Introduction

AEON Berhad is listed on the main board of Bursa stock exchange with a market capitalization of RM2.10 billion (share base of 1,404 million x current share price of RM1.50). AEON owns 28 shopping malls and operates 34 supermarket stores in Malaysia. Besides, AEON also owns and operates 65 AEON Wellness stores, 42 Daiso stores, 9 AEON Maxvalu stores and 4 Komai-so stores in Malaysia.

AEON Bhd is a retails cum property giant in the making and may be worth RM6.29 to RM8.60 per share, a hefty 420% to 570% higher than current share price of RM1.50. AEON will soon inject all its shopping malls into a new REIT listing worth RM10 billion or RM7.00 per share to reward long term shareholders.

Why AEON share price has dropped 65% since 2013?

AEON share price touched a peak of RM4.50 in 2013 and had been on a steady downtrend to a low of RM0.70 in Nov 2020 and has since rebounded to current level of RM1.50-1.60. A shapshot comparison of its financial performance of FY2013 and FY2021 is given below:

Over the past 8 years, AEON has expanded aggressively to open new shopping malls and supermarket stores. As can be seen in the table above, its revenue has not increased much though FY2021 was affected by covid-19 pandemic lockdown measures (FY2020 revenue was higher at RM4,051 million).

AEON’s EBITDA has increased substantially from RM484m in FY2013 to RM725m in FY2021, contributed mostly by its property management services that see EBITDA increased from RM333 million in FY2013 to RM548 million in FY2020 and RM507 million in FY2021, thanks to its rapid expansion of new malls and hence net lettable area.

However, pretax profit has taken a hit from RM332m in FY2013 to RM131m in FY2021 due to the 3x increase in depreciation charges and substantial interest costs of RM129m in FY2021. As a result, net profit and EPS has dropped by 63% from 16.5 sen in FY2013 to just 6.7 sen in FY2021. This explains why its share price has dropped by 65% since 2013.

The rapid expansion from 2013 to 2020 has unintentionally increased depreciation charges faster than the increase in EBITDA, resulting in lower EBIT. Coupled with high interest costs due to heavy borrowings to fund the expansion, pretax profit has taken a larger hit since 2013. Such expansion was not without merit, first it has indeed increased EBITDA and cash flows substantially from both the property management services and retail supermarket business. Second, AEON has built these new malls at lower construction costs in 2013-2018 than it were to build them today. Third, AEON has managed to put a flag in some new towns by building a new shopping mall in these strategic locations before other competitors come in, enjoying the first mover advantage.

AEON Business Segments and Latest Financials

AEON Bhd has two major business segments – (1) Retailing,  (2) Property Management Services (PMS). The retailing segment include all its supermarkets and retails stores (Daiso, AEON Wellness, Komai-so etc) inside AEON shopping malls as well as those leasing in other malls like 1 Utama and Mid Valley. The property management services segment owns and operates the AEON shopping malls and manages all the tenant retails shops inside.

Based on AEON quarterly reports, Retailing segment registered a revenue of RM3,099 million and segmental profits of RM129.6 million for FY2021, while Property Management Services registered a revenue of RM531.3 million and segmental profit of RM199.6 million.

I will try to segregate the profits, cash flows and cash for these 2 segments as follow:

* Unallocated expenses are allocated 80% to Retailing and 20% to Prop Managemt Service

** Lease liabilities payment and lease interests are allocated 80% to Retailing and 20% to Property Management Services

There was a cash payment of lease liabilities of RM158.9 million in FY2021 (RM149.2m in FY2020) and a cash payment of interests of RM128.7 million in FY2021 (RM146.6m in FY2020). Out of the interest payments, RM107 million (RM116.5m in FY2020) was for lease interests and RM22 million (RM32.9m in FY2020) was for interest charges. These 2 items of lease liabilities payment and lease interest payment are tricky as I do not know exactly what they are for and which segment they are related to. Intuitively these lease liabilities should be for long term lease entered into by AEON supermarkets as a leasee in shopping malls not owned by AEON as well as AEON supermarket leasing in AEON malls. Part of it may be for long term land lease entered into by AEON with landlord eg. Permas Jaya mall.

For simplicity, I allocate 80% of the lease liabilities payment and lease interests to the retails / supermarket segment, and 20% to the property management segment. Hence, there will be an amount of RM(RM158.9 + 107.0) x 80% = RM212.7 million of lease liabilities and lease interest payment allocated to the retailing segment and the balance RM53.2 million allocated to the property management services.

The Q4FY2021 quarterly result of AEON shows a good rebound in earnings and cashflows but Q1FY2022 has softened. Again, I segregate the revenue, segmental profit and cash flows for the two business segments as follow:

*Unallocated expenses are allocated 80% to Retailing and 20% to Property Management Services (PMS)

**The average Unallocated Expenses are cut by 10% due to exceptionally high expenses in Q1FY2022

^Lease liabilities  payment and lease interest are allocated 80% to Retailing and 20% to PMS

The financial performance in Q4FY2021 was exceptional as the country was reopened from MCO in end September 2021 and there was “revenge” style of retails spending in Oct-Dec 2021. Q1 FY2022 saw steady revenue but lower profits than Q4FY2021 due to lower margin and higher unallocated expenses as a result of the omicron wave pushing daily new Covid-19 cases to a peak of 33,000 during the quarter.

To project for the whole year of FY2022, I shall use the average of the actual numbers achieved in Q4FY2021 and Q1FY2022 as the basis. AEON retail sales are seasonal with typically strong quarter for Oct-Dec in conjunction with school holidays and Christmas and weak quarter for Jul-Sept due to lack of major festivals. Though there was Chinese New Year in Q1FY2022 but the high Covid-19 cases then had reduced retails footfalls to its shopping malls. So it may be reasonable to assume that Q3FY2022 performance may be similar to Q1FY2022 and Q2FY2022 (Apr-Jun) may be strong as Q4 due to Hari Raya festivals and pandemic SOPs relaxed from 1^st April and borders re-opened from 1^st May 2022. Furthermore, there have been a couple rounds of cash handouts and EPF withdrawal allowed by the government early this year, which have helped to inject at least RM40 billion of cash into household spending.

Hence, the operating cash flow for the Retailing segment may be projected to be RM36.5m x 4 = RM146 million. For the Property Management Segment, operating cash flow may be RM117.9m x 4 = RM472 million. . Hence, this brings the total operating cashflow projected for FY2022 to RM618 million. In comparison, AEON achieved operating cash flows (before working capital changes, capex and tax) of RM601 million in FY2019, RM578 million in FY2018 and RM549 million in FY2017 which increased over year until FY2020 when the Covid-19 pandemic started and operating cash flows dropped to RM507.8 million.

AEON Supermarket and Retails Business

AEON today operates a total of 34 supermarket stores across Malaysia, with 28 stores located in its own shopping malls while 6 stores in other shopping malls such as Mid Valley and 1 Utama). Other retails shops include AEON Wellness and Daiso mostly in its own shopping malls.

From the interview given by AEON CEO in April 2022, the company had no plan to build any new shopping malls in the next 2-3 years but would instead focus on improving sales and cost controls at existing business. AEON would spend some capex to rejuvenate some of the existing malls and to fast track the digitalization process of its retails business. It aimed to grow its online retails sales by at least double the sales in next few years.

I particularly like the Sayap Bagimu sustainability initiatives by AEON. CEO Shafie said AEON brought in 400 local suppliers comprising small enterprises in 2021. This is very smart and a win-win strategy, providing a platform for small enterprises to multiply their sales and at the same time broadening product offering especially local quality products and increasing sales for AEON. This indirectly reinforces AEON's status as a community mall, supporting local small enterprises around and providing more product choices to the local community.

The supermarket / retails division generated revenue of RM3,099 million in FY2021 (RM3,445m in FY2020) and operating profit of RM130.2 million in FY2021 (RM77.9m in FY2020) after deducting off depreciation and amortization charges of RM143 million in FY2021 (RM155m in FY2020).

From the above table, the retailing segment generated annual operating cash flows of RM5.2 million in FY2021 after adding back depreciation of RM143 million, minus off lease liabilities payment and lease interest of RM212.7 million. That was low as there were months in FY2021 when AEON malls were almost completely closed during Full Movement Control Order (FMCO) in July-September 2021.

In its quarterly result ended 31 Dec 2021, AEON’s retails segment showed a 10% jump in revenue to RM854.3 million and a bigger 270% jump in operating profit to RM88.3 million. There were unallocated expenses of RM21.9m during the quarter, assuming 80% of which was attributed to the retails segment, hence the operating profit for the retail segment still registered a good RM70.8 million for a quarter. I deem this Dec 2021 quarter exceptional as the movement control order (MCO) was lifted in mid September 2021 and retails spending showed a strong rebound. Such momentum has continued in the Jan-Mar 2022 quarter with retailing revenue up 0.37% from the Dec2021 quarter even though Malaysia witnessed the wave of omicron that saw a peak in February. Segmental profit for the Retailing segment in Q1FY2022 somewhat dropped 31% from Q4FY2021 due to seasonal year end annual rebate recognition in the fourth quarter. As projected above, I get free cash flow of RM146 million a year for the Retailing segment.

Assuming no big expansion in next few years and minimal maintenance capex for the retails segment, then annual free cash flows from the retails / supermarket segment would be about RM146 million or 10.4 sen per share. Using a free cash flow yield of 7%, AEON’s retails segment would be worth RM0.104 / 7% = RM1.49 per share.

Unlocking Value in Property Management Services

Aeon owns and manages a total of 28 shopping malls in Malaysia with total Nett Lettable Area (NLA) of 13.4 million sq ft. These shopping malls are located at strategic locations in various cities and towns across Peninsular Malaysia and Sarawak. Its shopping malls are listed below:

1. Aeon Taman Maluri
2. Aeon Alpha Angle
3. Aeon Bandar Baru Klang
4. Aeon Mall Bukit Raja
5. Aeon Bandar Puchong
6. Aeon  Mall Metro Prima
7. Aeon Mall Cheras Selatan
8. Aeon Mall AU2 Setiawangsa
9. Aeon Taman Equine Shopping Centre
10. Aeon Mall Bukit Tinggi
11. Aeon Mall Rawang
12. Aeon Mall Shah Alam
13. Aeon Mall Ipoh Station 18
14. Aeon Mall Seri Manjung
15. Aeon Mall Taiping
16. Aeon Mall Ipoh Klebang
17. Aeon Mall Bukit Mertajam
18. Aeon Mall Kota Bharu
19. Aeon Mall Kuching Central
20. Aeon Mall Seremban 2
21. Aeon Mall Nilai
22. Aeon Melaka Shopping Centre
23. Aeon Mall Bandaraya Melaka
24. Aeon Taman Universiti Shopping Centre
25. Aeon Mall Tebrau City
26. Aeon Mall Bukit Indah
27. Aeon Mall Kulaijaya
28. Aeon Mall Bandar Dato’ Onn
29. Aeon Permas Jaya Shopping Centre (on 10-year lease with Permas Jaya developer)

Many of these malls are carried at a very low book value especially those that were built many years ago. For example, Aeon Melaka that was built 28 years ago and extended 21 years ago has a total built-up area of 380,105 sf but is carried at book at a value of just RM38.281 million, or RM100 psf of built-up area;  one Aeon Mall in Pulai that was built 17.5 years ago has a total built-up area of 483,299 sf but is carried at a book value of RM19.467 million, or at just RM40.28 psf of built-up area; In comparison, another AEON mall in Mukim Pulai that was built 11 years ago has a total built-up area of 845,634 sf but is carried at a book value of RM212.205 millon or RM250 psf of built-up area. Aeon Mall Tebrau City that was built 14 years ago and extended 3 years ago has a total built-up area of 4,323,316 sf and is carried at a book value of RM321.144 million or just RM74.28 psf of built-up area.

Those malls recently built in past 3-5 years carry a much higher book value per built-up area, eg. RM136m/750,235sf = RM181 psf for AEON Mall in Seberang Pulau Penang; RM245m/1,573,114sf = RM156 psf for Aeon Mall Shah Alam; RM273m/1,294,639sf = RM211 psf for Aeon Mall in Mukim Tebrau. My point is that those AEON malls that were built many years ago are carried at a book value far lower than current market value or even current construction costs, if the value of these malls is re-valued then it will give a hefty revaluation gains to AEON Berhad.

As stated in its Annual Report 2021, AEON has a total nett lettable area of 13.4 million sf. Assuming a ratio of 70% for nett lettable area over total built-up area, AEON malls altogether may have total built-up area of 19.1 million sf. Using the book value psf of built-up area for recently built Aeon malls of RM211 psf to RM250 psf, I assume the current construction costs to be close to RM230 psf of built-up area. Hence, if AEON were to revalue its malls to current market value, it would give a total value of 19.1 million sf x RM230 psf = RM4.4 billion, giving a hefty revaluation gain of RM1.3 billion over its PPE value of RM3.1 billion as of 31 Dec 2021.

If I look at the assets from cash flow generation perspective, I would give a much higher value to AEON malls. For its property management services, AEON reported a revenue of RM606.64 million for FY2020 and RM531.26 million for FY2021. Its FY2021 revenue was affected by various lockdown that caused most of its malls to close for an unprecedented 2.5 months in July-Sept 2021. Hence for simplicity, I will assume a steady revenue of RM550-600 million from its property management services every year from existing AEON malls. That would imply an average retail shop rental rate of RM3.42-3.73 psf per month, which reflects the location of its malls mostly in city suburbs or secondary towns. This is much lower than that of bigger malls like Pavilion or Mid Valley that command rental rate of well above RM10.00 psf per month.

If I deduct off the operating costs of the property management services and PPE depreciation, I get the operating profit or EBIT as follows:

FY2020:  RM606.6m – RM340.9m (depreciation) – RM36.1m (opn costs) = RM229.6m

FY2021: RM531.25m – RM321.4m (depreciation) – RM10.3m (opn costs) = RM199.6m

If I add back the non-cash depreciation charges and allocate 20% of the unallocated expenses to this segment, AEON property management services generated operating cash flows as follow:

FY2020: RM229.6m + 340.9m – 9.6m = RM560.9 million

FY2021: RM199.6m + 321.4m – 13.7m = RM507.2 million

Based on table above where I took the average numbers of Q4FY2021 and Q1FY2022, AEON shall achieve a revenue of RM141.1 million for its property management services on average every quarter. Operating profit may come in at RM58.6 million on average every quarter. If I allocate 20% of the unallocated expenses to the property management services, then operating profit will decrease to RM53.7 million for the quarter, annualized to RM215 million which is between the actual operating profits for FY2020 and FY2021. If I add back depreciation charge of RM77.4m, then operating cash flows for this quarter will come to RM53.7m + 77.4m = RM131.1 million, annualized to RM524 million which will be within the range of the actual FY2020 and FY2021 level.

If I allocate 20% of the lease liabilities payment and lease interests (about RM52 8million a year) to the property management services, then the annual operating cash flows will decrease from RM524 million to RM472 million.

[Sanity check: my projected total cash flows of RM146m (retails) + RM472m (property management services) = RM618 million a year is reasonable as it is just 3% higher than AEON Bhd actual operating cash flows (before capex, working capital changes and tax) of RM601.4 million in FY2019 before the pandemic. The improved cash flows in 2022 reflect the various cost cutting efforts by the management (eg. rooftop solar power) and improvement projects to raise profitability (eg. engaging more local suppliers, increasing online sales & digitalization efforts, etc.). AEON CEO announced in April 2022 that the company had spent some RM10 million to install solar power at the rooftop of Taman Maluri and Alpha Angle AEON malls. My calculations show that this solar power project at these 2 malls alone will save up to RM2.9 million of electricity costs every year. If AEON embark on further solar power installation projects at its other 20 malls, it would save electricity costs by RM29 million a year!

Another check: Taking the cash flow difference between AEON’s Q4FY2021 and Q3FY2021, I calculate that AEON generated operating cash flows (before capex, working capital changes and tax) of RM454.8 million for 4 quarters of FY2021 and RM269.9 million for 3 quarters of FY2021. Therefore, for Q4FY2021 alone, AEON generated operating cash flows of RM184.9 million, annualized to RM739.6 million. As I pointed out earlier, this Q4FY2021 was exceptional due to “revenge” spending, hence the retails sales should be lower in subsequent quarters. Hence I think the projected operating cash flows of RM618 million for 2022 is reasonable. ].

AEON to Inject all AEON Malls into a REIT

To improve on its capital management and tax structure, AEON Bhd will inject all its malls into a new Real Estate Investment Trust (REIT). The benefits of injecting them into a REIT are as follow:

• To monetize part of its investments in these assets by properly re-valuing them in a REIT structure
• To raise funds to pare down borrowings and save interest costs
• To enjoy tax savings as REITs do not need to pay tax as long as they distribute over 90% profits as dividends
• To get rid of the huge non-cash depreciation charge associated to property management services (RM320-340 million a year) by shifting the mall assets into the REIT as a Real Estate Investment Trust does not need to depreciate the real estates it owns, hence improving profits substantially and enabling declaration of much higher dividends
• To recycle capitals which have been poured into building these shopping malls in past 10-20 years to enable future expansions
• To reward long term shareholders with special dividends and much higher dividends after structuring into a lean REIT structure

Malaysia big REITs are trading at a dividend yield of about 5.0% (eg. IGB REIT at 4.8%, Pavilion REIT at 5.3%). If AEON Bhd injected all its malls into a new REIT, call it AEON REIT, it would be able to raise funds from IPO to pare down existing net debt of RM458 million and hence interest costs for AEON REIT would be zero, and tax payment would be zero if it paid out over 90% of income as dividends. Hence, AEON would save on interest expenses of RM22m a year, which would increase its operating cash flow from RM472m to RM494 million a year. REIT would be able to distribute about RM494 million or close to RM500 million as dividends every year. Using a 5% dividend yield as a benchmark, AEON REIT would potentially be worth RM500m / 5% = RM10.0 billion.

Assuming AEON Bhd sold a 30-49% stake in an IPO of AEON REIT, it would raise cash of RM10 bn x 30-49%% = RM3.0 billion to RM4.9 billion and maintain 51%-70% majority control over AEON REIT. If it pared down some of its debts by say RM200 million, AEON Bhd would still have a hefty cash of RM2.8 billion to RM 4.7 billion or RM2.00 to RM3.36 per share for special dividend to AEON Bhd shareholders!

Better Capital Management after listing of AEON REIT

Once the AEON malls are to be injected into a REIT, then the bulk of the borrowings could be pushed down to AEON REIT or would be pared down using the cash proceeds from the REIT IPO. For future mall development, AEON could build it with a combination of equity and debts. Once any new AEON mall is completed and starts producing steady rental income, the new AEON mall could be injected into AEON REIT for a combination of cash and new shares in REIT. AEON Bhd could then pare down its borrowings used to build the new mall. This way, AEON Bhd would not be saddled with high debts every time it builds a new mall and AEON REIT would get bigger over time.

AEON Bhd could then recycle its capital once every new mall is injected into AEON REIT and focus on expanding its supermarket and retails business supported by steady dividend payouts from AEON REIT. If AEON Bhd were to maintain 70% stake in AEON REIT, it would still be getting dividend payouts of RM350 million every year for its retails expansion and dividend payouts. Plus the operating cash flows of about RM146 million from its retails / supermarket segment, AEON Bhd would have about RM500 million of annual cash flows for future expansion and dividend payouts. Every year, it could use RM100 million of such cash flows for a new mall development (coupled with RM200 million of borrowings) that typically requires capex of about RM300 million and would still have RM400 million of free cash flows for dividend payouts or 28 sen per share!

The benefits of injecting AEON malls into a new REIT are so obvious but why AEON Bhd has not done it yet? I think AEON management has been very patient in waiting for the right time to do it and the right time may be within this year for the reasons below:

• AEON has developed many new shopping malls in past 9 years since 2013 so it has a sizable portfolio now with 28 shopping malls. Its EBITDA increased from RM484 million in FY2013 to RM725 million in FY2021, a good 50% increase so AEON could raise more funds from injecting them into a REIT now

• Due to Covid-19 pandemic, the retails segment of AEON had been severely affected in the past 2 years. Now with the pandemic largely under control and almost all economic sectors reopened, all AEON malls are seeing rebounds in retails footfall and enjoying high tenancy. AEON no longer needs to provide rental subsidies to retailers in its malls and cash flows from the property management services can get back to RM500 million level

• REITs tend to command higher valuation in low interest rate environments and Malaysia interest rates are still near decades low (despite the latest hike of 0.25% of OPR by Bank Negara on 11^th May 2022). With Malaysia inflation rates under control at  around 2% levels (compared to 8.2% in the US), Bank Negara would not need to raise interest rates aggressively but may need to do so if inflation creeps up from 2023. So it is now an opportune time for AEON to do a REIT listing and still can get a good valuation at around 5% dividend yield or RM10 billion valuation for AEON REIT.

How much is AEON Bhd worth?

(i) Sum-of-Parts Valuation

If AEON Bhd injected all its shopping malls into a REIT, then I would value it as the sum of two parts:

(ii) Cash Flow Valuation

Based on projections above, AEON Bhd would have annual free cash flows of RM618 million or 44 sen per share. This assumes no future mall expansion nor improvement capex for simplicity in order to evaluate the amount of free cash flows every year in steady states.

Using a 7% free cash flow yield, AEON Bhd would be worth RM618m/7% = RM8.83 billion or RM6.29 per share.

At current structure without a REIT listing, AEON Bhd’s ability to declare dividends will be restricted by a low net profit level (reduced by high depreciation charges and tax) of around RM200 million (annualized from Q4FY2021 net profit of RM70.984 million and Q1FY2022 net profit of RM28.1m). If we assume a 100% dividend payout rate, then potential dividend may be max at 15 sen only and AEON should be valued at best RM3.00 at 5% dividend yield.

Summary

In summary, injecting the malls into a REIT will increase cash flows by over RM120 million a year (from reducing tax and interest payments to zero) and raise AEON’s valuation by RM7.87 billion over cashflow valuation at current corporate structure.

The existing market capitalization of AEON Bhd is just RM2.1 billion. By injecting all its malls into a new REIT, AEON will become a retails cum property giant with total market capitalization of RM12.1 billion, adding shareholders’ value by a whopping RM10 billion or RM7.00 per share! AEON's retailing business is already worth RM2.1 billion, that is the same of current market capitalisation, when AEON injects its malls into a REIT, AEON shareholders will get free REIT shares worth RM10 billion or RM7.00 per share!

It is now an opportune time for AEON Bhd to do a REIT listing for its sizable portfolio, retails segment rebounding well from the pandemic and low interest rate environment. I believe the highly effective management of AEON will pull the trigger within this year or may already have something on the table.