We came away feeling optimistic from a meeting with the management of Padini Holdings Berhad as we believe their stores rationalization strategy and regional expansion should sustain earnings momentum. Maintain OUTPERFORM with a higher Target Price of RM4.80 based on higher PER of 14x against FY18 EPS in line with +1.0 SD of its 5-year mean to better reflect Padini’s potential growth via regional expansion (from, RM4.60, previously).

Closing of underperforming stores to boost margins. FY17 recorded the highest revenue and core net profit since IPO at RM1.5bn and RM180.6m, respectively, with higher net profit margin at 12% (+0.9ppt), attributed to its stores rationalisation program, which saw: (i) the closing down of 22 underperforming stores, and (ii) opening of 6 Padini Concept Stores, 7 Brands Outlet Stores, 1 free-standing stores and 8 new franchise/dealers stores. In particular, the closing of the underperforming stores boosted the core net margin to double-digit growth starting FY16 at 11% (+2.4ppt) with total stores decreased to 241 stores from 326 stores in FY15. As of 30th June 2017, Padini has an unchanged number of stores at 241 stores. For FY18, Padini will continue to focus on opening of stores with 12 new in-house stores in plan for FY18 (6 Padini Concept Stores and 6 Brands Outlets Stores). However, currently there is no plan to close down stores. As of October 2017, Padini has opened 4 new stores with estimated CAPEX of RM1m to RM3m per store with an expected breakeven period of less than 2 years.

Shifting imports for favourable cost. Padini’s products are mostly imported from China (>90%) and with the recent rising cost of production, as well as the weakening MYR against RMB, Padini’s gross profit margin was reduced to 39.4% in FY17. Moving forwards, Padini is looking to return to the comfortable level of 40% level in gross profit margin with new production diversification of 70% from China, 25% from Malaysia and 5% from other countries (e.g. Bangladesh, India, Cambodia and Korea).

Cambodia as a pioneer for regional expansion. As of 30th June 2017, Padini has 59 foreign outlets managed as a franchise and dealership under the Vincci Label which contributed 4% of revenue. With the strong brand base built over the years, Padini has selected Phnom Penh, Cambodia for its first in-house outlets venture with three new stores opening in FY18 under Padini Concept and Brands Outlets stores with total CAPEX allocated at RM20m and expected breakeven period of 2 years. Cambodia was chosen as its first regional venture attributed to its attractive benefits such as; (i) Cambodia does not have capital control, (ii) leniency in regulation for 100% foreign shareholding, and (iii) potentially lower corporate tax rate of c.20% vs domestic of c.26%. No material impact is expected for FY18 and FY19.

Flying high above headwinds. We are positive on the strong set of results that was achieved despite weak consumer sentiment throughout the year. We believe Padini has adopted the right strategy in focusing on the valuefor-money segment in Brands Outlets while the business restructuring in Vincci and Seed has also born fruits. Moving forward, we expect the earnings momentum to be sustained, underpinned by the strong brand profile of Padini and the continuous expansion in new stores.

Maintain OUTPERFORM call with a higher Target Price of RM4.80 based on higher PER of 14x against FY18E EPS in line with +1.0 SD of its 5-year mean to better reflect Padini’s potential growth via regional expansion (from RM4.60, previously based on PER of 13.4x against FY18E EPS). The share price had risen 36% since we upgrade our call to OUTPERFORM and we believe the dividend yield of 3.8% on the back of sturdy balance sheet, and strong operating cash flow should continue to provide support to the share price. Key risks include lower-than-expected stores opening and lower-than- expected same-stores-sales growth.

Source: Kenanga Research - 27 Oct 2017