7-Eleven margins expected to improve further

This article first appeared in The Edge Financial Daily, on December 4, 2018.
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7-Eleven Malaysia Holdings Bhd
(Dec 3, RM1.29)
Upgrade to hold with a higher target price (TP) of RM1.34:
7-Eleven Malaysia Holdings Bhd recorded higher sales of RM1.7 billion (+1.3% year-on-year [y-o-y]) for the cumulative nine months ended Sept 30, 2018 (9MFY18), while core net earnings jumped 13.3% y-o-y to RM38.8 million.

This was above our and Bloomberg consensus expectations, making up 82% of respective full-year forecasts. The stronger-than-expected earnings were due to higher-than-expected other operating income and higher-than-expected profit margins owing to a more lucrative product mix.

Third quarter ended Sept 30, 2018 (3QFY18) revenue registered a 2% quarter-on-quarter (q-o-q) growth, thanks to: i) an increase in the store count (+18); ii) an improved merchandise mix, especially for fresh food and beverage products; and iii) a higher average spend per customer. The 3QFY18 earnings before interest, taxes, depreciation and amortisation margin also improved 0.3% percentage points (ppts) q-o-q to 6.8%, owing to a more profitable product mix.

This led to a 27.6% q-o-q jump in 3QFY18 net profit, which was further aided by lower depreciation charges (-8.2% q-o-q), an increase in other operating income (+21% q-o-q) and a lower tax rate for 3QFY18 (-3.9ppts q-o-q).

Going forward, we expect 7-Eleven’s margins to improve further, via three key strategies.

First, it will focus on ramping up sales of its own-brand products (the 7-Eleven brand) which generate higher margins and offer better product flexibility.

Also, it aims to grow revenue contributions from its fresh food products, which we estimate to be less than 5% of total 9MFY18 revenue.

It will also continue to rationalise its existing stock keeping units to prevent any product overlaps and to have sufficient space to cater for more products.

Given the stronger-than-expected 9MFY18 results, we have increased our FY18 to FY20 forecasts by 12.6% to 13.7%.

This is mainly to account for: i) a more profitable product mix; and ii) higher other operating income.

With our forecast upgrade and as we roll over our valuation to FY19 forecasts, our TP has risen to RM1.34.

We value its business at 24 times calendar year 2020 price-earnings ratio, in line with the regional peer average. We have also upgraded the stock to a hold.

Although we think the worst is over, we believe the current valuation has priced in the company’s better prospects. Downside/upside risks include weaker/higher-than-expected same-store sales growth. — CGSCIMB Research, Nov 30