Period  2Q14/1H14

Actual vs. Expectations The 1H14 reported net profit of RM56.3m (-57.7% YoY) came in below expectations, accounting for only 20% and 28% of our estimate and consensus full-year forecasts, respectively. However, stripping out provision for penalty for early termination of lease contracts for stores in China with potential closure amounting to approximately RM46m, core 1H14 net profit came in at RM102.3m (-23% YoY) or 37% of our full-year net profit forecast. The negative variance from our forecast was due to lower-than expected same-store-sales growth (SSSG) in China.

Dividends  No dividend was declared during the quarter.

Key Results Highlights  YoY, 2Q14 registered net profit of RM25.6m (-16.8% QoQ, -65.5% YoY) backed by RM948m in revenue (+4% YoY, +14% QoQ). Operationally, 2Q14 gross sales proceeds (GSP) grew 6% YoY to RM3.2b driven by same-store-sales growth (SSSG) for Malaysia (+0.2%), Indonesia (+7.3%) and China (22% growth in store gross floor area (GFA) to 1.99m sqm where it acquired 4 stores and opened 6 new stores but partly offset by a 2% SSSG decline which more than offset lower Vietnam (-2.7%).

 The weak SSSG rates for Malaysia was due to: (i) the worst flood situation in the east coast of Peninsula Malaysia, specifically affecting two stores in the town of Kuantan, Pahang, and (ii) the tuberculosis scare in the town of Kota Kinabalu, Sabah reducing the footfall in their two stores there.

 In Vietnam, the stores in the south (Ho Chi Minh City) registered positive SSSG for the quarter. However, the northern stores (Hanoi and Hai Phong) recorded negative SSSG, with the overall Vietnam SSSG in Q214 declining 2.7%.

 The SSSG rate for Indonesia showed sequential improvement from +3.9% in 1Q14 to +7.3% in the current quarter. Discretionary retail spending continues to grow in the Indonesian operations despite consumer sentiment being affected by inflationary pressure from the previous quarter’s significant hike in the price of subsidised fuel and the weakened Rupiah. Excluding a one-off provisions for stores closures amounting to RM46m, core 2Q14 net profit came in at RM71.6m (+33% QoQ; +4% YoY).

 For 1H14 YTD, revenue rose 2% YoY, driven by YTD SSSG rates for Malaysia (0.1%) and Indonesia (5.8%) but negated by China (-5.0%) and Vietnam (-2.0%). Despite the small increase in turnover, 1H14 reported net profit fell by 58% due to: (i) one-off provisions for store closures in China approximately RM46m (ii) start-up losses from new stores in Indonesia and China, (iii) China stores affected by subway construction as well as temporary closure of the Shanghai flagship store from May 2013 to September 2013 for major re-modelling, (iv) higher promotion expenditure incurred due to weaker market conditions and intense competition, and (v) exacerbated by a higher effective tax rate due to offshore interest expense, which is not tax deductible.

Outlook  Looking ahead, we expect Parkson to continue facing a tough operating environment on the back of the weak consumer sentiment due to the economic slowdown, particularly in the China market, which contributes the crux of its earnings. Coupled with the intense competition from online shopping and oversupply of retail space, we believe it is difficult for Parkson to reverse its SSSG declining trend given that its stores have reached maturity.

Change to Forecasts    We are downgrading both our FY14 and FY15 net profit forecasts by 11% to take into account the lower SSSG for China from 1% to -3% and higher effective tax rate assumptions.

Rating  The stock is down 25% since our downgrade to Underperform in the previous quarter. We are cutting our target

price from RM2.97 to RM2.79 as we impute consensus latest target prices for both its listed operating units (Hong Kong listed Parkson Retail Group Limited and Singapore listed Parkson Retail Asia Limited) which have been downgraded recently. At the current market price, the stock offers a total return of 3.0%. As such, we upgrade our Underperform call to Market Perform.

Risks to Our Call  A stronger-than-expected economic recovery in China.

Source: Kenanga