3Q results were mixed. The retail companies under our coverage (AEON, Amway, Eng Kah and Parkson) reported a set of mixed results. The aggregated revenue increased by 7.2% QoQ and 8.5% YoY due to several factors: 1) higher  sales during the festive season (Hari Raya) and new stores opening by AEON; 2) higher distributor productivity driven by sales and marketing programs by Amway and 3) a favourable product mix in Eng Kah. Meanwhile, Parkson reported a pretty flat sales number with its SEA revenue cushioning the slight drop in its China revenue.

However, the aggregated earnings dropped 2.6% QoQ and 16.1% YoY due to a previous oneoff insurance claim in the previous quarter from a  fire incident by AEON, a higher cost occurred by Amway and a higher tax rate in Parkson. Meanwhile, Eng Kah saw its best quarter to date due to lower additional costs incurred for new products. 

Watch out for the risks. Unavoidable, retailers will be affected by the uncertainties in the global economy and the slowdown in the purchasing power of consumers. However, there are also other key downside risks such as a higher advertising and promotional budget and pricing competitiveness could further lower their earnings. 

Mixed valuations.We are using the Price-to-Earnings (PER) methodology as our primary valuation model as retail companies have been consistently profitable over the years albeit suffering some ups and downs. 

Currently, AEON is trading at a +2SD from its 5-year mean PER. This is at its historical high and hence poses some risks to its valuation. We believe that the valuation of the company could have stretched at the current stage and we see potential downside risk in its share price. Meanwhile, Amway is trading at a +1.25SD level from its 5-year average. Based on its historical PER band, it traded at its highest point two months ago at the +2SD level. Parkson, on the other hand, is trading near the -1SD level from its 5-year average (its lowest level of -2SD occurred in 2008) due to the slowdown in China, where it has a large exposure. For small cap retailer Eng Kah, it is currently trading at its 5-year PER average (with the highest level of +2SD in 2009 and the lowest level of -1SD in 2010).

MAINTAIN Neutral.  Due to the slowdown in the global economy especially in China and India as well as the weak consumer spending, we are cautious on the outlook for the retail sector. Coupled with its high valuation, we believe that there could be further downside risks to the sector if the global economic weakness persists. We are maintaining a NEUTRAL rating on the Retail sector.

Source: Kenanga