This article first appeared in The Edge Financial Daily on April 28, 2017

7-Eleven Malaysia Holdings Bhd
(April 27, RM1.65)
Maintain reduce with a target price (TP) of RM1.15: 7-Eleven Malaysia Holdings Bhd has proposed to undertake a renounceable rights issue of up to 616.7 million new warrants at an issue price of 10 sen per rights share on the basis of one warrant for every two existing 7-Eleven shares. The warrant’s exercise price is RM1.

The group also intends to procure irrevocable undertakings from its substantial shareholders to subscribe in full their respective entitlements, which are equivalent to 253.4 million warrants (41% of total warrants).

Assuming a 100% take-up rate, the issuance of warrants could raise up to RM61.7 million, while the exercise of the warrants (expiring in 10 years) could raise up to RM616.7 million.

The proposed exercise is expected to be completed by the third quarter of 2017 (3Q17).

The rationale for the rights issue includes raising funds for its working capital, increasing the shareholders’ and hence improving gearing level, and strengthening the capital base of the company as well as improving the trading liquidity of the group’s shares with the exercise of the warrants.

The group’s working capital requirements include payments to suppliers as well as the financing of its operating expenses, such as rental, store utilities, insurance, store maintenance and royalties payable, within three months of the issuance of its warrants.

We are not too surprised by this proposal in view of its high net gearing level of 3.29 times as at end-December 2016.

The group will only raise up to RM61.7 million from the issuance of warrants, while the balance of RM616.7 million will only be received if the warrant holders decide to convert their warrants. Post conversion of all the warrants to shares, the net gearing is estimated to fall to 0.4 times.

We are negative about this as we estimate that the proposal will be dilutive to our financial year ending Dec 31, 2018 (FY18) earnings per share (EPS) forecasts by about 15% (assuming full warrant conversion) due to the expansion of share base and the exercise price of the warrants is 32% below 7-Eleven’s theoretical ex-rights price of RM1.48, based on the announcement.

Our earnings forecasts are unchanged for now. Upon the completion of the rights issue and full conversion of the new warrants, 7-Eleven’s share price ex-warrants will be adjusted to RM1.48 (based on its five-day volume weighted average price of RM1.66). 

All in, we maintain our “reduce” call and keep our end-2017 TP at RM1.15 (or 97 sen fully diluted ex-warrants), based on an unchanged calendar year 2018 forecast of price-earnings ratio (PER) of 22 times (in line with the average PER of its regional peers).

7-Eleven is currently trading at 37 times of FY17 forecast and 33 times of FY18 forecast PERs, which, in our view, seem rather excessive against its modest three-year EPS compound annual growth rate 11.5%.  — CIMB Research, April 26