MR DIY’s 9MFY22 earnings came in below expectations. YoY sales improved but margins eroded slightly on account of its strategic move to lock in prices in the first quarter, and on higher-than expected freight costs. We expect improvement in margins in the coming quarters due to price adjustments and easing freight costs but we are cautious on top-line performance on inflationary concerns. We cut our FY22F earnings by 9%, but lower our TP by a steeper 17% to RM2.00 as we now ascribe a lower forward PER of 28x (from 34x) to account for higher earnings risks. Maintain MARKET PERFORM.

Disappointing results. 9MFY22 PATAMI accounted for only 67% and 65% of our full-year forecast and full-year consensus estimate, respectively. We believe the variance against our forecast came largely from a higher operating expenditure in 3QFY22. DPS of 1.8 sen (implying a payout of 50%) is on track to meet our full-year forecast of 2.6 sen.

Results’ highlights. YoY, 9MFY22 top-line grew 22% to RM2.9b benefiting from the endemic phase and price increase (in the second quarter and third quarter). Average basket size was at RM28 (vs. our expectation of RM29). Likewise, gross profit (GP) grew 18% but margin saw 2ppt erosion on account of elevated inputs costs (coming from higher internal freight costs) and the company’s strategic move to keep prices low in the first three months of the year. Opex saw a 28% uptick on account of inflationary pressures.

Store expansion remained on track for 180 new stores for FY22 with 140 net stores added for 9MFY22 (95 in 1HFY22). Same-store-sales growth (SSSG) was flat at RM3.01m dragged by poor sales in 3QFY22 due the absence of festivities.

QoQ, 3QFY22 revenue fell 8% to RM966m while GP margin remained flat at 41% muted by higher inputs costs despite price increases. The absence of festivities and inflation saw SSSG declining by 13% despite the additional 45 new stores. Average basket size was at RM27 for the quarter.

The key takeaways from the results briefing are as follows:

1. Gross margin was impacted by both ex-China and internal freight costs (freight costs to East Malaysia). Ex-China freight costs reached its peak in Jan 2022 and have come down by 63% to RM5.7k/container. Given the lagging effect of 120-150 inventory days, full impact of declining costs expected to be seen in 1QFY23. Internal freight charges saw a 38% uptick since Jan 2022 to RM11k/container but had eased reaching its peak of RM12.1k/container in Jul 2022. These costs are charged to the P&L in the period the containers are shipped. The easing of freight charges is expected to improve GP margin by 1.5-2ppt by 1QFY23.

2. The company is investing in automated warehouse to support business growth while optimising operational efficiencies. This automation will enable the company to cater to 1,260 stores with a lower headcount of 5 catering to 10 stores vs. the present 12 catering to 10 stores. The capex is projected at RM100m with a payback of five years and expected to complete by end-2023. To date, it has spent RM6m with the remainder in the next 15 months.

3. It maintains its target to open another 180 new stores for FY23, comprising 125 MR DIY stores, 35 MR DIY Express and the remainder split between Mr Dollar and MR Toy. The MR DIY Express is expected to reduce opex as rental and labour costs will be comparatively cheaper.

Cautious for 2H. While we are positive on its store expansion for the remainder of FY22 and FY23, we remained cautious for its sales moving forward as inflationary pressures creep in. However, historically, festivities have proven to be MR DIY’s strong quarters and we expect 4Q to be so due to the year-end shopping season and festivities. With the adjustments in prices and easing of freight charges, we expect GP margin to remain stable at c.41% for the rest of the year.

Post results, FY22F earnings are cut by 9% as we reduced our basket size by RM1 to RM28. Although there is no change to our FY23F earnings, we have revised our assumptions as follows; (i) average basket size of RM28 (from RM29), (ii) 180 new stores (from 150), (iii) flattish SSSG (from 2% growth), and (iv) GP margin of 43% (from 42%).

Investment case. We like Mr DIY for: (i) its leading position in the home improvement market in Malaysia, (ii) its strong GP margin (c.40% vs. peers of 32%) given its strong bargaining position vs. suppliers and economies of scale arising from its size, and (iii) a strong balance sheet translating to war chest for expansion/higher dividends. However, with creeping inflationary pressure and the reopening of business, sales will be challenging as consumers will have wider and cheaper alternatives to MR DIY.

TP is lowered to RM2.00 (RM2.40 previously) as we ascribe a lower FY2F PER of 28x (from 34x) which is at a 5x multiple premium to the best forward PER of its regional peers of 23x (from 29x previously due to inflationary risks). The higher premium is based on the relatively still under-penetrated home improvement market in Malaysia, with approximately 216 home improvement stores per million capita (2019) vs. Thailand, Japan and Australia at 231, 236 and 405, respectively, according to Frost & Sullivan. The home improvement retail space in Malaysia is expected to chalk a CAGR of 22% (FY21-25) vs. ASEAN’s CAGR of 9% according to some market research. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4). Maintained at MARKET PERFORM.

Risks to our call include: (i) unfavourable forex trend, (ii) volatile supply and logistics, and (iii) high inflation eating into consumer spending power.

Source: Kenanga Research - 9 Nov 2022