This article first appeared in The Edge Financial Daily on October 20, 2017

Padini Holdings Bhd
(Oct 19, RM4.59)
Downgrade to sell with an unchanged target price (TP) of RM4.67: Key takeaways from our meeting with Padini Holdings Bhd’s management are: i) its store rendering programme; ii) its overseas expansion; and iii) reducing imports from China.

Padini has made a concerted effort in store rendering, which has yielded positive results for the past two years. Financial year 2016 (FY16) and FY17 earnings have increased by 64% and 17.3% respectively, underpinned by: i) the opening of new Padini Concept Stores, Brands Outlet Stores and free-standing stores; and ii) closing down of underperforming stores.

For FY18, Padini will continue to focus on its store rendering programme to sustain earnings growth. It has plans to open a total of 12 new stores in FY18, which we believe six would be Padini Concept Stores and six Brands Outlets. In the meantime, we expect the company to close down five underperforming stores in FY18.

Note that in the first three months of FY18, Padini opened four stores in the vicinity of the Klang Valley and Johor (two Brands Outlets and two Padini Concept Stores). We project Padini’s total stores to increase to 141 by end-FY18 from 132 in FY17.

Recently, Padini has announced plans to expand regionally to diversify its earnings. It has identified Phnom Penh, Cambodia, for its first venture with three new stores opening in FY18. Management guided that benefits of expanding to Cambodia includes: i) a 17% tax rate; ii) Cambodia does not have capital control; and iii) it is easy to set up a subsidiary with 100% foreign shareholding. The leniency in Cambodia has made it an attractive destination for Padini to test-run its first overseas Brands Outlets stores and Padini Concept stores.

Total costs of opening three stores are expected to be between RM1 million and RM3 million. Given its stage of infancy, we do not foresee material impact on Padini’s earnings. However, we believe that the group is in the right path to meeting its healthy growth strategy. Note that Padini also has about 50 foreign outlets which are managed by licensees and dealers under the Vincci label and revenue contribution was less than 3% as of FY17.

In the past, Padini’s products have mostly been (90%-100%) imported from China. However, Padini’s gross profit margin declined by 2.3 percentage points year-on-year to 39.4% in FY17 from 41.7% in FY16. This was attributable to: i) rising costs of production; ii) a weak ringgit; and iii) rising costs of transportation.

In light of diversifying the group’s earnings risks, Padini is looking at reducing its dependency on production from China. Management guided that as of October 2017, Padini’s production is now 70% from China, 20% Malaysia and 10% others (Bangladesh, India, Cambodia and Vietnam).

We believe that Padini is taking active actions in mitigating the reduction in gross profit margin and we project that the efforts will reflect positively in the next couple of years. Therefore, we project that Padini’s gross profit margin will return to a comfortable 40% level by FY19. We raise our FY18-FY20 earnings projections by 1.3%-3.8%. In our forecast, we also assume Padini’s same-store-sale growth to be 5.3%-6.9% for FY18-FY19.

We maintain our TP of RM4.67 per share for Padini based on 16 times 2018 earnings per share. However, we downgrade our stock recommendation to “sell” (from “buy”) as the stock valuation has run ahead of its fundamentals.

Note that Padini’s share price has gone up 80% year-to-date. We believe it has fully priced in some possible goodies to be announced in the upcoming Budget 2018. — TA Research, Oct 19