goods (food delivery, beauty, fashion, consumer foods, home & living, etc.). In addition, it exited three unprofitable and non-strategic countries (Rwanda, Tanzania, and Cameroon). Similar to the A&P in its early days, JMIA was likely headed towards an eventual bankruptcy if it didn’t change its mix of products and markets towards a path of eventual profitability. This has had a negative impact on revenue, as can be seen by the below table (see, for example, the Q4 2019 to Q4 2020 revenue decline of ~10% and a negative two-year revenue growth clip from Q2 2019 to Q2 2021), but a positive impact on gross profit after fulfillment expenses. Even though the market value per order has declined by almost 40%, the average order is now generating gross profit of >$1.
It’s a difficult decision for a management team to kill off product lines and exit geographies which are unprofitable to focus on long-term sustainability. The result is usually one-time charges and revenue expectations misses. Yet JMIA’s executives executed quickly to stabilize the company for long-term growth. I love, for example, this quote from JMIA co-founder Jeremy Hodara:
“I don’t think we at Jumia are interested in size. That’s good for ego, but that’s not really useful….I think what we care about is to last very long as a successful business and to be here in [156] years.”[1]
Because of this strategic decision, Jumia is finally at a scale where gross profit per item is positive (up from a substantial loss just a few quarters ago when the decision was made).
In my view, this is a major inflection point.
After a few years of difficult comparative periods with headwinds from the de-emphasized product categories and the exited geographies, the first few quarters of 2020 were positive revenue growth quarters. With sales and advertising expenses almost doubling sequentially in Q2 2021, it is likely that over the next few quarters JMIA will see an acceleration in both active consumers and orders, which will lead to stronger revenue growth (that is more profitable this time around).
If this thesis is correct, a clear line of site to profitability will soon be visible. Once this is achieved, the more profitable business can then reinvest in growth without further depleting its cash reserves.
IV. A Few Thoughts on Accounting & Internal Controls
First thought: Presentation Currencies
Jumia is a German AG (stock corporation), and therefore its functional currency has historically been the EUR. Then in Q2 2021, Jumia changed its presentation currency to US$ from EUR. There’s a chance that this was premeditated and JMIA always planned to make this change after raising hundreds of millions of US$ in its March 2021 secondary offering. Then again, it begs the question why they wouldn’t have made this presentation change when they completed their IPO in 2019 (and they first raised equity in dollars). In addition, I didn’t find any indication in the March 18, 2021 Secondary Prospectus that they were considering reporting in US$.
I’m always skeptical of functional and presentation currency changes, and have found that oftentimes they are done to avoid an FX loss in the P&L. In this case, JMIA raised US$341 million on March 30, 2021 when the USD / EUR was 1.17. Then, in the next 6 weeks the exchange rate jumped to almost USD / EUR 1.23.
That’s almost a five percent strengthening of the EUR v. the US$, which would have resulted in a ~$17.5 million FX loss in the income statement had the FX rate remained constant.
It’s pretty easy to imagine a situation in which JMIA management, in the middle of May, stared at a $17.5 million pregnancy and decided instead to change its presentation currency (a process which takes time because it requires re-doing the comparative periods financial statements to the new presentation currency). Then the EUR began to strengthen again and ended around the same place as it started (so there ultimately wouldn’t have been a loss).
Still, I think the change to US$ is a good one long-term given the US listing, their balance sheet currency mix and the absence of any material Euro exposure.
Second thought: Internal Control Weaknesses
Jumia has reported material weaknesses in its internal controls for two consecutive years. In 2019, they reported (emphasis added):
In connection with the audit of our consolidated financial statements as of and for the year ended December 31, 2019, we identified two material weaknesses in our internal control over financial reporting. As defined in the standards established by the U.S. Public Company Accounting Oversight Board, a “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses that have been identified relate to (i) deficiencies in the design and operation of the IT general controls, including: new users access provision, users access deprovision, user access monitoring and segregation of duties within user access management process, which in aggregate rise to the level of a material weakness and, (ii) the ability of our corporate finance and accounting functions to timely and appropriately implement new accounting standards or interpretations or practices under existing standards.
Then in 2020, they said:
Our management, including our co-chief executive officers and chief financial officer, concluded that our internal control over financial reporting was not effective as of December 31, 2020 due to the presence of a material weakness. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim consolidated financial statements may not be prevented or detected on a timely basis.
Specifically, we identified deficiencies in the corporate finance and accounting functions related to the failure to identify accounting adjustments in certain areas, including income taxes, share-based compensation and contractual commitments, and we did not adequately review or oversee the work of external specialists in some of these matters to assist us in the preparation of our financial statements and in our compliance with SEC reporting obligations. Such deficiencies, when considered in the aggregate, constitute a material weakness.
Internal control deficiencies exist at every company, but material weaknesses in internal controls can be an indicator of more substantial problems (i.e. there’s never just one cockroach). That indicator is triggered more loudly when there are substantial changes in what resulted in the material weakness on a year over year basis (the auditor found these problems last year, different problems this year – what will they find next year?).
This is especially relevant when the company has historically been accused of fraud (see Citron’s initial report before they went long).
Gut feeling from our side is that these are just growing pains to some extent, but if I were on the board of directors, I’d strongly encourage management to get their shit together and do anything necessary to have a squeaky-clean internal control record and audit report in 2021.
I’d like to see an additional expert to the board and the audit committee who can ensure these systems are fixed and the issues don’t recur in the future. The board appears to be lacking this type of person (for example, a former partner of an audit firm with experience in IFRS / 20-f filers that are listed in New York).
But as an even stronger action, to ensure a clean internal control audit going forward, it would be great to see the compensation committee change the incentive structure of management (especially the CFO) so that no variable or share based compensation can be paid when there is an audited material weakness outstanding. As Charlie Munger once said, “Show me the incentives and I’ll show you the outcome.”
Third Thought: Per ADR / Share Disclosure in the Half Year Report
A small frustration - each Jumia American Depository Receipt (ADR) that is traded on the NASDAQ represents two common shares (not one). There is a table in the 20-F which shows the weighted number of shares outstanding and the operational results per ADR. The Q2 2021 report doesn’t include the share count or an earnings per ADR calculation anywhere. This information is all-the-more relevant because Jumia raised equity capital in the first half of 2021.
I’ve found that disclosure like this is usually omitted for a reason, though I can’t comprehend what that reason might be in this case. Strange.
V. Shareholder Thoughts
One surprising aspect of the story is that there is no large (>10%) shareholder. The top 4 looks as follows, after the German Internet company Rocket Holdings sold their 11% stake in April 2020 and the South African Telecom company MTN sold its 18.9% shareholding in October 2020.
* It appears as if Baillie Gifford & Co. also participated in the recent secondary, as they now appear to hold 9.619,791 ADR’s (equivalent to 19,239,582 shares).
Given the average daily trading volume of 4.1 million ADRs (representing 12 million shares), it will be interesting to see if anyone acquires a substantial stake in the next year or so. Looks like a 10% position could be acquired in just a few weeks at a 20% VWAP.
VI. Valuation
Africa has become more investable, as can be evidenced by Softbank’s recent investment in OPay (a Nigerian mobile payments platform) at a $2 billion valuation and Visa’s 2019 investment in Interswitch (another Nigerian mobile payments platform) at a $1 billion valuation.
In the e-commerce space, in 2017, Amazon acquired Souq, Egypt’s largest e-commerce platform, for US$580 million[1]. Since then, the value of e-commerce companies has grown exponentially. As a comparison market, Egypt has a GDP per capital in line with the other countries where Jumia operates (see above table). Today, JMIA’s valuation is less than 3x that (ex-working capital), yet it has better brand recognition, at least 2x the market penetration and covers many more jurisdictions with 6x more potential customers.
Andrew Left of Citron summarized his long thesis by writing “[Jumia’s] positioning in Africa along should be worth minimum $7 billion, or $100 per share.” I tend to agree with him.
But dreaming just a little bit and looking at it a different way:
MercadoLibre’s market cap of US$67.9 billion is roughly equal to 2.1% of the GDP of the countries in which it operates (representing the penetration of the largest ecommerce player in those respective economies). This ratio compares to Jumia, whose market cap is roughly equal to 0.1% of the GDP of the countries in which it operates.
Using that same 2.1% ratio for Jumia’s markets yields a valuation of US$35.8 billion, almost twenty times JMIA’s current share price. This is before considering the potential for economic growth in Africa in the future. Using the same metric (market cap / GDP) for CPNG, BABA or AMZN yields a much higher result.
As Jeff Bezos once said, “If you have a 10% chance of 100x returns, you should always take it.”
Being the clear market leader in growing African economies, and with the secular trend worldwide to e-commerce from brick & mortar (even if slower-moving in Africa), so long as Jumia continues to reinvest in growth, finds a way to stem its operating losses and doesn’t go insolvent on the way…We think there’s an interesting long-term potential that JMIA achieves a similar market penetration in Africa as other leading e-commerce players around the world, and that it’s valuation will ultimately reflect that position. 10% as a probability feels about right, and we’re comfortable taking the risk for those potential returns.
Therefore, we’ve initiated a small long-position (shares and calls). Though of course I am confident - now that I have written this position publicly (and solely for that reason) - that it’s going to sell off further. I’ll plan on adding if it does.
Sherwood Ltd.
August 26, 2021
Disclosure
Sherwood Ltd. has prepared this report with the expectation that anyone reading this analysis isn’t foolish enough to think that it is anything other than an opinion that is held at the time of writing. This isn’t investment advice. Rather, Sherwood Ltd.’s investment advice is for you to read Burt Malkiel and invest monthly in a diversified low-cost index fund over a long period of time.
In no event shall Sherwood Ltd. or the author(s) of this report be liable for any claims, losses, costs or damages of any kind, direct or indirect, arising or in any way connected with this report. Any actions you take are at your own risk. Sherwood and the author(s) of this report have no intention on updating as to when and if they close out any positions or change their investment theses.
Hopefully there are no material errors in this analysis, but if there are, we would appreciate if you would contact us so that we may correct them. Even better if you can change our minds with your different perspective and facts which we may not have seen in the course of our research.