Highlights

Affin Hwang Capital Research Highlights

Author: kltrader   |   Latest post: Fri, 17 Jan 2020, 8:43 AM

 

Aeon Co. (M) - Welcome Breather After a Long Expansion Drive

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We came away from our recent meeting with Aeon Co’s management feeling more upbeat about the company’s prospects. We foresee stronger earnings expansion in 2020-21, driven by: (i) a turnaround in SSSG; (ii) a slowdown in capex given a pause in new mall openings; and (iii) signs of stability in the retail property space. At -0.5SD to its 10-year average PER, Aeon’s valuation looks reasonably attractive while its near-term earnings growth trajectory appears more assured. Upgrade to BUY, with a revised TP of RM1.79 (from RM1.61).

2H19: Seeing Slight Impact From Muted 3Q19 and Gestation of Malls

We foresee sluggish retailing sales growth in 3Q19 off a high base from the zero-rated GST period last year in addition to the recent haze outbreak which affected businesses in September. While 4Q19 is expected to post a stronger showing due to the resumption of festivities over the year-end, we expect some margin pressure due to start-up costs from the re-opening of AEON Taman Maluri with a twofold expansion in mall space.

Tapering Expansion Plans, Capex Will Improve Earnings Visibility

Post-2019, the annual capex would be scaled back to RM300-400m (from RM400-500m) and used mainly for maintenance, refurbishments as well as the opening of smaller-format stores, with no new mall openings over the next two years. Thus, we expect margins for the property management segment to stabilise as its expanded floorspace gestates, allaying the pressure on rental reversions due to excess supply in retail rental spaces.

Retailing Business Likely to Shine Once More

We expect another consumer-friendly Budget 2020 to preserve the private consumption growth engine and unlock the value of Aeon’s retailing business model once more, after a sustained store expansion drive in spite of the weak operating environment during 2015-17 which saw various competitors downsize their footprint. The ongoing recovery in same-store sales (6M19: +2-3% yoy) is likely to continue to propel the segment’s earnings contribution under an elevated fixed cost base. Recall that Aeon’s retailing segment used to account for half of the group EBIT before margins were eroded by negative SSSG during the GST regime.

Upgrade to BUY

We trim the 2019E earnings to reflect a slightly softer 2H19 performance, but raise that for 2020-21E on account of a progressive margin recovery. Subsequently, we upgrade Aeon to a BUY (from Hold) with a higher TP of RM1.79 (from RM1.61) based on an unchanged 19x 2020E PER. Downside risks: i) Decline in retail traffic; (ii) contraction in the property rental business; and iii) deterioration in the external macro environment.

Light at the End of a Long Tunnel

Earnings Likely to Recover After Tumbling From 2013’s Record High

To recap, Aeon’s core net profit tumbled 61% over a three-year period from 2013’s record high of RM231m to RM90.9m in 2016, before subsequently recovering to RM113m in 2018. This was due to a considerable erosion in margins rather than revenue which expanded at a 5-year CAGR of 4.4%, as management continued to invest aggressively on outlet expansions and renovations despite unfavourable headwinds over the period. These include the implementation of GST in 2015 which adversely impacted consumer spending and sentiment as inflation shot up, as well as the oil price crash and sharp Ringgit depreciation until 2017 before conditions began to improve.

Margins Affected by Past Expansions, Negative SSSG Over GST Shock

The 4.0ppt Fall in Core Net Margin From 2013-18 Was Attributable To:

(i) Decline in like-for-like growth with three years of negative retail SSSG during 2015-17. Over the same period, the property market suffered from an oversupply of new retail spaces which negatively impacted Aeon’s mall occupancy rates as well as rental reversions.

(ii) Inflated operating expenses as Aeon bit the bullet and maintained its aggressive expansion and refurbishment drive, incurring RM3bn in capex from 2014-18 with an average net opening of 1 mall each year in addition to smaller-format stores (Wellness, Daiso and MaxValu) and renovation works for aging malls/stores. Depreciation and amortisation costs consequently doubled up over that period. The high capex also led to:

(iii) Higher financing costs as the group geared up from its previous net cash position in order to fund the excess capex over its operating cash flows, while…

(iv) …effective tax rates shot up starting from 2015 over the revised accounting treatment of certain refurbishment works as nondeductible expenses – creeping up from a previous prevailing rate of 30% to 44% as of 2018.

Retail Earnings Fell Victim to Inflated Fixed Cost Base

Reasons (i) and (ii) had a larger impact on the retail segment’s earnings (5-year CAGR of -21%), as its already-thin operating margin of 5.6% in 2013 was slashed by 4.2ppts to just 1.4% in 2018. In contrast, the property management segment’s earnings contribution increased at a 5-year CAGR of 4% despite posting a 6.5ppt margin decline from 37.0% in 2013. Consequently, earnings contribution from both segments quickly tilted towards an 80/20 dependency on property management income in 2018 – despite retailing’s >80% revenue contribution – from a 50/50 contribution split in the past.

Retailing Segment

Improving Contribution Margin Offers a Much-needed Respite

Fixed costs notwithstanding, profitability of the retailing business has been commendably upheld, as gross margins of c.29% have been maintained over the past five years. We attribute this to progressively improving margins for food-line items – the main yet resilient volume generator – which mitigated cost pressures elsewhere, due to Aeon’s strong bargaining position with suppliers, in addition to increased contribution of ready-to-eat (RTE) sales which we estimate now account for 20% of supermarket sales.

SSSG on a Positive Trajectory Once More…

As SSSG recovered strongly in 2018 to +3.8% (2017: -3.4%) in tandem with the recovery in consumer sentiment and private consumption growth, the enlarged operating and financial leverage gave rise to a 32% jump in retailing earnings yoy. This partially made up for a 13% fall in property management earnings and contributed to core net profit growth of 6.8% for the year.

…which Paves the Way for a Strong Recovery in Segment Earnings

For 6M19, SSSG continued to trend positively (+2-3% yoy) which partially gave rise to the 6.5% sales growth and margin expansion of 1.0ppt, on a pre-MFRS 16 basis. As a result, retailing EBIT surged 92% yoy, albeit from a low base.

Segment’s Growth Momentum Tied to Consumption Spending

We believe the sustained strength of local consumer spending will continue to set the stage for a continued recovery in Aeon’s same-store sales performance, as we observe a strong positive relationship between private consumption spending growth and department store cum supermarket sales growth. According to our back-of-the-envelope calculation, a 1% growth in same-store sales will lead to a corresponding high-teens increase in the 2020E retailing segment profit.

Aeon’s Retailing Business Model Remains Sound

Retail trade data compiled by the Department of Statistics indicates that sales growth of non-specialised stores began to outpace headline retail trade sales once again from 2017. This was reaffirmed by Retail Group Malaysia (RGM)’s industry survey which shows that sales growth of department stores cum supermarkets have resumed outpacing industry sales growth from 2018. We believe this outlines the continued appeal of Aeon’s retailing business model – although its relevance necessitates constant re-modernising of retail outlets, as management has undertaken. In contrast, many of Aeon’s key competitors such as MyDin and Giant, within the grocery and department store retailing sector, have fallen by the wayside as they failed to keep up with the industry landscape and evolving consumer preferences.

Smaller-format, Specialty Stores Emerging as a Key Retail Driver

Aside from its traditional supermarket and department stores, we see Aeon’s smaller-format MaxValu stores and its specialty Wellness and Daiso stores driving its retailing sales performance. These stores have performed well since inception and now collectively account for >10% of total retail sales. As of now, we understand that the group operates 6 MaxValu outlets, 64 Wellness outlets and 40 Daiso stores. Management aims to open 5-6 Wellness and Daiso stores each per annum; SSSG for the two store formats have been relatively more stable than its in-mall stores, ranging from 8.4%/10.7% to 2.8%/2.5% respectively in 2017/18, reflecting the growing demand for health and wellness products and services as well as variety store merchandise. Although the profit contribution from these smaller-format stores to segmental earnings is still minor, we understand that the GP margins are decent at ~20%.

Rising Middle Income Population Should Underpin Long-term Growth

Given Aeon stores’ customers who are mainly middle income residential families, we expect the envisaged growth of Malaysia’s large M40 group to continue driving its retailing businesses. According to Euromonitor, the proportion of local households with annual income exceeding US$15,000 is expected to rise from 65% in 2018 to 76% by 2023.

Property Management Segment

Pause in New Mall Openings Positive Amid Oversupply Conditions

Thus far, management has not decided upon a new mall opening, which typically takes two years for approval and construction and incurs capex of RM200-300m. We view this as a positive over the near term, allowing Aeon some room to consolidate its finances from the freed up cash flow while the retail property market continues to record an influx of new competing retail spaces. The weak rental conditions has compelled management in recent times to take on an increased proportion of variable-rate tenancy agreements in order to sustain its >90% occupancy rate, at the expense of rental reversions and consequently margins.

Property Segment’s Margins Likely Bottoming Out in 2019…

That said, the overall retail rental market showed signs of stabilising in 1H19 with occupancy rates recovering from 2H18 as the take-up rate of retail spaces recovered despite the continued increase in new retail spaces. Aeon’s same-scale property management income turned positive at +1.0% in 6M19 (2018: -0.3%), while the segment’s margin decline eased in 2Q19 (-0.6ppt yoy) and recovered strongly on a sequential basis (+2.4ppts) on the gestation of the Nilai mall opened in 1Q19. We understand that the 6M19 occupancy rate was slightly affected by AEON Nilai’s opening (75%) but nonetheless remained high at 89%. In 2H19, we expect margins to be briefly impacted by the gestation of AEON Taman Maluri’s extended floor space which would double the mall’s net lettable area to approximately 1 million sq ft. Subsequently, however, we expect margins to recover in 2020-21 as the new establishments reach critical occupancy and there would be no earnings impact from new mall openings.

…as the Retail Rental Market Shows Signs of Stabilising

We believe the recovery in rental reversions is likely to be sustained in 2H19, as we note that the supply and demand conditions in areas where Aeon’s malls are situated have shown signs of stability in terms of occupancy rate, after recording a broad-based decline in 6M18 coinciding with the general election period. This occurred in tandem with the return in demand growth for retail spaces rather than a pause of new shopping complex openings.

Earnings Outlook

2H19: Looking Flat Off High Base and Malls’ Gestation Period

We foresee muted retailing sales growth in 3Q19 off a high base from the zero-rated GST period last year in addition to the recent haze outbreak which affected businesses in September. For the property segment, we expect some margin pressure due to start-up costs arising from the opening of AEON Taman Maluri’s extended Phase 1 and Phase 2 in 3Q19 and 4Q19, despite the positive uptick in rental reversions. As a result, 2H19 core net profit growth is likely to be flat yoy.

2020-21: earnings catalysts driven by discretionary spending growth, stabilising retail property conditions and pause in expansion plans

We believe the recovery in retailing SSSG could be sustained in 2020, owing to the healthy traction seen in private consumption spending and retail industry sales growth. Our in-house economist forecasts private consumption to grow 7.3% in 2019 and 6.5% in 2020; growth in Malaysia has been outpacing that for the ASEAN-5 economies since 1Q17. On the property side, we believe the stabilising market conditions will be a relief for rental reversions and consequently the segment’s earnings, while there would be no mall openings beyond 2019 to dilute margins apart from some scheduled refurbishments of 2-3 outlets per year.

Valuation & Recommendation

Upgrade to BUY; Growth at a Reasonable Price

We revise the 2019-21E earnings by -2%/12/16% respectively to incorporate our assumptions of the following: (i) aforementioned earnings impact in 2H19; (ii) lower interest costs from repayment of borrowings in 2020-21E; and (iii) improved margins for its retail and property management segments in 2020-21E. Post-revision, we arrive at a higher 12-month TP of RM1.79 (from RM1.61) which is based on an unchanged 19x 2020E PER target (-0.5SD to 10-year mean PER). We believe the valuation, which implies a discount to its historical valuation and regional peers, has priced in the retail sector’s competitive landscape and potential global macro headwinds.

Downside Risks: Competition, Weakening Macro Conditions

The key downside risks to earnings, in our view, are the heightened competitive pressures in retail and property space, alongside a deterioration in macro conditions which would affect consumers’ discretionary spending.

 

Source: Affin Hwang Research - 9 Oct 2019

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