PADINI – Fundamental Analysis (21 Aug 2015)

At the time of writing, I owned shares of PADINI.
Changes:
  1. 21 Aug 2015 – First write up of PADINI using new style, and covers FY15 Q4 results.

Important: MYR in ‘000s except per share data

Business Profile

The Padini Group is principally engaged in the garment industry in Malaysia. It distributes and retails adult’s garments, children’s garments, ancillary products, maternity wear, ladies’ shoes, bags, belts and other accessories. It distributes its products through its free-standing stores, franchised outlets and consignment counters, which are located in local and oversea markets.

Its products are distributed under the brand name of Vincci, Vincci+, Vincci Accessories, Tizio, Padini Authentics, PDI, Padini, Seed, Miki, and P&Co, all of which are owned by the Group except the Tizio label. In addition to those, the Group also utilises a number of lesser known house brands to market the merchandise that it offers for sale in its Brands Outlet stores.

The Group has arrived at five (5) reportable segments, which are determined by each of its subsidiaries. These companies are the strategic business units of the Group.

The strategic business units possess different brands and offer distinguished and different theme of products to cater to different customer segments. These strategic business units are managed separately because they require different business and marketing strategies. For each of the strategic business units, the Managing Director of the Group and brand managers collectively (the “Chief of Decision Maker” or “CODM”) review internal management reports at least on a quarterly basis.

The following summary shows brands possessed by each of the reportable segments of the Group:

Companies Brands
Vincci Ladies’  Specialties Centre Sdn. Bhd. (“Vincci”) Move, Tizio, Vincci, Vincci Plus and Vincci Accessories
Padini Corporation Sdn. Bhd. (“Padini Corporation”) Padini, Padini Authentics and PDI
Seed Corporation Sdn. Bhd. (“Seed”) Seed and Seed café
Yee Fong Hung (Malaysia) Sendirian Berhad (“Yee Fong Hung”) Brands Outlet and P&Co
Mikihouse Children’s Wear Sdn. Bhd. (“Miki”) Miki Kids and Miki Mom

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The following tables provide a snapshot of PADINI’s retail network, broken down according to our brands, and markets, as at the various dates indicated.

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Source: Annual Report 2014

Ownership

PADINI mainly owned by individuals like Pang Chaun Yong and Min Yang Thian, but institutional funds owned 27% of PADINI.

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Economic Moats

Cost Advantage (Moat: Narrow)

  • Its EBITA margin declined over the years from 18.8% (FY11) to 11.8% (FY15), but its margin is still the highest in this industry.

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Switching Costs (Moat: None)

  • Basically, there is no switching cost at all.

Network Effect (Moat: Narrow)

  • Lower to Middle Income Group
  • Strong Concept store strategy and Brands Outlet

Intangible Assets (Moat: Narrow)

  • Strong brand and regularly release new design.
  • Brand identity comes from sales and is supported by the quality of products. The success of PadiniH is its retailing strategy that focuses on the different market segments. Each brand under the group provides a distinctive image and identity for its targeted market. For example, Padini targets modern executives and managers in the mid 20s and late 30s and thus, it provides only office wear. On the other hand, Padini Authentics targets customers with relaxed and easy lifestyles. So, it provides products that are consistent with the casual image.
  • Store presence and a distinctive store layout are part of the brand building strategy. Store presence drives the group’s brand awareness, while store layout reflects the perception that the group wishes to send to targeted customers. To avoid brand dilution and customers having overlapping perceptions of the brands, each brand has its own unique floor place and style when they are housed together under a concept store. As such, the renovation and fixtures in a concept store cost about RM200 per sq ft, which is quite high.

Efficient Scale (Moat: Narrow)

  • A prominent retailer in the Malaysian market
  • Extensive branch network throughout the country.

Profitability

In the past 5 years, EBITA of PADINI maintained in the range of 100m to 130m, but the growth is not consistent. Furthermore, the margin declined consistently every year. This is mainly caused by the following reason:

  1. The implementation of the GST and subsidy rationalization program by the government could potentially hamper consumer spending.
  2. Higher-than-expected operating expenses resulting from new store openings.
  3. Padini is facing intense competition in the clothes and apparel retailer market segment especially with the entrance of foreign brands such as H&M and Uniqlo.

The recent EBITA margin is 11.8%, and this can be rated as Ba (equivalent to mediocre). If compare to other competitors in Malaysia, PADINI margin can be considered the highest.

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Even if its ROIC was above 10%, but the ROIC was trending down in the past 5 years. PADINI’s CROIC was very volatile, but it is mainly due to increase of working capital in inventory. Under normal circumstances, it is able to maintain above 10% CROIC.

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Leverage & Coverage

Refer to the following charts, PADINI’s leverage and coverage are very healthy.

  1. Debt/EBITDA – 0.27x (FY15) (Aaa)
  2. EBIT/Interest – 40.48x (FY15) (Aaa)
  3. Retained Cash Flow to Debt – 386.2% (FY15) (Aaa)

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Liquidity

Trend of cash conversion cycle is downtrend, and this is a positive sign where PADINI’s liquidity is improving. Days Sales of Inventory has been reducing since FY2012. This means number of days that PADINI sell out stock reduced.

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PADINI’s FCFF was very volatile, but it is mainly due to increase of working capital in inventory. Under normal circumstances, it is able to achieve quite a healthy level of free cash flow.

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FY15 Q4 Results

FY15 earnings fell 11% to 80,223 due to aggressive promotional and discounting activities. However, this was mitigated by top-line growth of 13% because of additional new outlets (five Brands Outlets and five Padini Concept Stores) which were opened throughout FY15, coupled with pre-festive season shopping (Hari Raya in July 2015).

4QFY15 net profit of MYR18.2m (+33% YoY, -32% QoQ) took FY15 net profit to MYR80.2m (-12% YoY). The surprise in 4QFY15 was mainly due to stronger sales and lower-than-expected opex, largely from competitive promotions/discounting and better cost management. QoQ revenue, however, fell 22% due to post-GST implementation in April 2015 which had affected consumer spending and sentiment.

Declared a 4th interim dividend of 2.5cent/share, bringing total dividend of 10.0cents/share in FY115 translating into 82% payout ratio, slightly lower from the previous year of 83%.

Growth Drivers

  • 19 Aug 2015 -6 Padini Concept Store & 6 Brands Outlet to be opened in FY16.
  • The strong retail presence and long retail experience of the Group would enable the Group to weather the competition in the retail sector.

Issues/Risks/Challenges

  • The implementation of the GST and subsidy rationalization program by the government could potentially hamper consumer spending.
  • Macroeconomic headwinds simmer down – hamper consumer spending.
  • Higher-than-expected operating expenses resulting from new store openings.
  • Intensified competition – Padini is facing intense competition in the clothes and apparel retailer market segment especially with the entrance of foreign brands such as H&M and Uniqlo. Nevertheless, Padini’s strong and expanding store network had given Padini an added edge due its ability to reach out to less urban areas. Padini’s wide range of merchandise also ensures the Company remains relevant to the various consumer needs. For instance, its presence in the value-for-money segment via BO.
  • Intensified competition from online shopping portal, such as Lazada, Zalora, etc…
  • 19 Aug 2015 – Over the short-term, costs will continue to stay at escalated levels due to the gestation phase of new stores opening this year (6 Padini Concept Store & 6 Brands Outlet).

Seasonal or Cyclical Factors

The apparel industry experiences shifting demand, due primarily to cyclical economic factors and changes in fashion trends. Spending is discretionary in nature, and can be deferred during weak economic times as the consumer can ‘shop the closet’ instead of buying new product. Demand is also a function of the vagaries of fashion – ‘gotta have it now’ often quickly turns into ‘wouldn’t be caught dead in this’ tomorrow. Few brands in this industry have demonstrated consistent and enduring appeal.

Most apparel products are seasonal – for example to be worn in either cold or hot temperatures. As such, apparel products are perishable in that product must be sold (i.e. few shorts are sold in the winter). As such, at the end of the season, prices will be lowered to clear out these goods. When sizable discounts are taken, there are arrangements in place where apparel companies provide ‘markdown allowances’ to the retailer. In simple terms, if goods are sold at lower than expected prices, the retailer will lower the price it paid for the garments such that the retailer achieves its desired gross margins. As such apparel companies bear the risks that related to final retail selling prices.

Shareholder Return

The table below is a simulation of shareholder return. Assumptions:

  1. Commission paid is ignored in this simulation.
  2. The current price is as of the time of writing.
  3. Unit purchased is 1,000.
  4. Stock price as of 21 Aug 2015 was 1.36.
  5. PADINI did share split in 2011, and in 2009.
Time Frame Date Bought at Original Value Dividend Received Dividend Yield % Unrealized  Gain/Loss Current Return CAGR %
3-Y 21/08/2012 2.26 2,260.00 295.00 13.1% -880.00 1,675.00 -9.5%
5-Y 20/08/2010 0.808 808.00 2,050.00 253.7% 6,092.00 8,950.00 61.8%
10-Y 19/08/2005 0.223 223.00 5,430.00 2435.0% 13,577.00 19,230.00 56.2%

Valuation

Historical EY%

  • Trailing:
    • FY15 (EPS: 0.122) – 1.72 (Uncertainty Risk: MEDIUM)
    • R4Q (EPS: 0.122) – 1.72 (Uncertainty Risk: MEDIUM)
  • Forward:
    • FY16 (EPS: 0.137 ± 5%) – From 1.84 to 2.03 (Uncertainty Risk: LOW to MEDIUM)
    • FY17 (EPS: 0.149 ± 5%) – From 1.99 to 2.20 (Uncertainty Risk: LOW)
  • EPS applied to reach the current stock price (1.36): 0.096

I think fair value of PADINI range from 1.84 – 2.20.

Peer Comparison

Profitability

BONIA and TGL margin are in the range of 10% to 14%. PADINI was the winner in profit margin, but now declined to the range where BONIA and TGL are in. As for other competitors, their margin have been squeezed due to intensified competition and higher operating expenses.

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As for ROIC, six of them are in the downtrend. This is in tandem with the risks and challenges mentioned above. PADINI is the champion in generating profits with the highest efficiency.

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As for CROIC, their CROICs are not consistent. This is industry norm where cash flow are highly dependent on working changes inventory. PADINI is the champion in generating cash flow with the highest efficiency.

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Leverage

Compare to others, PADINI is the least leveraged company.

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Liquidity

Compare to others, PADINI’s CCC is the lowest in the industry, and it is trending down. This means PADINI can sell their stocks in shorter period if compare to its competitors.

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Which is Better?

Obviously, if merely based on comparison of financial figures as above, performance of PADINI is better than its peers.

Going Forward

In my opinion, PADINI’s current valuation is very attractive. Its high dividend yield help cushion market dips.

I still cautious on Padini’s near-term earnings outlook due to risks of lower margins and profits from absorbing the GST amid the weakening consumer sentiments.

I will continue to hold and accumulate this stock.

Resources

Excel – http://1drv.ms/1huFMfc

Notes – http://tinyurl.com/lyevtd9

4Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4831797

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