Investment Highlights

• We downgrade Pos Malaysia (Pos) to an UNDERWEIGHT with a lower DCF-based fair value of RM2.70/share (WACC: 8.6%, terminal growth rate: 1.5%) from RM5.27/share previously.

• Our FV has an implied FY20 PE multiple of 24.8x and PB multiple of 1.06x. Its comparable GD Express Carrier (GDex) is trading at a forward PE of 50.7x and PB of 4.4x.

• Our resumption of coverage on Pos also opens our coverage on the sector of e-commerce, which will be our emphasis for this stock.

• The group’s e-commerce business has experienced strong growth (3-year CAGR of 18% to FY18) but faces increasing headwinds from competition, an absence of pricing power to defend its margins and slow results from reforms to improve the service quality by eradicating various legacy issues.

• We outline the key issues for Pos as follows:

1) Hurdles in optimizing its postal service.

This has been loss-making for years as the group is unable to fully right size its workforce and number of stores. In lieu of this, it has embarked on various initiatives to further monetize its assets and continues to campaign to the government for a tariff hike to raise its prices.

Pos has 691 post offices and a workforce of 24K. We understand that half of the post offices are running at a loss, while staff and administrative costs have taken up a whopping 65-68% of the group’s revenue in recent years. With few options to cut operating expenses, the group is left with finding ways to boost revenue from its postal segment and developing the more promising areas of its business.

Efforts to boost revenue include pushing for the tariff hike, innovating the front-end of its operations (by introducing door-todoor delivery) and expanding its reach with a franchise model.

2) E-commerce expansion amid crowding market.

Pos has budgeted an annual capex of RM400mil for the next three years with the FY19 amount prioritizing on a second sorting centre (IPC 2) and sweeping IT reforms to improve the effectiveness of items such as real-time tracking. IPC 2 is eyed for May 2019 and will raise the group’s total capacity to 500K parcels/day from 300K now in IPC 1 (Shah Alam).

Pos estimates its market share of e-commerce fulfilment at 30-40% next to other major players such as GDex and City-Link Express. Its main advantage has been the geographic reach to small towns and rural areas afforded by its nationwide network, large courier fleet and its cheaper options for non-express deliveries.

Major players in the segment are spending heavily to win market share, while new entrants have raised the number of licensed players to above 200 and put pressure on prices. While its infrastructure and network are unparalleled, Pos is taking measures to expand on these and improve the reliability of its existing assets. The effect of competition is evident in the courier segment’s operating margin, which had scored in the low teens in the recent quarters compared to a peak of 38% two years ago.

Fears of a digital tax in the 2019 federal budget were dismissed when the government announced a tax that would be limited to imported online services such as Netflix and Spotify from 2020. Malaysia is the second country in Southeast Asia to impose a digital tax, but a similar tax exists in Australia, India and the UK. We believe the government is still keen to develop the country’s e-commerce sector given that it is still in a nascent stage relative to the brick-and-mortal retail sector.

Furthermore, we emphasize it is important to preserve the democratic nature of e-commerce platforms and think it would best be led by privately-owned companies although government support is crucial in increasing the ease of doing business, i.e. to build on existing efforts to cut on the clearance time for cross-border parcel movements and incentives to position Malaysia as a regional hub for e-fulfilment.

3) Efforts to reprice e-commerce offerings are an uphill battle.

The group is eyeing a gradual repricing on the rates charged on its contractual customers, which are online platforms such as Lazada, Shopee and 11street. Pos may have a bargaining chip as one of the largest players in the fulfilment market, but we believe the rising competition and sector’s emphasis on keeping the affordability factor for customers would be major impediments.

We believe the ongoing efforts to expand its e-commerce offerings and improve the effectiveness of its IT infrastructure will contribute towards a better position in negotiating for price hikes in the future.

4) Leadership changes create some ambiguity in the group’s long-term vision.

Syed Md Najib Syed Md Noor took over as CEO in Oct this year, replacing Al-Ishal Ishak who served from February to October. Prior to Al-Ishal, Datuk Mohd Shukrie Mohd Salleh served in the role for five years. We believe a continuity in leadership is crucial for Pos given that its operational issues are fundamental and the reforms for these require long-term oversight.

• We are projecting for net profit to recover in FY20 with a 25% growth following a 47% drop in FY19. However, we are cautious of earnings for the current year following a disappointing 1QFY19. 1QFY19 net profit tumbled 83% YoY to RM6.5mil as its postal side deteriorated further and margins for courier declined.

• The key challenges for Pos now are to reduce the operating expenses for its postal segment and boost the revenue for its courier segment more substantially. A failure on both ends has led to the negation of the decent topline growth (3-year CAGR of 20%), which was led by the rise of its e-commerce business and the inclusion of the aviation and logistics segments.

• Pos sees a fair dividend yield of 2.0-3.1% based on a dividend payout assumption of 70%. The group still pays an ample amount in annual dividends but the quantum has fallen from 100% of its net profit in FY16 to 67% in FY18. We believe it will lean towards conserving more as earnings come under pressure and capex spending remains substantial. Additionally, it has been conservative with debt by maintaining a net cash position in recent years.

Source: AmInvest Research - 12 Nov 2018