We recently met with Aeon’s management. Going forward, we believe that the group’s sound growth strategies should be able to support its earnings as: i) refurbishment of underperforming malls could yield better returns, ii) specialty stores continue to deliver solid performance, and iii) the retailing business sustains its positive momentum. These factors, alongside the emergence of value following the decline in Aeon’s share price, we recommend investors Buy Aeon on weakness with a higher DDM derived target price of RM1.85/share. Upgrade to Buy.

Focusing on Mall Refurbishment; Scaling Specialty Stores

Aeon’s focus from now till FY20 would be on mall refurbishment instead of new mall opening. This comes after three successive years of opening Aeon Nilai (FY19), Aeon Kuching (FY18) and Aeon Bandar Dato’Onn (FY17). We believe taking a breather from being overly aggressive in the current market condition to be a reasonable strategy. Moreover, a well-planned and successful refurbished mall could potentially yield greater returns on investment compared to building new malls.

Presently, Aeon Taman Maluri is undergoing refurbishment works, which are expected to be completed by 4QFY19. We understand that the renovation and expansionary works would nearly double the net lettable area of the mall (to c.1.0mn sqft) and believe occupancies and rentals could improve post renovations. Despite management acknowledging that Property Management is expected to remain challenging, we understand that the group has a commendable average occupancy rate of 90% (i.e: higher than the industry’s average of 79.3% for FY18 based on NAPIC data). This is typical reflection of Aeon’s capability in leveraging on its strong branding in managing family malls.

Additionally, the group plans to continue scaling its specialty stores i.e. Wellness pharmacy (FY18 SSSG of 10.7%) and Daiso flat price outlet (FY18 SSSG of 2.5%) which have demonstrated solid performances. As of to date, Aeon operates 68 Wellness and 40 Daiso outlets, and we believe this store format contributes c.8% of Aeon Retailing’s revenue.

Retailing is Sustaining its Positive Momentum

The retailing business is sustaining its positive momentum with 1HFY19 samestores-sales growth (SSSG) of c.2.5%. Note that FY18 SSSG was 3.8% while FY17 was in negative territory at -3.4%. We believe the continuous improvement since FY17 are due to: i) increasingly attractive merchandise mix offered by Aeon, ii) effective marketing and pricing strategies, as well as iii) higher consumer disposable income following a better targeted Budget 2019. From Aeon’s Retailing’s division perspective, we believe ready-to-eat offerings are one of the key drivers supporting the growth of Foodline (c.50% of retailing revenue); whilst Softline (c.35% of retailing revenue) is supported by the lady’s fashion segment alongside kids and baby’s segment.

2HFY19 Will Be Stronger than 1HFY19

We expect FY19 to be no different from its previous years in terms of seasonality where earnings are expected to be back-end loaded especially in the fourth quarter due to: i) year-end festive season sales, and ii) year-end discounts and promotions. Note that in the recent 3 years, fourth-quarter earnings accounted for 43-55% of respective year’s earnings. As for 3QFY19, undoubtedly it would be a seasonally weak quarter due to absence of major festive holidays. However, we opine that the effective Retailing’s strategies implemented by Aeon would permit some YoY growth in the quarter.

Impact

We reduce our FY19/20/21 capex assumption to RM350.0/300.0/300.0mn from RM400.0/400.0/400.0mn given that the group would not be focusing on capitalintensive mall openings in the near term. As a result, FY19/20/21 earnings forecast have been raised by 0.7/3.5/6.6% due to lower depreciation charges and lower net interest charges.

Valuation

Following the decline in share price since our previous downgrade, we recommend investors to Buy Aeon on weakness with target price of RM1.85/share (previously RM1.75/share) based on DDM valuation (k: 6.9%, g: 3.0%). The DDM derived target price has been raised as we change our riskfree rate assumption (cutting Rf to 3.5% to be consistent with our in-house forecast). In all, upgrade Aeon to Buy from Sell on Aeon’s compelling valuations.

Source: TA Research - 4 Oct 2019