Best Recovery Play

AEON Bhd is one of the best recovery plays in Bursa as Malaysia rebounds from Covid-19 pandemic. At current share prices, AEON offers limited downside but huge upside potentials. AEON Bhd should be worth at least RM3.36 (+120% upside) based on 5% dividend yield to RM5.25 (+250% upside) based on 7% cashflow yield in its current form with twin income drivers from retailing / supermarket segment and property management segment.

To save income tax and improve net profit level to over RM500 million level, AEON will inject its shopping malls into a new Real Estate Investment Trust (REIT) listing. Sum-of-parts valuation will go up RM8.60 per share (+566% upside) and AEON Bhd shareholders may expect a dividend windfall of RM3.00 per share.

Main reasons as best recovery play are as follow:

1. AEON is in a strong position to capture the strong consumer spending rebounds after pandemic lockdown. The government has in early 2022 allowed cash handouts such as special Duit Raya of RM500-1000 to civil servants,  special EPF withdrawals that will inject RM40 billion into households’ spending and various incentives to teenagers, consumer spending is set to rebound to pre-pandemic level soon.

2. AEON is the largest shopping mall owner with a total of 28 shopping malls across the country and total 13.4 million sf of retails lettable space. Retails footfall has come back to almost pre-pandemic levels and retailers are coming back to take up retails space in AEON malls. AEON has enjoyed increasing occupancy rates above 92% in 2021 from below 90% in 2020.

3. AEON had total assets of RM5.7 billion with PPE (Property, plant & equipment) alone of RM3.06 billion already higher than its market capitalization of RM2.1 billion.  Many of its shopping malls were built 15-20 years ago and are still carried at a low book value. If these malls were to be re-valued to today construction costs, it would add at least RM1.3 billion to AEON asset value.

4. AEON has resilient business models –

(i) its property management services segment enjoys certain consumer monopoly as most of its shopping malls are located in residential communities and enjoy strong community support in terms of local supplies and consumer spending, hence enjoying high occupancy rates;

(ii) its retailing and supermarket segment is inflation proof as it has strong bargaining power over supplies and it has very low imported contents (<3%).

5. There is a real possibility that AEON Bhd will inject all its shopping malls into a new REIT (Real Estate Investment Trust) listing to save income tax and to unlock asset value. When it implements this corporate exercise, there is a potential windfall dividend of about RM3.00 per share to be rewarded to AEON shareholders.

For more details on the AEON business segments, financials, potential REIT listing and special dividend, please refer to my earlier article:

https://klse.i3investor.com/web/blog/detail/dragon328/2022-05-20-story-h1623331448-AEON_Bhd_is_rewarding_shareholders_with_Free_REIT_shares_worth_RM7_00_p

While the benefits of injecting its malls into a REIT are huge, AEON Bhd may have its own considerations in terms of timing to carry it out. It may want to wait for the Covid-19 pandemic to be completely over towards year end so that the retail tenancy in its malls will not get disrupted again, or wait a little longer for another 1 or 2 new malls to be added to its portfolio for a bigger listing, or to wait for the tenancy rates (both in terms of occupancy rate and monthly rental rates) to improve further. Before that, let’s examine the potential of its retails business in the current form.

Upsides in Bricks-and-Mortar Retails Business

AEON Bhd has been embarking on various initiatives in the past 2 years to grow its retails business and to save operating costs, some of which have produced encouraging results:

1. Optimising Personalisation Approach – since the start of the pandemic, AEON has swiftly adjusted the product assortments across all its AEON malls and outlets to cater to the evolving changes in consumer pattern and behavior. By understanding custumers better and piercing together their needs, emotional cues and stages of life, AEON is able to better serve the targeted customer groups by giving customers exactly what they desire and improve affinity with AEON brand. AEON introduced the AEON Personal Shopper Program in March 2020 to provide personalized advice, guidance and concierge services to its customers. This service started within the grocery products and has since been expanded to include the Softline, Hardline and Wellness categories. For FY2021, sales from this segment grew 66% vs FY2020 with an average basket size of RM230 and serving 1.1 million customers since March 2020.

2. Driving Digitalisation - As part of the digital transformation journey, AEON have further accelerated expansion into integrated Online-Merge-Offline (OMO) digital platforms during FY2021. Building upon its collaboration with Boxed, AEON introduced the myAEON2go e-commerce platform in August 2021. Since its soft launch, myAEON2go has seen encouraging growth in sales in the fourth quarter of FY2021 as a result of the change in buying behaviour; which has evolved into greater acceptance of digital adoption and online shopping.

3. Diversification Within Retail - Learning from the success of the Personal Shopper programme, AEON continued to progress diversification into non-traditional retail channels and collaborated with Mamasab International Sdn Bhd (Mamasab), one of Malaysia’s largest dropshipping networks, focusing on baked goods and snacks. Through this collaboration, AEON developed a co-branded series of products to be sold by Mamasab agents throughout Malaysia. By allowing Mamasab agents to sell selected AEON products, the collaboration offered an additional income stream for dropshippers, including those whose incomes were affected by the pandemic. For AEON, this collaboration yielded positive results from the sale of more than a million sushi rolls, doughnuts, takoyaki and others, directly to customers all over Malaysia.

4. Building bonds with tenants - To help its tenant partners weather the impact of the pandemic, AEON’s Property Management Services took a longer-term view and implemented strategies to ensure that its tenant partners would be able to sustain their businesses. AEON shifted towards a variable rental structure to assist its tenant partners to manage the cost of paying higher fixed rental fees and as a result, tenant renewals increased about 85% in FY2021 vs only about 50% in FY2020. In addition, AEON organised targeted and thematic marketing initiatives to support its tenant partners, for example, during the month of August to celebrate the Mid-Autumn Festival and to commemorate National Day.

5. AEON Sayap Bagimu - In FY2021, AEON underwent a paradigm shift in our approach to sustainability, recognising that AEON have an immense platform to effect positive change among all its stakeholders. In conjunction with AEON’s 37th anniversary, the Company moved forward to spread its wings to become a bigger part of the lives of Malaysians. Through its sustainability initiative for the nation, AEON Sayap Bagimu, AEON engaged with the communities to navigate the challenges brought about by the new normal. The aspiration for AEON Sayap Bagimu is based on the spirit of supporting one another to succeed together and to fly higher in creating better tomorrows. This is a sustainability initiative with plans to help improve the community’s access to health and education, reduce inequality and spur economic growth that is aligned with the objectives of the United Nations SDGs. True to the spirit of AEON Sayap Bagimu, AEON have recently announced a major initiative as it adjusted AEON’s minimum wage upwards to RM1,500 from RM1,200 a month in recognising that ther AEON People are the most important asset and who are critical for the long-term sustainability of the organisation. This change took effect from 1 January 2022, and it has benefitted 2,738 AEON People, indicating its commitment to prioritising the welfare of AEON People.

         6. AEON Member Plus Card - As of end 2021, AEON Member Plus (AMP), a membership programme AEON undertakes   together with AEON Credit Service (M) Berhad now has 2.2 million cardholders compared to 1.9 million in 2020. The main features of the AMP are points collection, special deals and free parking for the first two hours at any AEON Malls. The presence of AEON Stores in almost every state and the promotion of the loyalty programme, weekly and monthly promotions including e-vouchers has helped to boost the number of cardholders. The AMP can be utilised at all AEON outlets, AEON Wellness and AEON Maxvalu stores.

         7.   Saving Energy Consumption - To be more responsible in managing its consumption of electricity, AEON adopted best industry practices such as ensuring air-conditioning is set to an optimal temperature and only activating the air-conditioning during business hours. AEON have also reduced the number of lights switched on during non-business hours and increased the number of LED light fittings in its premises to conserve energy.

In 2021, AEON collaborated with Malakoff Radiance Sdn Bhd to install rooftop solar panels at AEON Taman Maluri Shopping Centre. The solar panels will generate approximately 2,797 MWh, contributing to 13% to 15% of the shopping centre’s electricity consumption. Through these energy saving measures practiced in 2021, AEON recorded savings of RM28.9 million. This is equivalent to lower usage of 32.7 million kWh and equates to a reduction in CO2 of 20,909 tonnes. Electricity consumption (kWh) is lower this year in comparison to 2020 due to prudent usage and lower usage by tenants during the COVID-19 pandemic.

The following table illustrates AEON's annual energy savings:

Energy Savings System 2021 (17 Malls)

Total Bill before Saving (RM)           Total Bill After Saving (RM)       Savings (RM)         %

                117,313,914                            88,406,153                              28,907,761              25

The table below shows the annual energy consumption at AEON’s 28 malls and six standalone stores:

Annual Electricity Consumption – 28 malls and six standalone stores (total 34)

Year     Total kWh (‘000)        Cost (RM million)       CO2 (tonnes)

2021    407,141                       148,606                       260,164

2020    439,863                       160,550                       281,073

2019    540,032                       197,112                       345,081

Kudos to AEON management, the energy saving effort has produced remarkable results. When AEON implements similar energy saving approaches to all its other shopping malls and outlets, it is reasonable to expect another 15% savings or RM22 million savings in energy costs per year, bringing total savings to over RM50 million every year from FY2021 level.

8.   Improving online sales multi-folds – Through its myAEON2go and other efforts, AEON has increased its online sales many folds in 2021 to RM28 million, which is 0.9% of its FY2021 retails revenue. In AEON Japan’s FY2021 presentation materials, AEON Japan achieved online sales of 3.3% of total retails revenue in FY2020, comparing to 10.2% in the US and 12.0% in China. It is projected that online sales will contribute 21.5% total sales in the US and 34.3% in China by 2025. AEON has plans to increase its online sales many folds in the next 4-5 years to catch up with the trend in the US and China. Assuming that AEON Bhd will increase its online sales proportion to 10% of total sales, then online sales revenue will increase 10 folds to RM300 million level.

9.   Smaller format stores expansion potential – There is huge potential in Malaysia for AEON to expand in its current shopping mall format and/or in a smaller store format like what Tesco in the UK and Coles in Australia have done. Coles is the largest supermarket chain in Australia with 807 stores across the country or 1502 stores if including Coles Express branded petrol stations. Its revenue topped AUD38 billion in 2019 with operating profit over AUD1.4 billion in 2018. Australia has smaller population (30m) than Malaysia (33m), yet allowing Coles to have 807 supermarket stores. If AEON adopted similar approach, it might have 300 or 500 stores across Malaysia in future from current 34 stores. It could see 10 folds increase in its revenue from currently RM3.5 billion a year to over RM30 billion p.a. like what Coles achieved in Australia.

10. Digital Bank boost – AEON Bhd’s sister company, AEON Credit has been awarded a new digital bank licence in early May 2022. This will boost the topline of AEON Credit as it rolls out more innovative credit products at more competitive pricing. Indirectly this will also boost sales of AEON Bhd especially the bigger budget items like motor cycles, furnitures and electrical appliances. With its strong 2.2 million AEON cardholders base, AEON Credit will be able to take advantage of this loyalty programme to offer more innovative financing options to boost AEON members’ consumer spending.

Through these various initiatives above, AEON Bhd should have no issue in improving its

retails sales from RM3,455 million in FY2020 by 10%-15% to RM4,000 million levels by

FY2025. I see retail segment margin to improve from 4.2% in FY2021 to close to 5.5% level

by FY2025 (Note retail segmental margin was strong at 10.3% in Q4FY201 and 7.1% in

Q1FY2022). Hence, there is a good chance that retailing segmental profit will improve to

RM220 million level by FY2025. All this assumes no new store expansion for next 3 years.

Projected Earnings to double up by FY2025

AEON property management services registered a segmental profit of RM229.6 million in FY2020 and I see a good chance for this to improve 8% to RM250 million level by FY2025 through removal of tenant subsidy, improved retails sales commission and revision of tenancy rates over the next 3 years.

Together with the projected RM200 million of retailing segmental profit above, AEON may well register a total EBIT of RM470 million by FY2025:

Cashflow Valuation

AEON’s cashflows will be stronger when we add back the non-cash depreciation and amortization charges (RM465m) and deduct lease liabilities payment (RM158.9m) to become RM236m + RM465m – RM158.9m = RM542 million or 38.6 sen per share.

I have in my earlier article projected an operating cashflows (before capex and tax) of RM618 million for FY2022. Deduct off 35% income tax, projected net profit for FY2022 will come to RM202 million, implying a total increase of 16.8% over 3 years from FY2022 to FY2025 which I deem achievable.

Using a 7% free cashflow yield valuation, AEON should be worth RM0.386/7% = RM5.25 per share. If using 5% dividend yield valuation, AEON should be worth RM0.168/5% = RM3.36 per share.

If AEON injects all its malls into a REIT, then it will be able to save most of the income tax as REITs do not pay tax as long as they distribute more than 90% earnings as dividends. It is expected to save some RM100 million in income tax every year for its property management service segment. Hence cash flow valuation will increase by RM1.03 per share to RM6.29 per share as what I derived in my earlier article. Based on sum-of-parts valuation, AEON should be worth RM8.60 per share once it injects its malls into a REIT.

Summary

AEON Bhd has weathered through the pandemic and emerged stronger. It is in a strong position to benefit from economy recovery and consumer spending rebounds. It is one of the best recovery play due to its resilient business models, widespreading shopping mall footprints and government incentives for consumer spending.

AEON Bhd has embarked on various initiatives to improve its retails business and to save operating costs. There is a good chance that AEON net profit may increase by 178% over next 3 years to RM236 million by FY2025. This can be achieved purely from improving retails margin through the various initiatives discussed above, cost cutting measures eg. energy cost saving efforts and improved tenancy rates in its malls without any new mall expansion.

When AEON Bhd injects all its malls into a REIT listing, it will save income tax of about RM100 million a year and remove RM350 million of depreciation & amortization charges from its profit lines, and cash flows will improve to over RM600 million a year. With the benefits so obvious, it is only natural for AEON to carry out this corporate exercise soon and AEON Bhd shareholders may expect a special dividend windfall of about RM3.00 per share.

The crowds are back to AEON Malls

Carpark full house at Sunday afternoon 22 May 2022 at Ipoh Station 18 AEON Mall

Long queue at sushi and Japanese food counter

Food court filled to the brim at 3.00pm Sunday 22 May 2022

Long queue at the bakery counter