We came back from visiting Parkson Holdings feeling cautiously optimistic that its plans to rejuvenate flagging profitability across operating markets particularly China (under 52.1%-owned Parkson Retail Group (PRG) listed in Hong Kong Stock Exchange) which accounts for c.70% of earnings would mildly improve subsequent quarters’ performance. The stage is set for Parkson Retail Group’s earnings to slowly recover backed by our expectations of improving QoQ same-store-sales growth (SSSG) and margin uplift from a proactive store rationalisation/optimisation plan, including closure of non-profitable stores as well as faster-than-expected stores turnaround. Standing testimony to the increasingly strong (or perceived to be strong) sequential recovery in Parkson Retail Group; some analysts surveyed by Bloomberg consensus have turned more positive and upgraded the stock to a Buy. By the same token, we attached a higher target price for PRG into our sum-of-parts valuation. Correspondingly, we upgrade our Parkson Holdings recommendation from Underperform to Market Perform and TP to RM3.12.

Strategy to revive flagging Parkson China stores. Plans are already underway to revive the flagging fortunes of Parkson China, including: (i) consolidation of its portfolio of stores in China, and (ii) improving merchandising mix via brand collaboration. The Group has been revamping and remodeling its existing flagship stores as part of the continuous effort to enhance store image and improve productivity. Such strategy has been generally successful with the majority of flagship stores showing noticeable improvement in performance thereafter. During the period under review, the major remodelling program of its Shanghai flagship store was fully completed with the completion of major renovation last year and followed by the façade upgrading works, which were completed in 1H2014. Looking ahead, Parkson China will continue to make necessary upgrade and revamp to other flagship stores in order to enhance the store’s competitiveness in the highly competitive and fast changing market. Elsewhere, in 1HCY14, a new store in Zhongshan with a gross floor area of approximately 22,000 square meters was opened. In a bid to rationalize its store portfolio, the Group has closed two underperforming stores namely Jinan Store and Changzhou Second Store, while the operation of Beijing Metro City Store is temporarily ceased due to an impending restructuring process. As at 30 June 2014, the Group operates and manages 57 stores across 37 major cities in China, with a total gross floor area of approximately 2 million square meters. The strategy is to focus on opening bigger new stores in the nearby cities of which they are currently operating in order to better utilize the Group’s advantageous position.

China narrowing SSS growth in 2QCY14 indicating worst is over. The just concluded 2QCY14 results of Parkson China shows an indication of potential better outlook ahead in terms of SSS growth. Despite remaining in negative territory, 2QCY14 SSS growth saw narrowing sequential SSSG rate. Specifically, excluding the impact from gold and jewelry products, the SSSG decline was narrowed from 7.3% in 1QCY14 to 5.5% in 2QCY14. Due to the change in merchandise mix and the Group’s continuous effort in monitoring the stores’ marketing and promotional activities, the Group’s overall merchandise gross margin increased by 0.4% to 17.8% in 1H2014.

Turnaround of five new stores bearing fruit and expected to continue showing improvement going forward. YTD 1HCY14, there is a total of 20 lossmaking stores of which one is expected to be closed this year (total closed is 3 with 2 closed in 1HCY14). Five stores which were opened during the last three to five years, especially Tianshan, Kunshen, Nanning (opened 2 years ago) and also Zhangjiakou stores have turned around. The Changshu Store that was opened last year has turned into a profit-making store in the early CY14 which has only been in operation for <1 year. In total, losses in the five stores estimated to be RMB30m in CY13 (equivalent RM15m). Since these five stores are beyond the gestation period and considered to be moving into the matured stage, there is potential for margin improvement coming from savings in less promotional activities.

Maiden collaboration with Mango and seeking collaboration with other brands. In line with the initiative to build a successful brand portfolio that complements its departmental store business, the Group launched its maiden series of brand collaboration with Mango, an established international fashion group, with the opening of its first Mango flagship store in Shanghai in June CY14, together with the takeover of the Mango outlets in a few cities in China. The target is to open 6 outlets in the next six to twelve months and thereafter to increase to as many as 20 outlets depending on on-going negotiations with the Mango Group (Orginated from SPpain and part of the Inditex Group). Looking ahead, the group is constantly exploring and leveraging on its widespread network across China for potential collaborations with international renowned brands on exclusive basis to introduce new and distinctive brands to its customers with the latest range of products in order to enhance the competitiveness of the departmental store operations. As stipulated in the agreement with Mango, Parkson only pays the licensing fees.

Cost savings explained. We understand that cost saving in PRG is due to following items: - (i) at the staff cost level, there was a decline by about 4.6% mainly due to the absence of the share options expense of about RMB11.2m that was recorded in 1H13, (ii) savings on the advertising and marketing costs by about > RMB20m in 1H14 due to a migration to the digital marketing platform. PRG owns eight properties in China that are sitting on leasehold land. Out of the 8-owned properties, two malls – Tianjin 2 and Qingdao – are under construction and expected to be operational by end-2015. We understand that some of these self-owned properties are lossmaking. As such there is a possibility of a divestment. Nonetheless, PHB plans to build stand-alone shopping malls and lease out the NLA to improve margins in key operating markets given the rental increases for its existing leases. This move is seen as an alternative source of revenue for PHB to bump up its gross margins given the tough operating environment and higher operating costs.

Parkson’s China SSSG is at lowest point and we expect mild recovery in subsequent quarters. The recent quarterly results of 4Q14 could have marked the lowest QoQ SSS growth decline in the China market after several quarters of decline. We forecast China’s SSSG to recover from its historical low and see sequential improvement emanating from: (i) margin recovery from consolidation of its portfolio of stores in China, (ii) improving merchandising mix via brand collaboration, and (iii) faster-than-expected turnaround of its stores as well as ramp-up of newer stores. We forecast China’s SSSG to be -3% to -2% in FY15 (FY14: -7%) and recover to +1% in FY16E.

Revival in China GDP growth augers well for Parkson China. We expect the stronger-than-expected 2QCY14 GDP growth in China to directly benefit the fortunes of Parkson China. Data earlier this month showed that China's economic growth quickened to +7.5% YoY in 2QCY14 as a raft of stimulus measures helped lift the pace from an 18-month low of 7.4% in 1QCY14. Separately, other positive indicators include China’s retail sales clothing sales which surged by 12% YoY in the month of July, the most since September 2013. More importantly the Chinese consumer confidence rebounded for a second consecutive month in July on a month-on-month basis amid an upward trend for economic growth. The Bankcard Consumer Confidence Index (BCCI), compiled by Xinhua News Agency and China UnionPay, a national bank card association, edged up 0.06 point from June to 85.33 points in July. A higher reading in the index shows a boost in consumers' desire to spend. A report released along with the index attributed the rebound mainly to rising consumption in tourism during the summer holiday and promotions by businesses. Last month, the spending of bank card users in hotels and plane tickets rose 13.05% and 34.29% from June, respectively, and spending on tickets for large tourist resorts soared 61.8%.

Outlook for 67.6%-owned Parkson Retail Asia, driven by Malaysia, but growth coming from Indonesia and offset weaker performances in Vietnam. In FY14, the flattish SSSG rates in Malaysia was impacted by inflationary pressure arising from the government’s implementation of subsidy rationalization programmes and the central bank’s tightening measures to curb household debt. There was also some drag to the performance of the Malaysia operations in 4QFY14 due to the reduction in Chinese tourist arrivals into Malaysia. Going forward into FY15, the implementation of the GST hike next year in 2015 could se a spike up in consumer spending pre-GST, which is likely to contribute to FY15 results. In Malaysia, there are three stores expected to open namely in (Kota Kinabalu), IOI City Mall (Putrajaya) and Perda City Mall (Seberang Prai). As such we project a SSSG of +2% and +1% respectively in FY15 and FY16.

Note that Malaysia accounts for c.30% of group’s earnings. In Vietnam, discretionary retail spending remained weak despite signs of economic stability. Sales at stores in Hanoi were especially affected by the significant increase in new retail space amid a weak retail environment. The Vietnam operations for the final 4Q14 were also affected by negative consumer sentiment arising from the fallout of the China-Vietnam dispute and the resulting reduction of Chinese tourist arrivals into Vietnam. Going forward, the Group intends to focus its efforts on marketing and promotion activities for its stores in Ho Chi Minh. For the Group’s Hanoi stores, it intends to lease out part of the store space and improve store layout and offerings to attract consumer traffic. The consumer spending potential in Vietnam remains intact as the country’s economy restructures for longterm growth. Vietnam will see two new stores opening this year in Vinh Trung (Danang) and Lemang (Ho Chi Minh City). Due to the softer conditions in Vietnam, we project SSSG of -5% and -4% in FY15 and FY16, respectively. We are not perturbed by Vietnam considering that earnings contribution to the Group is only <10%.

The strong SSSG rate for Indonesia was due to strong consumer sentiment. Centro and Parkson Indonesia as well as its store in Bali especially benefitted from increased tourist arrivals driven by the weak currency and improved flight connectivity. It remained the sole bright spot to deliver a SSSG rate of 6%. The opening of the Parkson stores in Jakarta and Medan marks the Group’s expansion of the Parkson brand into Indonesia. The group expects to open 4-5 stores in Indonesia each year to capitalise on the growing middle-class population and rising consumer spending in Indonesia. Indonesia growth is expected to remain buoyant, backed by the strong domestic consumption trend and the growing middle-to-upper class. We project Indonesia’s SSSG of 7% in both FY15 and FY16.

RM110m gains from proposed divestment of Festival City Mall. In an announcement to Bursa Malaysia, Parkson Holdings Berhad (Parkson) is divesting wholly-owned Festival City Sdn Bhd (FCSB) via a conditional sale and purchase agreement (SPA) with Festiva Mall Sdn Bhd (Festiva Mall or the Purchaser) and AsiaMalls Sdn Bhd (AsiaMalls or the Purchaser’s Guarantor), the holding company of Festiva Mall, for a total cash consideration of RM349m. Note that Festival City Mall is an asset parked under the holding company. AsiaMalls is a wholly-owned subsidiary of Pramerica Asia Retail Limited, one of the largest private open-end property funds in Asia. KL Festival City Mall is a 3-level shopping mall with a basement car park constructed on a piece of 99-year leasehold commercial land located along Jalan Genting Klang, Setapak, Kuala Lumpur with a remaining term of approximately 92 years. It has a total net lettable area of approximately 487,342 square feet with a current occupancy rate of c.99%. The divestment is expected to be completed by 2H14. The financial impacts of the sale on Parkson are follows :

- Parkson’s estimated exit PER works out to 29x based on KL Festival City Mall FY13 net profit of RM12m,

- Parkson will recognise an exceptional gain of RM110m or 10 sen/share which would increase its NTA by 9% from RM1.16 to RM1.26 as at 30 June 2014,

- Neutral impact to our earnings forecast for Parkson as Festival City Mall only contributes 4% to FY14E net profit estimate, and _ proceeds from disposal is expected to be utilised for: (i) investments including acquisition, development and management of retail malls (RM200m), and (ii) working capital and expenses related to the proposed disposal (RM149m).

Upgrade to Market Perform and raise Target price to RM3.12. Standing testimony to the increasingly strong (or perceived to be strong) sequential recovery in Parkson Retail Group, some analysts surveyed by Bloomberg consensus have turned more positive and upgraded the stock to Buy. By the same token, we attached a higher target price for PRG into our sum-of-parts valuation. Correspondingly, we upgrade our Parkson Holdings recommendation from Underperform to Market Perform and TP to RM3.12 from RM2.51. We impute higher target price for Hong Kong listed Parkson Retail Group Limited on the back of consensus upgrade. While we are cautiously optimistic, the worst is over for Parkson China, operating conditions could still be challenging. Key risks to our forecasts includes: (i) higher-than-expected slowdown in markets across PHB’s operating countries, and (ii) longer-than-expected gestation period

of stores in China. Valuation appears undemanding; PRG is currently trading at trough valuations of which the market has already priced in a multi-year low since 2009. PRG is presently trading at 15.6x consensus FY15 EPS or 40% below its 6-year historical mean of 24x of which we believe the price has already factored in the weaknesses of PRG’s operations. Similarly, Parkson Holdings is trading at trough PER valuations of 14x PER compared to historical average of 19x.

Source: Kenanga