We came away from a meeting with management feeling more upbeat on Padini’s near-term prospects. However, we expect earnings growth to remain unexciting as margins could revert to mean due to higher input costs and competition, against the backdrop of its subdued expansion plan. We raise our TP to MYR2.22 from MYR1.64 (5% upside) post our earnings revision and a change in our valuation method to DCF (from P/E). Maintain NEUTRAL.

Padini Concept Store (PCS) in a sweet spot to capture down-trading. Post meeting with management, we are more upbeat on the reception of PCS’ recently-introduced bundling exercise (Figures 1-2) in the short term. Recall that PCS’ same-store sales growth (SSSG) for 1QFY16 (Jun) increased 23% as a result of the exercise. While this is amid an all-time low in consumer sentiment as at 4Q15 (Figure 7), we see this as an opportunity for Padini. Specifically, its value segment, Brands Outlet (BO) and the middle range segment, PCS should benefit from down-trading by middle-income consumers. From our price check,men’s shirts in Padini’s bundling exercise are c.40-60% cheaper than those of Uniqlo, H&M and G2000 (Figures 3-6).

Limited FY17F visibility of store expansion. Padini has opened eight new stores in FY16, and remains on track to achieve its target of 13 new stores (FY15: 10 new stores). Going into FY17, management is committed to at least four new stores in second-tier cities/towns by 1HFY17, while firming up its store expansion strategy for the remainder of FY17 (Figure 9 shows RHB assumptions). Furthermore, since c.42% of the combined PCS and BO storesare located in malls free from competition from Uniqlo or H&M (Figure 8), thisshould provide Padini with better quality of earnings. Meanwhile, we are positive on adini’s committed effort to gradually phase out its suboptimal consignment stores, which form the majority of its 54 consignment stores (as at Jun 2015).

Forecasts and risks. We lift FY16F-18F earnings by 24%/17%/10% to reflect better-than-anticipated reception from PCS’ bundling exercise. Key investment risks include: i) intensified competition from other retailers, ii) sustainability of promotional activities as the novelty factor diminishes, and iii) efforts such as bundling at PCS may dilute brand perception in the long run.

Maintain NEUTRAL. Despite our upward earnings revision, we remain NEUTRAL on the stock. We change our valuation method to DCF from P/E to derive a new MYR2.22 TP (from MYR1.64). The implied P/E is at 12.2x 2016F EPS, aligned with both its peers and its 3-year historical P/E mean at 11.6x and 12.5x respectively (Figures 11-12). Earnings growth going forward should remain unexciting as margins are expected to revert to mean due to higher input costs and competition, against the backdrop of its subdued store expansion plan.