We left Padini’s analyst briefing feeling positive given that GP margin is expected to improve on the back of i) devaluation of CNY and ii) escalating US-China trade war alongside strong SSSG. We adjust our FY20/21 earnings by 7.7/6.8% while introducing FY22 earnings forecast of RM211.2mn. Reiterate Buy call with a higher target price of RM4.60/share.

GP Margin is expected to Improve from CNYMYR Movement

Understanding that 60-70% of Padini’s products are imported from China, we believe the recent sharp drop in CNYMYR to 0.59 (-2.5% since 1 July 2019) (Figure 1) would translate into lower purchase cost and better GP margin for Padini. Moreover, we opine the benefits could become more apparent as Padini increases its effort of direct dealing with its Chinese counterparts. Note that Padini has been purchasing its Chinese imports largely through Malaysian agents (who help to liaise with Chinese agents/manufacturers) for the convenience of logistics, licenses and time savings in search for products’ varieties. Lately, it has increased the amount of direct dealings with large Chinese manufacturers with proper export licenses. We believe these dealings are transacted in CNY and could have better term of trade i.e. pricing, lead time, credit term and quality.

That’s Not It: US-China Trade War Could Lead to be Better Price Negotiation Ability

With clothing articles included in the tariff list, the escalating US-China trade war could exert further pressure on Chinese manufacturers in terms of exports diversification. In other words, Chinese manufacturers with significant exposure to US are in dire need of new replacement markets to take up the slack. To do this, we believe significant discounts would be given to new nonUS buyers, including Padini and/or its agents, which can leverage on the opportunity to negotiate for better pricing and business terms. All in, we expect the decline in costs of purchase along with Yuan devaluation are expected to boost GP margin.

Sustained Growth to be Driven by SSSG and Newer Stores

The group’s efforts in rationalising stores and focusing on bigger multi-brand stores are fruitful with revenue rising despite flat store counts (FY19 sales increased by 6.2% YoY, despite the 4 newer stores, in I-City and Mid Valley South Key were only opened in 2HFY19). Padini recorded a strong SSSG of +4% during FY19 (with remarkable +6% SSSG in 4QFY19), which reflects management’s effectiveness in growing its matured assets through improved merchandises, product differentiation and optimal pricing strategy. Moving forward, we expect Padini’s revenue to be sustained by positive SSSG, contributions from the newer stores and improvement from its Cambodian and Thailand stores.

Impact

We adjust i) FY20-21 revenue downward by revising our new store assumptions to 2 from 4, ii) our CNYMYR assumption to 0.57 from 0.62 and iii) FY20-21 operating expenses downward (from 22% of revenue to 18%) in line with the decline in expenses seen in 4QFY19 results. Meanwhile, corresponding with the implementation of MFRS16 starting FY20, we assume the combined lease interest and depreciation expenses amounting to c.RM175mn (putting a mild drag on PBT by c.RM10mn) that partially offset by de-recognition of rental expenses. All in, we adjust our FY20/21 earnings by 7.7/6.8% while also introduced FY22 forecasted earnings of RM211.2mn.

Valuation

Following the earnings adjustment, reiterate Buy on Padini with higher TP of RM4.60/share (previously RM4.28/share) based on unchanged 16xCY20 EPS.

Source: TA Research - 10 Sept 2019