We maintain our Buy recommendation on Padini with a lower target price of RM3.76/share, based on 16x CY17EPS. The lower target price is underpinned by earnings downgrades on the back of i) lesser stores opening, and ii) rise in operating costs. Earnings are lowered by 5.2% and 6.8% for FY17 and FY18 respectively.

Slowdown in Store Expansion

Given the weakening of Ringgit, Padini is taking a passive approach in its stores expansion plan for FY17 and FY18 as compared to FY16 when the group opened five new Padini Concept stores and nine new Brands Outlet stores in Malaysia. Management guided that for FY17, the group will open 3 new stores in Malaysia, i.e.: Vincci and Padini Concept stores in MyTown Mall as well as a Padini Concept Store in Melawati Mall in Kuala Lumpur, and these new stores would make full-year contributions from FY18 onwards. For FY18, Padini is expected to open one Brands Outlet store in Genting Premium Outlet and currently in negotiation to open one store in Aeon Kempas, which is expected to open by end-2017. Other than that, given Padini’s price sensitive target market, management guided that the group will continue adopting its competitive pricing strategy for FY17 to stimulate sales. Therefore, we can expect no increase in selling price and the topline revenue growth would all be driven by volume and contribution from new stores. Furthermore, in order to keep up with the fashion trend, new clothing lines would be released almost every week. Note that, end of last year Padini launched an active wear collection to cater to the active and health cautious market. We are positive as this would enable the company to fend off competition from rivals like Cotton On and H&M.

Mitigating Margin Pressure Through Efficiency

Management guided that the gross profit margin is expected to be below 43% level (vs. 41.7% for FY16) for FY17. This is a tad lower than the average gross margin of 45.2% over the past five years. The increase in cost can be attributed to unfavourable ringgit movement in recent years (see Figure 1) which has inflated the cost of sales. Currently, it is estimated that 90% of the group’s cost of sales are transacted in Chinese Yuan. As such, management explained that the group is always on the look-out for suppliers from other countries to diversify the risk. Padini has tested production from Bangladesh, which is believed to be cheaper than China. However, due to lack in support industry i.e. infrastructure and logistics, the turnaround time from Bangladesh is slower. Therefore, Padini is currently still heavily reliant on production from China. To mitigate the cost pressure, the company would continue closing down underperformed consignment stores and open more Padini Concept and Brands Outlet stores. Last year, the company had closed down 79 consignment stores in Malaysia.

Exponential Growth in eCommerce Sales Channel

In terms of e-commerce channel, Padini launched the group’s first e-commerce platform in 2015. Currently, the turnover from the platform accounts for less than 1% of the group’s total revenue as sales are only limited to within Malaysia. However, sales volume did show exponential growth i.e. more than 1000% YoY for FY16. We view the online ecommerce platform as a requirement to prepare Padini to compete effectively within the retail market in the future. Although the Malaysia ecommerce market is a relatively young market as compared to the rest of the world, the future growth potential is enormous. According to Statista, Malaysian eCommerce market for 2016 is expected to reach RM4.1bn in revenue, which is relatively low as compared to global e-commerce revenue of RM14.5tr. However, according to iPay88 (60% market share in Malaysia for online transaction service provider), online transaction volume doubled in 2015 to RM1.6bn and could increase by 63% in 2016 to RM2.6bn.

Overseas opportunities

Padini is also exploring possible ventures in other South East Asian countries through franchising of Vincci brand stores. Other than that, after closing 12 stores in Saudi Arabia in FY16, Padini is still interested in continuing the business in the country subject to finding a suitable franchisee. This is to ensure the best service quality to customers and to enhance brand awareness.

Forecasts

We reduce the expected number of new stores for FY17 and FY18 from a total of 10 and 11 stores to three and two stores respectively. We also reduce the number of consignment stores to 46 and 31 stores for FY17 and FY18 respectively. Consequently, earnings are adjusted lower by 5.2% and 6.8% for FY17 and FY18 respectively. This is after taking into consideration the i) weaker consumer sentiment, ii) competitive pricing strategy adopted by Padini as well as iii) the slowdown in domestic expansion plan.

Valuation

We maintain our Buy call for Padini with a revised target price of RM3.76/share (previously RM4.00) based on 16x CY17 EPS. Potential downside risks to our call are i) weakening of Ringgit to Chinese Yuan, ii) unexpected opening of new stores and iii) recovery in consumer sentiment.

Source: TA Research - 7 Apr 2017