-  We upgrade Parkson Holdings (PHB) from SELL to BUY, and raise our fair value to RM3.85/share (from RM2.20/share previously), pegged to a PE of 22x FY15F earnings – one standard deviation above its 5-year historical mean PE. We deemed this fair as earnings are recovering from the trough level and in line with select consumer names including AEON Co (22x) and Bonia Holdings (17x). Stripping out its net cash, PE stands at 11x.

-  PHB has put in place a sound strategy to restore profitability across its operating markets under the direct stewardship of founder Tan Sri William Cheng. Such a move could be quickly executed because 88% of its gross floor area (GFA) are leased, which gives flexibility for the closure of less profitable stores and ramping up of younger stores.

-  We raise our earnings estimates by a significant 24%-39% for FY15F-FY17F given our expectations of improving SSSGs and margin uplift from a proactive store rationalisation/optimisation plan, including closure and divestment of non-profitable stores. New store turnarounds in China are gaining traction and this would continue to boost margin. The five younger stores that turned around in 1H14 were losing RMB26mil in 2013.

-  Consensus rating on HK-listed Parkson Retail Group (PRG) – which accounts for 65% of PHB’s EBIT – has seen a nascent positive inflexion point, on the back of a significantly stronger performance in relative to depressed market expectations. PRG 1H14’s operating profit fell 22% YoY but management expects flat operating profit for the fiscal year, which implies a stronger 2H14. SSSG contraction appears to be abating.

-  Management is expanding its brand portfolio (with at least 20 new brands) and merchandising mix to boost traffic footfall. PRG recently secured the distributor rights for the Mango brand. Its SSSG is believed to have bottomed given the two consecutive years of contraction. We forecast SSSG to be flat this year (FY14: -7%) and to recover to 2% in FY16F and 4% in FY17F, vs. the average of 10% during its high growth period (FY10- FY12). Renewed optimism over China economic growth should also be supportive of a turnaround in SSSG.

-  Singapore-listed Parkson Retail Asia (PRA) will continue to emphasis on its high growth Indonesian market, where it continues to open three new stores per annum. The mild SSSG contraction in Malaysia (-0.1%) should turn around as the three performing stores that were closed temporarily for renovation had reopened.

-  PHB’s business model is highly cash generative with all three listed entities in net cash positions. As at end-9MFY14, PRG has RM600mil, PRA (RM426mil) and PHB (RM130mil). Cash pile would be boosted by the sale of KL Festival City Mall for RM349mil. Free cash flow projection of more than RM400mil per annum is sufficient to fund its RM300mil annual capex. The group does not have a formal dividend policy but historical dividend payout is above 40% of earnings.

-  Downside risk to share price is limited due to its active share buy-back policy. It continues to engage in share buy-backs even after the recent distribution of 62mil treasury shares.

-  The key valuation drivers for PHB are improvement in SSSG for China and the monetisation of retail assets, particularly from loss-making stores.

Source: AmeSecurities