1Q18 CNP of RM8.8m (+9%) came in below our/consensus expectations at 15%/16% of full-year estimates due to the lower-than-expected sales and higher-than-expected operating expenses. As such, we cut our FY18E/FY19E CNP by 16%/14%. Downgrade from OUTPERFORM to MARKET PERFORM with a lower TP of RM1.55 based on the revised FY19E price-multiple blended valuation (from RM1.70 based on FY18E price-multiple blended valuation).

1Q18 below expectations. 1Q18 CNP of RM8.8m (+9%) came in below our/consensus expectations at 15%/16% of full-year estimates due to the lower-than-expected sales and higher-than-expected operating expenses. No dividend was declared, as expected.

YoY, 1Q18 revenue increased by 3% driven by the new sales contribution of 10 new stores and supported by the existing stores (total of 2,235 stores as at 31st March 2018). Gross profit grew higher than revenue, by 7% as gross profit margin expanded by 1.3ppt to 31.9% from 30.6% in 1Q18, attributed to the improved merchandise mix, especially by the overall growth in all food and beverage categories. Additionally, other operating income was higher by 3% arising from the increase in marketing income and compensation income from vendors. Nonetheless, operating expenses allocation was higher at 35% (1Q17:30%) mainly due to new store expansion resulting in high rental cost, utility cost, store depreciation and maintenance expenses, which constrained margin expansion at the PBT level to only 0.1ppt to 2.2% from 2.1% in 1Q17. On the other hand, CNP grew slower than PBT by 9% due to the higher effective tax rate at 27.2% (1Q17: 26.6%).

QoQ, 1Q18 revenue declined by 2% due to the seasonally stronger long period of school holidays in 4Q17. Furthermore, PBT plunged by 59% from the lower other income (-25%) as vendors improved their efficiency in meeting the group's products demand, which lead to the lower compensation income and further weakened by the higher operating expenses allocation at 35% (4Q17:34%). Nonetheless, net profit fell slower by 45% cushioned by the lower effective tax rate of 27.2% (4Q17:36.7%).

Outlook. With the zero-rated GST starting 1st June 2018, SEM, which had previously absorbed GST into their respective merchandising prices, may lower its selling prices for all its products to enable consumer to purchase in a larger volume. 7-Eleven is targeting to open at least c.150 new outlets for FY18 (currently at 2,235 stores as at 31st March 2018). Besides stores expansion, the group has been working towards an overhaul in its stores operation and end-to-end supply chain operations. However, we believe that this move will take a longer time to achieve depending on the current pace. The group has been facing stiff competition from new players which are revolutionizing the high-margin fresh-food space.

Cut FY18-19E CNP by 16-14%. We cut FY18E and FY19E earnings by 16% and 14%, respectively, to take account the lower-than-expected sales and higher-than-expected operating expenses.

Downgrade from OUTPERFORM to MARKET PERFORM with a lower TP of RM1.55 based on the revised FY19E price-multiple blended valuation (from RM1.70 based on FY18E price-multiple blended valuation). Our current TP implies FY19E PER of 33x, which is close to the average of 3-year mean forward PER (please refer to overleaf for details on the P/E multiple valuation).

Risks to our call include: (i) lower-than-expected sales, and (ii) higher- than-expected operating expenses.

Source: Kenanga Research - 25 May 2018