We came away from a meeting with Padini CFO, Sharon Sung, feeling confident of better 2QFY20 performance on year-end Christmas, and early CNY shopping sprees, boosted by the new Disney-theme apparels line which improves gross profit margins given its higher pricing point compared to others brands, while, regional expansion in Indonesia could potentially be realised in the next 2-3 years. Reiterate OP with a TP of RM4.00 based on 15x FY20E EPS.

Expecting a better 2QFY20 performance. We expect Padini to report a better 2QFY20 (Oct - Dec 2019) on festivities sales (i.e. year-end, Christmas, and early CNY shopping spree), boosted by the new Disneytheme apparels line. Historically, 2QFY is the second strongest quarter for Padini, accounting for 30-35% of full-year earnings. Note that, the last 1QFY20 was weak (typically the weakest quarter is the 1QFY) due to the absence of festivities, which was worsened by the adverse impact of the maiden implementation of MFRS 16 (the impact which reduced PBT by RM4.8m in 1QFY20). However, its SSSG turned positive at +1% compared to 1QFY19 of nil.

Disney Apparel Line to improve gross profit margin. A 2-year collaboration with Disney which started in November 2019 to sell Disneytheme apparels is expected to improve gross profit (GP) margins with higher pricing points compared to other brands. Sales of these Disney lines have exceeded the target set by Disney itself within a short time frame and Padini expects to secure more Disney characters to diversify the collection. The Disney-theme apparels for the upcoming Hari Raya are already under production and are expected to sell well especially during the festivity promotion. Overall, this is in line with Padini’s strategy of targeting above its comfortable GP margin of 40%, together with maintaining the supply production diversification of 70% from China, 25% from Malaysia and 5% from other countries (e.g. Bangladesh, India, Cambodia and Korea). Note that Padini recorded GP margin of 40.5% in 1QFY20, better than FY19 average GP margin of 39.1%.

Regional expansion, Indonesia next? As of 30th June 2019, Padini has 40 foreign outlets managed as a franchise and dealership under the Vincci label which contributed less than 4% of group revenue, and Padini will continue to pare down its underperforming franchisees. 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 opened in FY18 (1 BO & 2 PADINI stores), and has taken over seven Vincci Stores in Thailand in FY19. From our observation, Indonesia accounted for the most footfalls among Padini stores, which could entice the group to select Indonesia as its next regional expansion target. The Indonesian Vincci franchisee agreement will expire in the next 2-3 years which may open up the possibilities of expansion there (currently, the franchisee owned 14 Vincci stores there). As of 30th October 2019, Padini has net cash position of RM446.0m, with capex of RM20m/year which should provide ample space for expansion.

Outlook. We like the stock for: (i) its resilient business model, focusing on the value-for-money segment through its Brands Outlet stores, and (ii) expected improvement in its SSSG and cost allocation. For FY20, the group will not be opening more than 10 outlets in the local market to streamline cost allocation. We understand that the new, slower expansion plan is to streamline the operational cost towards strategic locations, while expanding regionally through own-managed stores to strategically control the stores’ value which includes Cambodia (1 BO & 2 PADINI stores), and Thailand (7 Vincci stores).

Reiterate OP with a TP of RM4.00 based on 15x FY20E EPS (at +1.0 SD of its 5-year forward historical mean PER). Risks to our call include:

(i) lower-than-expected sales, and (ii) higher-than-expected operating expenses.

Source: Kenanga Research - 20 Jan 2020