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The Academy of Economic Studies

Faculty of Business Administration

INVESTMENT CREDIT ANALYSIS SPAR South Africa

Authors: Boldojar Ioana Branga-Peicu Livia Group 131 Coordinator: Assistant Professor Madalina Moroianu

Bucharest, 2012

[SPAR]
Contents

April 19, 2012

1) 2) 3) 4) 5) 6)

Loan description Description of the company Credit history Analysis of the market/ industry SWOT analysis Financial analysis a) Turnover evolution b) Main financial ratios c) Assets evolution d) Equity and liability evolution 7) Cash flow and projected cash flow analysis 8) Collateral evaluation 9) Risk evaluation 10) Credit scoring 11) Credit committee decision Statement of financial position 2011 Bibliography

pg 3 pg 3 pg 5 pg 6 pg 7 pg 8

pg 11 pg 12 pg 12 pg 13 pg 14 pg 15 pg 16

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1. Loan Description

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Spar Group Limited is interested in extending its distribution area as it has 13 more stores in 2011 compared with 2010. In order to cope with the additional distribution demands from the various independent stores in 2012; Spar has decided to purchase an additional Distribution Center in the North West Province in the city of Mafikeng. It also wishes to purchase 5 brand new and ecological Mercedes Benz Axor long distance trucks. The trucks will be from Mercedes Benz as Spar has a long-term relationship with this company and believes Mercedes Benz trucks are more reliable than similar trucks from other brands. In addition, a discount will be given. The total cost is the following: Land = 15 million Rand 5 Mercedes Benz trucks (15 million Rand) -Discount (10%) = 13.5 million Rand Construction of Buildings and Warehouse = 100 million Rand Equipment = 30 million Rand Other expenses = 41.5 million Rand Total cost of new distribution center = 200 million Rand The company applied for an investment credit of 200 million Rand over a period of 7 years. The company will be contributing an additional 20 million to the project from Spar's existing cash flow as a safety measure in case of any additional unforeseen expenses. The credit is backed by a land (33 000 square meters) and real estate used as a Distribution Center situated on 5 Kohler Street, Perseverance, Port Elizabeth (Eastern Cape province), South Africa. With an accepted collateral value of 227.2 million Rand. The reimbursement is paid in equal monthly installments as agreed upon previously in the repayment schedule. The source of the reimbursement is the monthly cash flow of the company.

2. Description of the Company


Spar was introduced in South Africa in 1963 by 8 wholesalers to service 500 small retailers. The use of the 'Spar' name and business model was taken from Adriaan van Well, a wholesaler in the Netherlands, who used the concept of voluntary trading - uniting independent wholesalers and retailers- in order to combat the rising power of grocery chains. Adriaan van Well's slogan was "Door Endrachtig Samenwerken Profiteren Allen Regelmatig"-DESPAR (later shortened to SPAR), which translated into English means "all will benefit from united co-operation". Today, after a number of mergers and takeovers, SPAR Group Limited (listed on the Johannesburg Stock Exchange since 2005) operates 6 distribution centers that service over 750 independent stores across South Africa.

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The SPAR organisation is made up of 2 types of members: SPAR retailers/independent store owners who collaborate with SPAR distribution centers responsible for providing leadership and services to SPAR retail members. These distribution centers have as their main activity the supplying of goods and services of a similar nature to the group's voluntary retail members. However, SPAR retailers are not obliged to buy from the Group. Alongside these members, the SPAR Guild of Southern Africa is a non-profitmaking company founded to co-ordinate and develop SPAR in Southern Africa. SPAR retailers and SPAR distribution centers pay subscriptions to the Guild who use this money towards advertising and promoting activities of SPAR. The following diagram exemplifies the SPAR Group Limited operational structure:

TradeIntelligence 2012 [online]. Available at: http://www.tradeintelligence.co.za/TradeProfiles/SPAR.aspx

To conclude we can state that SPAR Group Limited operates as a wholesaler and distributor of goods and services to the independently owned stores, it is a public company listed on the Johannesburg Stock Exchange, it is both a parent company as well as a holding company but also a subsidiary for Investec Ltd, Metropolitan Holdings Ltd, Sanlam Ltd, Tiger Brands Ltd and other 6 companies. The group has 16,426 shareholders, 171,625,804 outstanding shares and 3,816 employees. The vision is "to provide goods and services to independent retailers allowing them to compete successfully against all chains".

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3. Credit History

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Spar Group Limited has a credit relationship with Standard National Bank South Africa, who is the sole current account holder and the intended investment loan provider. Important to note is that Standard National Bank holds shares in Spar Group limited and is therefore one of the owners. Standard Bank and Spar have also launched the 'Instant money' project together making it easier for South African citizens to transfer money. Due to the fact that Spar Group limited does not have any current long or short-term loans (all investments have been made out of internal sources), we will use the following table to exemplify Spar's credit reliability: Spar Group Limited Operating lease payables (million Rand) Current Non-current Bank overdrafts (million Rand) Guarantees providedContingent liabilities (million Rand) Total interest paid (million Rand) 15.5 141.5 351.0 29.9 134.4 531.1 37.0 130.4 114.9 2009 2010 2011

330.5

366.0

415.6

29.5

20.9

24.7

As can be seen the company has greatly decreased its bank overdraft (2011) showing a strong ability to decrease its debts. Total interest paid and non-current lease amounts have similarly decreased over the 3 years. The company is seen to have a good credit track with respects to repayment of debt, however, increasing contingent liabilities may cause the company possible financial problems if they come into play. Spar had a deferred taxation liability within its long-term assets in 2011 of 0.6 million Rand. The company will plans on repaying the total amount in 2012.

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4. Analysis of Market and Industry
A. Market Analysis and Competition

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The Retail and Wholesale Food industry within South Africa is dominated by 3 main competitors: Shoprite, Pick 'n Pay and MassMart. Characteristics of this industry are intense rivalry, high volumes and low margins. In a report by Statistics South Africa, the country has an average wholesale margin of 3.6%, with the lowest average wholesale margin for the food and beverages being 0.8% followed by agriculture 1.6%. Spar increased its market share to 26.4% in 2011 and grew about 10% in sales in 2011, even though South Africa was still feeling the effects of the economic crisis. The Spar shares added 0.32 percent to R92.14, yet other competitors had similar increases. Spar's competitors have been implementing expansion strategies outside of South Africa which is something Spar has been hesitant to do as a new distribution center cost between 300-400 million Rand. Spar has as a single Distribution Center outside South Africa, situated in Harare, Zimbabwe. Pick 'n Pay has implemented the expansion due mainly to partnerships with locals through franchising. Pick 'n Pay has operations in Zimbabwe, Botswana, Lesotho, Namibia, Mozambique and Zambia. In 2012, the company will open 2 further stores in Mauritius. Shoprite boasts a total of 161 stores outside of South Africa, in 15 different African countries. Massmart's current strategy is to develop operations in sub-Saharan Africa. The company has 30 stores in 12 other African countries. This year it plans on opening 5 stores outside South Africa in addition to the store opened in Gaborone earlier this year. It is therefore important for The Spar Group Limited to also increase its operations and by building a new Distribution Center in the North West Province Spar will have access to the nearby African Country, Botswana, as well as better coverage of South Africa. B. Spar's suppliers The suppliers are the different wholesalers, local farmers as well as international businesses, who register on an online listing. The Distribution Centers host a number of trade shows each year, where retailers can view and order new products displayed by suppliers. C. Spar's customers The Group caters to all ethnic groups within South Africa and all LSM (Living Standards Measurement) segments due to its diverse product range and stores. The demographics of general consumers within South Africa has changed over the past years as can be seen in the following graphs (Thomas White Global Investing, July 2011):

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Black as well as white consumers have increased consumer confidence as Consumer Confidence index levels are currently high for both groups (as measured by FNB/BER). This means both have high buying power and should be considered by Spar as current and potential customers.

Spar's strategy to cover and supply goods to all ethnic types is an advantage as we can see from the graph of Percentage Distribution of Population Groups that the trend is of a growing African population and a decreasing White population,. Also the South African population is very varied distributed in 4 population groups.

5. SWOT Analysis
Strengths Strong financial performance Wide product range Employee training programs (SPAR Academy of Learning) Opportunities Weaknesses Increasing Operating Costs Limited Geographic Presence Differentiated products in each store Threats

Growth in wine industry of South Reduction in discretionary spending Africa Economic growth from emerging Unfavorable government regulations: African countries Broad-Based Black Economic Empowerment Corporate Social Investment Technological advances 7|Page

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The above table clearly illustrates the SWOT analysis, therefore only explanations necessary will be mentioned below: SPAR GROUP LIMITED's strength lies in its large product range of over 1000 exclusive SPAR brand products within its SUPERSPAR, SPAR and KWIKSPAR stores. In addition to these are products within TOPS (liquor stores), Build-it and newly established Pharmacy at SPAR and Savemor stores. Among its weaknesses, the group has limited geographic presence with only 6 Distribution Centers responsible with covering the entire country. The 6 centers are located in: South Rand, North Rand, KwaZulu-Natal, Western Cape, Eastern Cape and Lowveld (Nelspruit). This leaves the following provinces with no Distribution Centers in the area: Limpopo, North West, Free State and Northern Cape. The opportunity of becoming involved in Corporate Social Investments leads to increased brand image, CSI ratings (which facilitate government interactions) and brand awareness. Spar is uses 1% of net profit after tax towards funding programs for AIDS projects, Business Against Crime, local projects and charities helping with the alleviation of health and hunger problems. Threats include the government regulations BBBEE (Broad-Based Black Economic Empowerment that encourages all businesses within South Africa to place previously disadvantaged "Black" citizens into management positions. The group was rated as a C level contributor by Empowerdex providing both a threat to business if the company does not improve as well as an opportunity of improvement to differentiate itself from other retail stores.

6. Financial analysis
The performance of a business comes as a result of many individual decisions that are made by its management on a continuous basis. Therefore, to asses business performance implies to analyze the financial and economical effects of those decisions and to understand the results by using comparative measures. Decisions such as the investment in a new facility are major and must be evaluated in the course of financial analysis. Performance assessment is normally based on the examination of the financial statements that are periodically issued by a business which reflect the effects of the decisions made by management. In order to gain an insight upon the financial health of the company, we will study the evolution of turnover, assets, financial ratios and equity and liability over the past three years, 2009-2011. 8|Page

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Year Turnover (net sales) Net profit Equity Operating profit (EBIT) Assets Liabilities Net cash flow Current assets Current liabilities Cost of goods sold Gross profit

2009 31397.5 745.8 1930.2 1136 6322.7 4392.5 (41.5) 4509.6 4183.1 (28847.1) 2550.4

2010 34197.8 921 2193 1302.9 7240.8 5047.8 (190.3) 5276.9 4839.6 (31463.3) 2734.5

2011 37562.9 969.7 2529.3 1425.7 7974.6 5445.2 433.6 5939.6 5229.5 (34565.6) 2997.3

a) Turnover evolution

Turnover evolution
Turnover (Rmillion) 40000 30000 20000 10000 0 Year 2005 2006 2007 2008 2009 2010 2011

SPAR's financial statements show a steady increase in turnover over the past 6 years of 4000 million Rand per year in average. Over these six years, the turnover has almost tripled, from 13599 million Rand in 2005 to 37562.9 million Rand in 2011. In 2011, the company had to face increased competition in the South African market, a soft inflation of 1-2%, but also the pressure put on consumer spending in the context of the world's economic situation. Nevertheless, as compared to the previous year, in 2011 the turnover increased by 9.8%, while the increase in sales volume was about 7%. These numbers provide an insight as to the underlying financial health of the business. 9|Page

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b) Main financial ratios Year Total debt ratio Current ratio Formula Total liabilities/ Total equity Total Current Liabilities Assets/ Total 2009 2.27 Current 1.07 3.61% 0.081 0.023 16.26

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2010 2.3 1.09 3.8% 0.079 0.026 15.59

2011 2.15 1.13 3.79% 0.079 0.025 14.85

Operating profit Operating Profit/ Sales * 100 margin ratio Gross margins Net margin profit Gross Profit/Net Sales profit Net Profit/Net Sales

Return on equity Net Income/Total Equity

The liquidity ratios show whether the company will be able to pay back its creditors, loans and expenses. SPAR's current ratio for 2011 is of 1.13 which is very close to the recommended level. All throughout the 3 years which we are analyzing, the current ratio exceeded 1:1, which brings evidence that the company is able to raise the cash needed to pay its obligations on term. SPAR operates in a labor intensive industry, for which the normal debt-to-equity ratio is an average of 1:2. The total debt ratio is above 100% gives a warning signal to investors, showing that the company may have problems to generate enough income to cover its debts and operating expenses. According to various experts in the domain, the average operating profit margin in the retail industry is of 3.5% (Michigan Retailers Association, 2012). The fact that operating profit margin has been constant over the three-year period proves that the company is able to control its operating costs and overheads. The gross profit ratio of 8% is well below the average of the retail industry of about 20-30% (Tamara Monosoff, 2006) and is a concerning number for any investor. This number can be explained by the increasing volume of sales for which even a small profit margin can be satisfactory. The net profit margin ratio provides a measure of profitability of the business and it summarizes the income statement performance. Retailers are usually known for their low-cost, high volume approach, which explains the low profit margin of 0.025 that SPAR had last year. c) Assets evolution In 2011 the current assets have increased by 12.55% and the fixed assets by 3.62%, resulting in an increase in the total assets with 10.13%. Both inventories and total receivables have increased as compared to the previous year, as well as the investment in subsidiaries.

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d) Equity and Liability evolution The liabilities have increased in 2011 by more than 700 million Rand, mainly due to an increase in payables of 18.15% and of taxation payables from 2.3 million Rand in 2009 to 40.6 million Rand in 2011. The increase in profit and revenues also led to an increase in equity by more than 15% which is due to a raise in retained earnings. The quick ratio has a promising value of 1.23 which is much more than ideal for the retail industry. This shows that, if the sales of the company somehow stopped, it would be able to pay its obligations by converting its funds on hand. The interest coverage ratio has an amazing value of 58.44 showing that its interest rates can be comfortably paid by its earned profits. A fall in EBIT will not have too great consequences related to the profits obtained for ordinary shareholders. Generally, a return on equity is considered good if it falls between 15% and 20%. The fact that SPAR managed to have a relatively constant return on equity shows that its management knows how to allocate investment funds in order to generate earnings growth.

7. Cash flow and projected cash flow analysis


Over a period of time changes in assets and liabilities will definitely occur, particularly in the accounts making up working capital, such as cash, receivables, inventories and payables. These changes can be seen in the cash flow statement, which is a dynamic analysis that focuses on the changes in financial condition resulting from the decisions made during a given period. Among its elements, the cash flow from operating activities is the most important one, as its represents the capacity of the company to carry on its current activity with the cash collected from its core activity, excluding the revenues that come from the sale of assets, bonds shares or other non-monetary items. The operating cash flow for 2011 was of 703.4 million Rand, which shows a considerable increase of 228% as compared to the previous year. Due to this increase in operating cash flow, the net increase in cash and cash equivalents at the end of 2011 was positive as opposed to the negative figures the company had for the previous 3 years, giving a good signal to investors. The financing part was of a modest 16.2 million Rand and, as it represents only 2.3% of the operating cash flow, it proves that SPAR is successful in raising most of its money from its core activity. SPAR Group prepares cash-flow projections for ten years in advance, based on the most recent budgets and cash flows that are approved by its management. The growth rate included in these projections does not exceed the average long-term growth of the market. Although the management expects 2012 to be a challenging year, they are still positive about new 11 | P a g e

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opportunities for business. The positive signs that show an improvement in trading are the expectation of lower interest rates, the improvement in economic activity and gradual inflation increase in food rates. The operating cash flow is anticipated to increase cash generation in order to cover all debts.

8. Collateral analysis
The credit will have as collateral a first rank mortgage on land and real estate: a 33 000 square meter terrain together with the SPAR Eastern Cape Distribution Center build on it. The land is situated on 5 Kohler Street, Perseverance, Port Elizabeth (Eastern Cape province), South Africa. The assets are owned by SPAR Group Ltd and are appraised at a market value of 284 million Rand. The bank considers a risk coefficient of 20%, diminishing the value of the collateral to 227.2 million Rand. This value is enough to cover the amount of the loan (200 million Rand), the interest payable and other expenses that might need legal enforcement.

9. Risk evaluation
The bank must apply a consistent evaluation to its investment opportunity, taking into account the interdependencies between several factors that can have a material risk exposure. Key Risks Mitigation Factors The company operates in South Africa since 1963. Here it has 6 distribution centers and 788 stores, and much more worldwide. The management of the company has great experience in this domain, as proved by the good investment decisions they have made along the years. The company has shown a steady increase in sales volume over the past few years. The projected sales show a significant growth, as an anticipation of emergence from the global economic crisis. As seen, SPAR Group Ltd. has very good financials, and its current ratio of 1.13 shows that the company is able to pay its debts on time. Its operating profit has always been the most important part of SPARs revenues, proving that the company is successful in raising money from its core activity. As can be seen in the chart below, the average exchange rate for the past few years has been considerably stable. In the case of a major unfavorable change in the currency rate, the company will still be able to compensate through its profit margin.

Business Risk

Market Risk

Repayment risk

Foreign Exchange Risk

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Average exchange rate (ZAR/USD)


15 10 5 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Average exchange rate (ZAR/USD)

SPARs balance sheets over the past few years have been very strong and liquid, its assets are qualitative, and its management has excellent reputation. Considering the above mentioned factors, we can state that lending to this business presents a minimal risk.

10. Credit scoring


Evaluation criteria Qualitative criteria Management quality Ownership structure Quality of guarantees Quantitative criteria Current ratio: Current assets/ Current debts Operating profit margin : Operating profit/ Sales * 100 Equity ratio: Equity/ Total assets * 100 Solvability: Total assets/ Total debts Interest cover ratio: Operating Profit/ Interest Expenses Client rating- financial performance Weight Values Mark Evaluation

11% 4% 10%

Well known company, experience within the field, 1 excellent business strategy. Majority owned by a powerful 1 international company. First rank mortgage on real estate covering the loan, interest 1 and other expenses. 1.13 3.79% 31.71% 1.46 58.44 3 3 1 1 1

0.11 0.04 0.1

18% 12% 9% 18% 18% 100%

0.54 0.36 0.09 0.18 0.18

1.6

The company has an overall credit scoring of 1.6 which, according to the norms established by the bank belongs to category A high performance credit. This class comprises borrowers with profitable activity and excellent financial health which have no problem in repaying the loan.

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11. Credit Committee Decision

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Taking into consideration the above-presented influencing factors, the Credit Committee approved the credit, establishing the following conditions: Credit type: investment credit; Purpose: purchase of land and building of a new distribution center in North West province, and the acquisition of 5 new ecological trucks; Amount: 200 million Rand; Interest: 7.4%; Collateral: 1st rank mortgage on land and building, worth 227.2 million Rand; Contract date: April 2012; Maturity date: March 2019; Other conditions: the company will not pay dividends to shareholders without the written approval of the bank. In case the company fails to observe the loan terms, the contract will become null and void and the bank will request the payment in advance of all the obligations.

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Bibliography:

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SPAR original website, available online at :< http://www.spar.co.za/HomePage1.aspx>. SPAR international website, available online at: <http://www.sparinternational.com/Default.aspx>. Dima, A.M. et al., 2010. Banking: Theory, Cases and Applications. Bucharest: ASE Publishing House. Helfert, E.A., 1987. Techniques of financial analysis. Homewood: Irwin Publishing House. Smith, N., 2011. How to Determine the Debt Ratio from Financial Statements [online]. Available at http://www.ehow.com/how_12085701_determine-debt-ratio-financialstatements.html [Accessed April 20th 2012]. Ford, M., 2009. The Lights in the Tunnel [e-book]. U.S.: Acculant Publishing. Available through Google Books website: http://books.google.ro/books?id=13UqxRhU0U8C&pg=PA131&lpg=PA131&dq=retail+i ndustry+capital+intensive&source=bl&ots=7tIgoO66tw&sig=DFWZOq6c5jYu0HHeSPP KhqyMg6s&hl=ro&sa=X&ei=cVOQT_zOJ43ZsgaRpKGhBA&ved=0CDsQ6AEwAw#v =onepage&q=retail%20industry%20capital%20intensive&f=false. Investopedia, 2012. Debt/ Equity Ratio [online]. Available at <http://www.investopedia.com/terms/d/debtequityratio.asp#axzz1sVhMLQAt> [Accessed April 19th 2012]. Michigan Retailers Association, 2012. What is a good profit margin? [online]. Available at <http://www.retailers.com/FAQRetrieve.aspx?ID=51529>. Monosoff, T., 2006. Demystifying Profit Margins and Markups [online]. Available at <http://www.entrepreneur.com/article/170964>. [Accessed April 20th 2012]. Kennon, J., 2012. Net profit margin [online]. Available at <http://beginnersinvest.about.com/od/incomestatementanalysis/a/net-profit-margin.htm>. USDA Foreign Agricultural Service, 2012. South Africa's Food Retail Assessment [pdf]. Pretoria: Global Agricultural Information Network. Available at <http://gain.fas.usda.gov/Recent%20GAIN%20Publications/South%20Africa%27s%20F Foo%20Retail%20Assessment%20_Pretoria_South%20Africa%20%20Republic%20of_4-2-2012.pdf> [Accessed April 20th 2012]. Desynit, 2011. Client stories: Spar Group of South Africa [online]. Available at: <http://www.desynit.com/Clientstories/SPARGroupofSouthAfrica.aspx > [Accessed April 21st 2012]. African Financials, 2010. The SPAR Group Limited 2010 Annual Report [online]. Available at: <http://ipaper.ipapercms.dk/AfricanShareHolder/za/SPP/2010/?Page=80> [Accessed April 22nd 2012]. Docstoc, 2011. The SPAR Group Limited Financial and Strategic SWOT Analysis review [online]. Available at: <http://www.docstoc.com/docs/102115110/The-SPAR-GroupLimited-(SPP)---Financial-and-Strategic-SWOT-Analysis-Review> [Accessed April 22nd 2012]. Southern African Legal Information Institute, 2005. South Africa: Competition Tribunal (Spar Group Ltd and Sparit Family Supermarkets (Pty) Ltd) [online] Available at: <http://www.saflii.org/za/cases/ZACT/2005/62.html> [Accessed April 19th 2012]. 16 | P a g e

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Tigerbrands, 2004. THE SPAR GROUP LIMITED Pre-listing Statement [pdf]. Available at:<http://www.tigerbrands.co.za/Investor/MediaCentre/ArticleArchive/NewsArticles200 4/Article02.pdf> [Accessed April 22nd 2012]. Mbendi Infomation Services, 2012. The Spar Group Ltd [online]. Available at: <http://www.mbendi.com/orgs/d7jd.htm> [Accessed April 22nd 2012]. Thomas White Global Investing, 2011. Retail in South Africa: Making an Impression [online]. Available at: <http://www.thomaswhite.com/explore-the-world/emergingmarket-spotlight/south-africa-consumer-goods.aspx> [Accessed April 22nd 2012].

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