We initiate coverage on 7-Eleven Malaysia with BUY and a TP of MYR2.00, representing a 19% potential upside return. Our TP is based on a 28x FY15F P/E multiple which is a 17% premium over its regionallylisted peers’ average P/E of 24x. We are positive on its well-planned growth strategy and promising outlook for the convenience store industry in Malaysia and estimate a 3-year earnings CAGR of 29.1%over 2013-2016F. 

- Leading convenience store chain in underpenetrated Malaysia. 7-Eleven Malaysia is the largest convenience store chain in Malaysia, with a dominant 82% market share through its 1,600 outlets nationwide. Its strong presence within the market has earned the company brand recognition and reputation. In our view the convenience store industry in Malaysia is the least penetrated sector in the region, and this should complement 7-Eleven Malaysia’s expansion plan. 

-  Aggressive expansion and refurbishment to drive revenue growth. We believe that the company’s revenue should improve in tandem with its network expansion plan – which is a net increase of 600 stores over the next three years. The company’s store renovation exercise maycontinue to improve customer experience and drive store traffic. We expect the company’s revenue to expand by a 3-year CAGR of 15.4% over 2013-2016F. 

-  Potential margin upside. Moving forward, we expect the company’s better product mix and higher commission revenue generated from instore services to continue improving its net margin from 3.1% currently. 

- Initiate coverage with BUY and MYR2.00 TP. We are upbeat on 7-Eleven Malaysia’s growth prospects and forecast a 3-year earnings CAGR of 29.1% for 2013-2016F, driven by its network store expansion, consistent same-store sales growth (SSSG) and better commission income generated from its in-store services. Our MYR2.00 TP is based on a 28x FY15F P/E, which is a 17% premium over its regionally-listed peers’ average P/E of 24x. We believe the premium reflects its stronger earnings growth and more exciting prospects compared with its peers. 

- Key risks: A potential slowdown in consumer sentiment. The company’s reliance on three suppliers which amount to 40% of total purchases.

Investment Case 

Leading convenience store chain in Malaysia.7-Eleven Malaysia is the sole operator of 7-Elevenconvenience stores in Malaysia, with a nationwide chain of 1,642 stores currently. Having commenced its business 30 years ago, the company has built a strong presence in the convenience store market in Malaysia over time. Its 82% market share shows its strong position and high brand awareness in the country.

Significant network advantage hard to replicate.We view 7-Eleven Malaysia’s robust store network as an advantage, placing the company ahead of its competitors. We believe it may be difficult for its peers to replicate a sales network of comparable size and scope to 7-Eleven Malaysia, as it will be costly and time-consuming. Topline growth driven by aggressive store expansion plan.Given Malaysia’s low convenience store penetration rate compared with other countries, the company plans to have a net increase of 600 stores over the next three years. We believe this plan should continue to boost its revenue, as evidenced by its past expansion exercise. From Jan 2010 to Jul 2014, 7-Eleven Malaysia has opened approximately net 580 stores, driving its sales at a CAGR of 12.1% between FY10-1HFY14.

Room for margin improvement. We believe the company’s margin may continue to improve as evidenced by its past four years’ performance. From 2010 to 2013, its gross profit margin improved to 27.9% from 26.1%, while its net margin climbed to 3.1% from 2.1%. We see more room for margin improvement in the medium to longer term, potentially coming from: i) its effective product mix, which focuses on increasing contributions from higher-margin products, ii) better commission revenue from instore services, for which cost of sales is minimal, and iii) consistent contributions from other operating income.

Support from Berjaya Group and 7-Eleven Inc. 7-Eleven Malaysia has been granted the rights by 7-Eleven Inc, USA (3382 JP, NR) to operate 7-Elevenconvenience stores in Malaysia and Brunei. As a sole operator, 7-Eleven Malaysia enjoys the benefits of sharing brand equity as well as merchandising and operational support. In addition, the company is blessed with support from its majority shareholder, Berjaya Retail Berhad, which is indirectly owned by Tan Sri Dato’ Seri Vincent Tan through its investee company. Its strategic relationship with the leading consumer-focused conglomerate in the country enables 7-Eleven Malaysia to benefit from Berjaya Group’s (BC MK, NR) experience and network within the consumer space. Other collaborations include its existing partnership with MOL AccessPortal SB (MOL) in providing mobile phone and online game reload services at 7-Eleven convenience stores. Riding on this capability, going forward we believe 7-Eleven Malaysia could offer additional in-store services that may improve its profitability, as MOL will be providing the funding investments.

Valuation 

TP of MYR2.00.We initiate coverage on 7-Eleven Malaysia with a BUY recommendation and a TP of MYR2.00. We derive our TP by pegging the group’s FY15F earnings to a 28x P/E, which implies a 17% premium over its regional listed peers’ average multiple of 24x, as shown in the table below. We apply the premium due to 7-Eleven Malaysia’s: i) stronger 3-year expected earnings CAGR of 29.1% vs its 3-year peer average CAGR of 14.8%, ii) more exciting growth prospects, iii) operational upside potential, and iv) strong brand name known globally.

Key Risks 

Potential slowdown in consumer sentiment.The upcoming implementation of the goods and services tax (GST) in April 2015 coupled with the gradual rationalisation of subsidy programmes may weaken consumer spending in the short term at the very least, due to a potential decrease in disposable income. As products at convenience stores are generally priced higher, consumers may switch to cheaper substitutes at the expense of convenience. However, we believe the impact on 7-Eleven Malaysia should be mild as most of its products have inelastic demand, such as tobacco products and food and beverage (F&B). In FY13, these two types of products contributed 35.8% and 49.0% respectively to the company’s revenue. 
Reliance on few suppliers. 7-Eleven Malaysia relies on three key suppliers which account for about 40% of its total purchases. Among the names are Commercial Marketers and Distributors SB (for British American Tobacco (ROTH MK, SELL, TP: MYR57.80) products) and Lein Hing Holdings SB (for Philip Morris products). Hence, any delay or disruption in any of its suppliers’ operations may directly affect 7-Eleven Malaysia’s business operation. 

Renewal of regulatory licenses. 7-Eleven Malaysia’s business operation is subject to several licenses. The most important license is the area license agreement from 7-Eleven Inc, which effectively allows 7-Eleven Malaysia to operate and grant subfranchises to franchisees to operate 7-Elevenconvenience stores in Malaysia and Brunei. With validity until 30 Nov 2033, the agreement also has a renewable option of additional 10 years subject to material compliance with the terms included. However, 7-Eleven Inc has the right to reject or even revoke the license before its expiration. 
Dependency on partnership with MOL.7-Eleven Malaysia earns commission revenue from its in-store services through its strategic partnership with MOL, which is also part of Berjaya Group and effectively a related party of 7-Eleven Malaysia. However, should MOL terminate the strategic partnership, this could disrupt and affect 7-Eleven Malaysia financially. 

Thin profit margins. As a convenience store operator, 7-Eleven Malaysia has managed to maintain profit margins of around 2-3% from 2010-2013. This thin margin could pose a risk as a slight increase in operating costs could negatively impact its profit levels. Therefore, we think the company should quickly respond to any undesirable cost hike and pass it on to end-consumers. Common retail business operational risks.Due to the nature of the retail business in which most transactions are settled in cash, the company is exposed to the risks of petty cash shortages and security issues like theft. Furthermore, as all its stores operate on a 24-hour basis, this makes them susceptible to pilferage, shoplifting, theft and robbery. However, those risks are mitigated by insurance coverage.

Industry Overview 
Domestic market overview 
Underpenetrated market.According to a report by Vital Factor Consulting independent market research (IMR), as of 2012, Malaysia had a convenience store penetration rate of 131 stores/million people (56 stores/million people on a standalone basis), which is relatively low compared with the penetration rate of other countries in the region such as Thailand, Taiwan, and Korea as shown in the chart below.

Competitors small and fragmented. With its stong 82% market share, 7-Eleven Malaysia faces little competition in the covenience store industry in Malaysia. Its wide network nationwide has provided it with economies of scale, putting it in a good position to capitalise on the growth potential in the industry and further establish its market dominance. In comparision, other convenience store operators have rather smaller networks and offer little competition. For example, KK Supermart (established in 2001), which is the second-largest convenience store chain in the country, has approximately 500 standalone stores. Other players in the market including Orange 

Mart, Quick & Easy, Happy Mart andMymarthave less than 100 stores each. In our opinion, 7-Eleven Malaysia’s strong presence in the convenience store market in Malaysia has earned the company brand recognition and reputation. 
Demographics still positive for demand growth. We believe the convenience store market in Malaysia still has plenty of room for growth. Malaysia’s per capita income is growing, with overall consumer spending likely to increase in the coming years. In 2013, 54.9% of Malaysian population comprised the age group of 29 years old and younger, according to the Department of Statistics. Thus, we expect the growing young population to provide a large consumer base which would drive the retail industry going forward. Furthermore, we envision the country’s increasing urbanisation and booming tourism to continue to support the retail industry.

Low barriers to entry for individual stores, but scale is king here. We consider the barriers to entry fo the convenience store market as low, as any individual with sufficient capital can set up the business. However, start-ups without economies of scale and bargaining power against suppliers can face challenges in building a retail network that is on par with that of 7-Eleven Malaysia. 

7-Eleven’s overseas market performance Japan. Established 40 years ago, Japan’s 7-Elevencaters mostly to the needs of the blue-collar population. Japan has one of the most-developed convenience store markets in the world, bolstered by its “rush hour” lifestyle and hectic culture. To cater to the needs of primarily the blue-collar population, Japan’s 7-Elevenfocuses on selling lunch or dinner bento rice boxes. Currently, there are a total of 16,664   7-Elevenoutlets throughout Japan.

Thailand.7-Eleven in Thailand has been able to fetch good margins due to economies of scale. Its large number of stores (7,816) has given the company better bargaining power, allowing it to source for products at lower costs. Besides, Thailand’s 7-Eleven also benefits from encouraging sales of its in-house manufactured products, particularly F&B. 

Indonesia. 7-Eleven’s presence in Indonesia can be regarded as relatively new, having been established only about five years ago. With 168 stores opened, the business has just recently broken even. Given the country’s large population and improving spending power of the people, we estimate that 7-Eleven in Indonesia will likely surpass its regional peers over time, as the business capitalises on economies of scale to achieve better margins. 
The Philippines.7-Eleven in the Philippines is by far the most similar to the business in Malaysia, as both were established about 30 years ago. Although the former’s 1,121 stores recorded better revenue per store due to a lower penetration rate, the Philippines’ business only managed to yield low net profit margins as it focuses more on expansion, which has weakened its profitability.

Growth Strategies 
Store network expansion to drive future growth.In view of the low convenience store penetration rate in Malaysia, 7-Eleven Malaysia targets to have a net increase of 600 stores over the next three years. We project the company to have a net increase of 200 stores per annum in FY14-16F and have incorporated this projection into our estimates. The company’s new store rollout plan will focus on the Klang Valley, East Malaysia and East Coast of Peninsular Malaysia, in order to gain larger geographical exposure. The plan also includes a collaboration with Chevron Malaysia to open 23 new stores at Caltex petrol stations by Jun 2015. Management guided for costs of the new store opening at MYR200,000-300,000 per store. As at Jul 2014, a total of 85 new stores have been opened. 

Major refurbishment to improve customer experience and drive store traffic.
7-Eleven Malaysia has also been actively renovating its stores to ensure good customer shopping experience and improve its store image. The company plans to refurbish 600 stores in 2014-2016F, which will cost approximately MYR100,000-150,000 per store. Note that 7-Eleven Malaysia was relisted on Bursa Malaysia on 30 May 2014, and about 14.8% of the IPO proceeds have been allocated for this purpose, with a total of 102 stores having undergone the renovation exercise to date. Apart from the major refurbishment, 7-Eleven Malaysia also has been embarking on transforming its stores into a café-cum-convenience store style, by incorporating seating space (about 25% of the store space) and providing wireless network coverage within the stores. This is dubbed as the “next-generation-stores” aimed at attracting younger customers.

Source: RHB