Thursday, December 5, 2013

Courts Asia :Up Against The Wall (MKE)

Courts Asia
Sell (from Hold)
Share price: SGD0.675
Target price: SGD0.60 (from SGD0.72)
Up Against The Wall, Cut To SELL

 Mired in a highly competitive market; downgrade to SELL. The electronics and furniture retailing market is highly fragmented, with scant opportunities for price or cost leadership. As such, we think Courts Asia is taking steps in the right direction to create differentiation, though for now, the company’s credit operations seem to be its only competitive edge. Share price has declined 22% YTD but a reversal looks unlikely anytime soon. Downgrade to SELL. We transfer coverage of Courts Asia to James Koh.


Negative margins signal weak pricing power. In our view, Courts Asia will not be able to pass on most of the impending cost pressures, including labour wages and rental. This will mean operating margins, which are already down significantly YTD, slipping even further. Stripping out customer credit income (and associated costs), operating margins for the group have historically been negative, a sign of the intense competition in this industry.

Overhang from impending GST in Malaysia. The 6% GST to be implemented in Malaysia from April 2015 will only affect Courts Asia from FY16 onwards. In the meantime, we expect this to be a share overhang. While details remain under discussion, our analysis shows it will increase the tax burden on the company, a cost it may not be able to fully pass on. When Singapore rolled out a 3% GST in 1994, overall retail sales shrank 1.5% that year and 19% QoQ seasonally adjusted.

Credit book quality healthy, but fully valued. Courts Asia has a gross credit book of SGD523m, funded against borrowings of SGD291m. Indeed, 180-day delinquency rates represent historical lows and reflect management’s efforts to keep the integrity of its credit book. However, upside value here is already reflected in the lower provision allowances (4% of gross credit book). Thus, any deterioration in terms of higher impairments may reduce margins going forward.

Trim earnings forecasts. We cut our FY14F-15F earnings by 3-5% mainly on less optimistic margin assumptions. Courts Asia’s ROE profile and EPS growth this period is among the lowest in its peer group. As a result, we peg our new TP of SGD0.60 to a lower PER of 10x (FY14F-16F average EPS).

Mired in a highly competitive market
Unfavourable market structures. In Singapore electronics retailing, the top five players account for less than 30% of the total market. This is already the most favorable market compared to others which Courts Asia participates in, where typically the top 5 players do not even account for 10% market share. Courts Asia is #1 and #2 respectively in Singapore and Malaysia for combined sales of electronics and furniture, but we think in reality, the market structures does not give Courts Asia any semblance of either price or cost leadership.

Little room for differentiation. Courts Asia carries brands/ products which are often similar to other retailers. Brand loyalty typically resides with the product brand owners rather than the retailers and price competition is intense as a result. We think Courts Asia’s one true source of differentiation is currently its in-house credit financing scheme, although that comes with its own set of risks.

Nonetheless, we think management has been working hard in the right direction to create differentiation, with initiatives such as innovative retail concepts (Big-Box, Market Hall, Cool Zone, Sleep Clinic and Sofa Maker), Courts Connect for telco network needs, eCourts for an online presence and launching its own private label brands.

Negative operating margins. The company segments revenue into cash sales, credit sales and service charges. The latter comprises mostly of interest earned from customer financing. To better understand the nature of the company’s source of operating margin, we stripped out services charges and added back allowances for impairment of trade receivables (which is a part of the customer-financing cost). As can be seen, Singapore margins were mostly slightly negative while Malaysia, which is a more competitive market, has very negative margins.

Negative operating margins. The company segments revenue into cash sales, credit sales and service charges. The latter comprises mostly of interest earned from customer financing. To better understand the nature of the company’s source of operating margin, we stripped out services charges and added back allowances for impairment of trade receivables (which is a part of the customer-financing cost). As can be seen, Singapore margins were mostly slightly negative while Malaysia, which is a more competitive market, has very negative margins.

Rental pressure remains. Courts Asia leases its operating premises. In both Singapore and Malaysia, retail rental have generally been on an uptrend since 2009. This is partly a function of high capital values, arising from the low interest rate environments. We are of the view that rental prices will likely remain elevated over the next 2-3 years in these markets. As the company renews existing leases, prices are likely to be higher, and will increase the operating cost base.

Start-up expenses on new stores. New stores typically require a full fit-out. Even though retail fit-outs can be capitalized, they are usually depreciated aggressively over the operating lease period. Together with other start-up costs such as promotions and new staff, these expenses will eat into bottom-line, especially given the company’s aggressive expansion plans.

Rental pressure remains. Courts Asia leases its operating premises. In both Singapore and Malaysia, retail rental have generally been on an uptrend since 2009. This is partly a function of high capital values, arising from the low interest rate environments. We are of the view that rental prices will likely remain elevated over the next 2-3 years in these markets. As the company renews existing leases, prices are likely to be higher, and will increase the operating cost base.

Start-up expenses on new stores. New stores typically require a full fit-out. Even though retail fit-outs can be capitalized, they are usually depreciated aggressively over the operating lease period. Together with other start-up costs such as promotions and new staff, these expenses will eat into bottom-line, especially given the company’s aggressive expansion plans.

No signs of receivables deterioration so far
Credit book quality healthy, but fully valued. Courts Asia has a gross credit book of SGD523m, funded against borrowings of SGD291m. This book includes future unearned service charges.

Indeed, 180-day delinquency rates represent historical lows, at 3.8% in Singapore and 7.9% in Malaysia. This reflects management’s efforts to keep the integrity of its credit book. However, we believe upside value here is already reflected in the lower provision allowances (4% of gross credit book).

Actual impairments have been in-line with estimation. Based on the past two financial years, actual impairments have been very similar to allowances made and there is no evidence management has been overly-conservative on allowance estimation. Thus, any deterioration in terms of higher impairments may reduce margins going forward in the form of higher impairments.

Valuation
Courts Asia’s ROE profile and EPS growth this period is among the lowest in its peer group. We expect average ROEs of 10% over the next three years, and negative EPS growth over the course of this period. As a result, we peg our new TP of SGD0.60 to a lower PER of 10x (FY13F-15F average EPS). This is also in-line with the valuations of AEON Credit in Malaysia, which provides consumer credit services.



Source/Extract/Excerpts/来源/转贴/摘录: MKE-Research,
Publish date: 04/12/13

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