This article first appeared in The Edge Financial Daily on June 10, 2019

Padini Holdings Bhd
(June 7, RM3.65)
Upgrade to buy with an unchanged target price (TP) of RM4.28: Concerns for importers typically arise and further escalate when the US dollar to ringgit skyrockets. However, in Padini’s context, we believe such generalisation may not reflect its entirety.

This is because 60%-70% of Padini’s products are imported from China and the majority of the products are purchased via local forwarders. Hence, it reduces the sensitivity of product costs due to fluctuation in foreign currency.

Moreover, observing the movement of the Chinese yuan to the ringgit, the ringgit has instead strengthened against the yuan by 1.7% year-on-year (y-o-y) during the January-May 2019 period.

While the Malaysian overnight policy rate (OPR) cut of 25 basis points in May and further speculation of OPR cut may lead to some weakness in the ringgit, the yuan is similarly experiencing downside weakness owing to the rising tensions between the US and China over trade and technology, alongside fear of massive capital outflow.

Hence, we opine that concerns over foreign currency movement are unjustifiable.

As per guidance, Padini opened four new stores in FY19, in which a set of Brands Outlets and Padini Concept Stores were opened in Central i-City, Selangor and Mid Valley South Key, Johor.

The group’s efforts in rationalising stores and focusing on bigger multi-brand stores are seemingly fruitful with revenue rising despite lesser store counts (cumulative nine-month [9MFY19] sales increased by 5.5% y-o-y, despite three net reductions of stores throughout the period).

Moreover, Padini recorded a strong same-store sales growth of 4% during 9MFY19 which reflects management’s effectiveness in growing its matured assets through improved merchandises, product differentiation and optimal pricing strategy.

Padini intends to generate operational efficiencies by improving its internal operations, namely on workforce optimisation and warehouse automation.

As the group shifts its strategy towards bigger multi-brand stores that is Brands Outlets and Padini Concept Stores, we believe aforementioned efficiencies are more likely to be achieved because the strategy would give rise to flexibility in resource allocation.

For example, we believe staff in a bigger store can be cross-trained for multiple brands, thus resulting in a more effective and leaner structure.

Note that composition of salaries to selling and distribution expenses has declined to 39% in 9MFY19.

The Malaysian Financial Reporting Standard 16 shall come into effect on July 1, in which the new accounting standard requires application of a right-of-use approach. Based on our back-of-the-envelope computation, we believe the current yearly rental expense (about RM150 million) could translate into a combined lease interest and depreciation expenses amounting to RM160 million — hence, putting a mild drag on profit before tax of about RM10 million or about 4% of our FY20 PBT projection. — TA Securities, June 7