To recap, Aeon’s 9M18 results missed expectations after failing to benefit strongly from the zero-rated GST period. Following our recent meeting with management, we turn less upbeat on Aeon’s prospects, foreseeing its business model to lose further favour. Maintain HOLD on Aeon with a lower TP of RM1.52.

SSSG Improvement Could Persist, But Margins Likely to Suffer

Aeon’s retail sales grew at a decent 6.8% yoy in 9M18 with contribution from new malls at Bandar Dato’ Onn (3Q17) and Kuching (2Q18), alongside a recovery in same-store sales growth (SSSG), which management has guided to have ranged between 1.5-2% in FY18. The turnaround in SSSG, subsequent to the three consecutive years of decline previously, came on the back of non-profitable store closures (AEON Mahkota Cheras and Index Living Mall stores), the brief tax holiday sales boost, as well as strong recovery in consumer confidence. We believe SSSG would eventually normalise but remain positive, driven by the improved sentiment, alongside higher disposable income for the average consumer from supportive Budget 2019 measures. Yet, facing intensified competition in the retail space, Aeon will likely contain ASP hikes for hardline and soft-line goods, despite rising product costs seen from certain suppliers. Prices for food-line items, which are regulated will also remain fixed. As a result, gross margins are expected to trend lower.

Mixed Performance Across Outlet Locations

On Aeon’s new outlets, we gather that the performances have been rather mixed, where AEON Shah Alam has fared well, while AEON Bandar Dato’ Onn’s performance is only mediocre. On the other hand, AEON Kuching and AEON Kota Bahru have been underperforming and are consequently expected to take longer to breakeven (around six years compared to 4 years typically). For the existing stores, management’s rationalisation exercise is still ongoing but we do not expect further store closures.

Property Segment Coming Under Heavy Pressure

While Aeon’s property management segment continued to record occupancy rates above 90%, we understand that management is facing heavy pressure to maintain those occupancy levels under unfavourable market conditions. For selected malls, management has begun shifting towards a higher variable rental portion while lowering fixed rental rates. While this should support take-up of rental spaces as well as customer footfall, it would also lead to heightened exposure to tenants’ sales under stiff competition alongside higher earnings volatility, in our view. Recall that the property management segment accounted for c.90% of EBIT in 9M18.

Expansion Plans Tapering Off

Following on, management is also looking to cut down on capex, indicating a more prudent stance on mall extensions and refurbishment works, aside from their target of opening one new mall annually. For FY19, nonmaintenance capex is guided to be approximately RM400m for the new Nilai mall opening, Taman Maluri mall extension, Bandar Utama Phase 2 as well as for store refurbishments.

Maintain HOLD With Lower TP of RM1.52

Given our view of stiffer competition in the retail space, as well as the revised rental structure towards revenue-sharing under challenging market conditions, we foresee more downside to Aeon’s earnings . We thus cut FY19-20E earnings by -12%/-13% respectively and maintain our HOLD recommendation, with a revised TP of RM1.52 based on a lower 19x 2019E PER (from 22x previously), pegged to 2SD below its 5-year historical mean. Aeon remains one of the safer picks for exposure to consumer stocks, however, given its wide range of offerings to the mass market. Upside/downside risks: i) higher/lower-than-expected retail traffic; and ii) lower/higher-than-expected start-up costs in new malls. This note marks a transfer in analyst coverage.

Source: Affin Hwang Research - 4 Jan 2019