Retail - Slower growth risk ahead

We are maintaining our rating of the Retail sector at NEUTRAL. All the companies under our coverage reported recent 3Q12 results that came in broadly in line with the street and our expectations except Parkson, which was far off ours and the consensus’ numbers. Due to the global economic uncertainty and the slowdown in consumer spending, the industry players have started to be more cautious on their outlooks and prospects for the next few quarters. In addition to that, fierce competition, pricing competitiveness and higher marketing cost will all further have a negative impact on the retail companies’ earnings. Post-3QCY12 results, we are still maintaining the earnings of the retailers except Parkson as we believe a higher operating cost due to the initial losses at its new stores in China will hurt the earnings of the company. Consequently, we have  revised down Parkson’s earnings and its TP (target price) recently. Currently, retail stocks are trading at the level from -1SD to +2SD level from the mean of  their PERs, which is not too excessive. Hence, we are still maintaining a NEUTRAL call on the RETAIL sector. Note that we have MARKET PERFORM calls on Amway (TP: RM11.68), Eng Kah (TP: RM3.57) and Parkson (TP: RM4.50) and an UNDERPERFROM call on AEON (RP: RM11.30) at this juncture.

3Q results were mixed. The retail companies under our coverage (AEON, Amway, Eng Kah and Parkson) reported a set of mixed results. The aggregated revenue increased by 7.2% QoQ and 8.5% YoY due to several factors: 1) higher  sales during the festive season (Hari Raya) and new stores opening by AEON; 2) higher distributor productivity driven by sales and marketing programs by Amway and 3) a favourable product mix in Eng Kah. Meanwhile, Parkson reported a pretty flat sales number with its SEA revenue cushioning the slight drop in its China revenue.

However, the aggregated earnings dropped 2.6% QoQ and 16.1% YoY due to a previous oneoff insurance claim in the previous quarter from a  fire incident by AEON, a higher cost occurred by Amway and a higher tax rate in Parkson. Meanwhile, Eng Kah saw its best quarter to date due to lower additional costs incurred for new products. 

Watch out for the risks. Unavoidable, retailers will be affected by the uncertainties in the global economy and the slowdown in the purchasing power of consumers. However, there are also other key downside risks such as a higher advertising and promotional budget and pricing competitiveness could further lower their earnings. 

Mixed valuations. We are using the Price-to-Earnings (PER) methodology as our primary valuation model as retail companies have been consistently profitable over the years albeit suffering some ups and downs. 

Currently, AEON is trading at a +2SD from its 5-year mean PER. This is at its historical high and hence poses some risks to its valuation. We believe that the valuation of the company could have stretched at the current stage and we see potential downside risk in its share price. Meanwhile, Amway is trading at a +1.25SD level from its 5-year average. Based on its historical PER band, it traded at its highest point two months ago at the +2SD level. Parkson, on the other hand, is trading near the -1SD level from its 5-year average (its lowest level of -2SD occurred in 2008) due to the slowdown in China, where it has a large exposure. For small cap retailer Eng Kah, it is currently trading at its 5-year PER average (with the highest level of +2SD in 2009 and the lowest level of -1SD in 2010).

MAINTAIN Neutral.  Due to the slowdown in the global economy especially in China and India as well as the weak consumer spending, we are cautious on the outlook for the retail sector. Coupled with its high valuation, we believe that there could be further downside risks to the sector if the global economic weakness persists. We are maintaining a NEUTRAL rating on the Retail sector.

Source: Kenanga