Puregold

Company Report PHILIPPINE EQUITY RESEARCH

Puregold Price Club, Inc.: In Prime Position for Growth Initiating Coverage 10 FEBRUARY 2012

SHARE DATA

HOLD

Rating Ticker

PGOLD

Fair Value (Php)

21.00

Current Price

20.90

Upside (%)

0.48

We are initiating coverage on Puregold Price Club, Inc. with a HOLD recommendation and an FV estimate of Php21.00/sh based on the DCF method. Puregold is well positioned to capitalize on the existing growth opportunities in the country’s retail sector given its well-recognized brand, differentiated focus on middle to lower income customers and resellers, and aggressive expansion plans. However, current valuations are unattractive, with the stock trading at par with our fair value estimate and relative to peers. Pullbacks below Php18.00/sh Php18.00 /sh should be viewed as opportunities to BUY the stock. A growing retail industry. Over industry. Over the past decade, the country’s country ’s retail industry has grown significantly, benefiting from the steady economic and population growth, higher disposable incomes, and increasing urbanization. This trend is expected to continue going forward, with Planet Retail forecasting a 2-year CAGR of 11.0% for total retail sales until 2012.

ABSOLUTE PERFORMANCE (%) 1M PGOLD

3M

YTD

18.99

43.92

19.13 19.13

5.02

9.74

9.10 9.10

PSEi

Penetrating the larger traditional retail market by tapping resellers. Over 70% of the country’s retail sales still come from traditional formats. Puregold Puregold actively tries to penetrate the said market by tapping resellers. Puregold’s Tindahan ni Aling Puring (TNAP) loyalty program attracts resellers by giving reward points and discounts. The program has been quite successful, with sales from TNAP members currently accounting for 30% of the company’ company’ss sales.

(Php)) MARKET DAT DATA A (Php

Market Cap

Favorable competitive landscape supportive of growth. growth. While competition in urban areas particularly in Metro Manila is relatively intense, much opportunity still lies in provincial areas which are still dominated by independent local stores. Larger players such as Puregold offer value to consumers by providing greater convenience, more product variety, and lower pricing. This should provide large players much room to grow without having to fight for market share.

42,600.00 Mil

Outstanding Shares

2,000.00 Mil

52 Wk Range (Php)

10.68-21.70

3 Mo Ave Daily T/O

87.27

Store expansion to drive earnings growth. growth. Over the next five years, Puregold plans to spend Php10.2Bil to expand its branch network from 100 stores as of end 2011 to 200 stores by 2016. Puregold’s aggressive expansion should continue to fuel earnings growth through higher s ales and margins. We forecast net income to increase at a CAGR of 22.5% for the next five years, reaching Php4.17Bil by 2016. Valuation is unattractive; wait for pullbacks to buy. At the current market price of Php20.90/sh, Puregold is trading in line with our FV estimate of Php21.00/sh. Puregold is also fairly valued relative to its peers, trading at 17.8X 2012E P/E, which is slightly higher than the 17.0X average of comparable companies. Nevertheless, pullbacks to prices below Php18.00/sh should be viewed as opportunities to buy. FORECAST SUMMARY Year to Decemer 31 (Php Mil) Net Sales % change y/y Gross Profit % change y/y Gross Margin (%) Operating Income % change y/y Operating Margin (%) Net Income % change y/y Net Profit Margin (%)

RESEARCH CONTACT

Charles William Ang [email protected]

RELATIVE VALUE P/E (X) P/BV (X) ROE (%) Dividend Yield (%) Source: PGOLD, COL estimates

2009 24,112

2010 29,108

2011E 36,990

2012E 49,915

2013E 58,505

28.0

20.7

2 7.1

3 4.9

2,219

3,531

5,437

7,487

1 7 .2

59.5 9 .2

59.1 12.1

5 4.0 1 4.7

3 7.7 1 5 .0

458

985

2,246

3,401

54.3 1 .9

1 1 5 .1 3 .4

1 2 7 .9 6 .1

5 1.4 6.8

131

510

1,515

2,349

1 .6 0 .5

2 8 8.3 1 .8

1 9 6 .8 4 .1

5 5 .1 4 .7

2 0.4 4.8

187.3 19.5

51.8 14.8

21.6 4.5

17.8 3.6

14.8 2.9

11.0 0 .0

30.8 0 .0

2 6.6 0 .0

2 2.4 0 .0

2 1 .6 0.0

8,776 1 7 .2 1 5.0

4,097 2 0 .5 7.0

2,829

10 FEBRUARY 2012

Initiating Coverage with a HOLD rating

Exhibit 2: Store Formats 1

We are initiating coverage on Puregold Price Club, Inc. with a HOLD recommendation and an FV estimate of Php21.00/sh based on the DCF method. Growth prospect for the modern retail industry is very attractive, with the modern retail industry accounting for only 21.2% of the total retail industry. At the same time, the modern retail industry should benefit from increasing urbanization in the country. Puregold is well positioned to capitalize on the existing growth opportunities in the country’s retail sector given its wellrecognized brand, differentiated focus on middle to lower income customers and resellers, and aggressive expansion plans. Despite Puregold’s growth prospects, we believe valuations are unattractive. At Php21.90/sh, the stock is already fairly valued, trading at par with our FV estimate. Puregold is also unattractive in terms of relative valuation. At its current price, the stock is trading at 17.8X 2012E P/E, which is slightly higher than the 17.0X average P/E multiple of peers. Nevertheless, pullbacks to prices below Php18.00/sh should be viewed as opportunities to buy.

Company Background Puregold is currently the country’s second largest retailer among hypermarkets, supermarkets, and cash and carries based on gross sales. The company conducts its operations through three retail formats and store brands. These include hypermarkets under the brand “Puregold Price Club”, supermarkets under “Puregold Junior”, and discounters under “Puregold Extra”. As of end September 2011, the three formats comprise 86.7%, 11.7% and 1.7% of net sales respectively.

No. of Stores

Puregold Price Club Puregold Junior Puregold Extra Total

61 28 11 100

Avg. Net Selling Stock-Keeping 2 Units (SKUs) Space

3,368 947 432

up to 50,000 up to 8,000 up to 2,000

Source: PGOLD as of end 2011 2

as of August 2011

Puregold targets middle to lower income retail customers or the Cclass and D-class households with monthly income of Php8,000 to Php50,000/mo. It also targets local resellers such as sari-sari stores, canteens, bakeries, etc. As of end 2Q11, retail customers accounted from approximately 70% of total revenues, while resellers accounted for the remaining 30%. In line with its focus on the lower end market, the Puregold brand is associated with low prices, high value-for-money, and a wide assortment of products. Puregold has successfully grown its business at an above average pace, with net sales increasing from Php18.9Bil in 2008 to Php29.2Bil in 2010, representing a 2-year CAGR of 24.3%. During the first three quarters of 2011, sales reached Php27.0Bil, up 36.3% from the same period in 2010. Net income increased at a faster pace, rising by a 2-year CAGR of 98.6% from Php129.4Mil in 2008 to Php510.4Mil in 2010. Earnings for 9M11 were also strong, increasing by 185.0% to Php1.08Bil. Following its initial public offering last year, the Co Family beneficially owns 65.5% of Puregold. Four of the seven directors are also members of the family, with Lucio Co serving as the Chairman of the company.

Exhibit 1: Revenue Breakdown by Retail Format Puregold Junior, 11.7%

A growing industry

Puregold Extra, 1.7%

Over the past decade, the country’s retail industry has grown significantly, benefiting from the steady increase in the population, improvement in the economy, higher disposable incomes, and increasing urbanization. This trend is expected to continue going forward, with Planet Retail forecasting a 2-year CAGR of 11.0% for total retail sales until 2012.

Puregold Price Club, 86.7% Source: PGOLD

Growth prospect of the modern retail industry, which is comprised of hypermarkets, supermarkets, convenience stores, cash and carries, etc., is even more attractive. As of end 2010, the country’s modern retail industry was highly under-penetrated, having only 17 sqm of total modern retail sales area for every 1,000 inhabitants. This is much lower than the average for the region. Also, ap-

PGOLD/Field Notes/ page 2

10 FEBRUARY 2012

proximately 79% of total retail sales still come from the traditional formats such as wet markets and sari-sari stores. In contrast, only 51% of retail sales in Asian countries excluding Japan come from traditional formats. Exhibit 3: Modern Retail Formats Total Sales Area per 1000 Inhabitants (sqm)

Exhibit 5: Sales of Top Market Participants (in US$ Mil) 1,825

743

570 195

270

S M In ve st me nt 149

133

South Korea

Malaysia

473 222

R us ta n' s

R ob in so ns

145

239

B en is on G ro up

120 120 Un iwi de

2010

Source: Planet Retail

32

T aiwan

P ur eg ol d

326

2006

108

Japan

712

China

17

14

6

Philippines

Indonesia

Vietnam

Source: Planet Retail

Exhibit 4: 2010 Modern vs. Traditional Retail Sales

Modern Retail Sales 21%

Traditional Retail Sales 79% Source: Planet Retail

Favorable competitive landscape supportive of growth Puregold is currently one of the largest and fastest growing hypermarket and supermarket retail chains in the country. As of 2010, Puregold trails only the SM group – comprised of Supervalue, Inc. (SM Supermarkets), Sanford Marketing (Savemore), and Supershopping, Inc. (SM Hypermarkets) – in terms of sales and selling space. Other notable competitors include Rustan’s, Robinsons, Benison Group of Companies, and Uniwide.

Philippine retailers have benefited from the absence of foreign competitors. Up until 2000, regulations have prohibited global leaders such as Wal-Mart and Carrefour from entering the country. This has allowed local players to grow significantly and to gain superior insight into the market before any foreign competitors. The huge size of dominant players is also expected to discourage new entrants from coming in. For example, as of end 2010, SM had an asset base of Php65.3Bil and sales of Php74.6Bil, while Puregold had an asset base of Php10.1Bil and sales of Php29.1Bil. Size is important as this leads to economies of scale in terms of overhead costs and greater bargaining power with suppliers. The top players also benefit from having substantial control of the market. As of end 2010, the top six players already accounted for 91% of total sales of hypermarkets, supermarkets, cash & carries, and convenience stores, with the top the top four already accounting for 83% of total sales. While the competitive environment in urban areas, particularly in Metro Manila is relatively intense, much opportunity still lies in provincial areas. Such areas are still currently largely dominated by independent local stores, which would be prime markets as the larger players could offer more value in terms of convenience, products, and pricing. This should provide the top players much room to grow without having to fight for market share.

Penetrating the larger traditional retail market by tapping resellers As discussed earlier, over 70% of the country’s retail sales still come from traditional formats. Puregold actively tries to penetrate the said market by tapping resellers. To attract resellers, Puregold launched the Tindahan ni Aling Puring (TNAP) loyalty program. The TNAP program is a free, lifetime membership club for retail micro-


10 FEBRUARY 2012

entrepreneurs. It is primarily a rewards based program which allows members to accumulate points based on the quantity of their purchases. On the top of these rewards, the program also offers additional services such as sales delivery, training sessions, and insurance benefits. Such promotions have successfully allowed the company to attract resellers. Since launching the TNAP program in 2001, the number of its members has grown from 30,000 in 2005 to 170,000 as of end August 2011. Of the current TNAP members, approximately 93% are sari-sari store owners. Sales from TNAP members currently account for over 30% of total net sales. While Puregold doesn’t have a specific growth target for this segment, we expect this to comprise a bigger percentage of revenues going forward as it expands into less urbanized areas. Exhibit 6: Breakdown of Net Sales as of 1H11

TNAP Members 31%

Store expansion to drive earnings growth Over the past two years, Puregold rapidly expanded its portfolio of stores from 34 branches in 2009 to 100 branches as of end 2011. This led to a 23.9% CAGR of sales. Meanwhile, we forecast earnings to grow by a much faster pace from Php131 Mil in 2009 to Php1.52 Bil in 2011, representing a two-year CAGR of 240%. The improved scale and stronger bargaining power with supplier resulting from Puregold’s larger size allowed gross margin to increase from 9.2% to 14.7%, and operating margin to expand from 1.9% to 6.1% respectively. Going forward, we expect Puregold to continue with its rapid branch expansion. Over the next five years, Puregold is expected to increase its branch network from 100 stores as of end 2011 to 150 stores by 2013 and 200 stores by 2016. The company is projected to spend Php10.2Bil in capital expenditures, funded by the proceeds of its initial public offering and internally generated funds. Our growth forecast is generally in line with the company’s guidance. Exhibit 7: Store growth forecast 200

100

Retail Consumers 69%

0

2009

2010

2011 Hypermarkets

2012E

2013E

Supermarkets

2014E

2015E

2016E

Discounters

Source: Puregold, COL Forecasts Source: Puregold

Focus on lower income segments improves resilience Compared to its competitors, Puregold believes that it will be less affected by negative economic developments such as a potential drop in remittances, or weaker-than-expected GDP growth. This is largely due to its focus on lower income segments. Most of Puregold’s customers are from the broad C and D markets and the local resellers. PGOLD believes that during times of economic hardships, its business stands to benefit from a shift down from higher classes, increasing its overall market and offsetting the decline in purchasing power.

Puregold’s aggressive expansion should continue to fuel earnings growth. By 2016, we expect net sales to rise to Php79.53Bil, corresponding to a five-year CAGR of 16.5%. Meanwhile, we expect gross margins to peak at around 15.0%, just slightly above its current level and comparable to the margin of other major players. Nevertheless, we forecast operating margins to steadily increase to 7.6% in 2016 since Puregld’s larger network will allow the company to benefit from increasing economies of scale. Given these assumtions, Puregold’s net income is expected to grow at a CAGR of 22.5% for the next five years, reaching Php4.17Bil by 2016.


10 FEBRUARY 2012

Exhibit 8: Margins Forecast

Puregold faces operational and logistical risks of doing business in new territories. Possible difficulties include obtaining regulatory or local government approvals and distributing/transporting inventories. Also, Puregold may experience difficulty in building its brand in these new areas.

16% 12% 8% 4% 0% 2008

2009

2010

2011E

Gross Margin

2012E

2013E

Operating Margin

2014E

2015E

2016E

2 01 5E

2 01 6E

Net Margin

Source: Puregold, COL Forecasts

Exhibit 9: Net Income Forecast Stores Net Sales (PhpMil) Net Income (PhpMil)

2 00 9

2 01 0

2 01 1E

2 01 2E

2 01 3E

2 01 4E

34

62

100

128

150

169

185

200

24,112 29,108 36,990 49,915 58,505 66,049 72,858 79,525 131

510

1,515

2,349

2,829

3,290

3,728

While the risks may be substantial, Puregold believes that the risks are worth taking given its growth potential. The company understands that Visayas and Mindanao are largely underserved in terms of the large-scale hypermarkets and supermarkets. Currently, Visayas and Mindanao account for 39% and 32% of the country’s total population and GDP.

Competition could intensify as Puregold gains recognition

4,173

Source: PGOLD, COL Forecasts

Efficient business model key to rapid expansion Puregold’s strong track record of growth is mainly attributable to its efficient business model which features multi-format offering of hypermarket, supermarket, and discounters; strategic store locations; and efficient and scalable operations. Using its three available store formats, Puregold aims to maximize coverage and penetration by offering the most suitable format/s for a particular area. Primary factors in choosing a location include the targeted catchment area and the accessibility of the store by its target customers. The company’s efficiency is further supported by outsourcing its logistics and distribution functions to third-party cross-docking providers. All restocking of the company’s inventory are conducted either through direct store deliveries using the distribution channel of its suppliers, or by a third-party cross-docking, which involves the transfer of a cargo from one transport vehicle to directly to another with minimal warehousing. Such a setup allows Puregold to rapidly expand its operations without sacrificing its operating efficiency.

Expansion into Visayas and Mindanao presents notable risk A significant part of the Company’s medium term expansion plan is to open stores in Visayas and Mindanao. Specifically, Puregold is planning to have 12 stores each in Visayas and in Mindanao by 2013, which would mark the first time that the company is opening stores outside of Luzon. With no prior experience in these areas,

With the success of Purergold, competitors might decide to replicate the company’s business model. Particular strategies that competitors might replicate include the company’s focus on resellers; targeting the lower income segments; and utilizing the same multiformat offering. Such actions could potentially reduce the company’s competitive advantage going forward. Also, competitors might follow Puregold’s plan to expand in areas outside of Luzon. This could possibly give competitors first mover advantage in some areas. Nevertheless, given Puregold’s current scale, extensive experience, and established brand name, we believe that the company would continue to have an advantage over other players. Puregold’s aggressive expansion plan and adequate capital base also allow it to remain a step ahead of the competition.

Valuation unattractive; Pullbacks are opportunities to buy Despite Puregold’s attractive growth prospects, we believe valuations are unattractive. At Php20.90/sh, the stock is already fairly valued, trading at par with our FV estimate. Puregold is also unattractive in terms of relative valuation. At Php20.90/sh, the stock is trading at 17.8X 2012E P/E, which is slightly above the 17.0X average P/E multiple of peers. Nevertheless, pullbacks to prices below Php18.00/sh should be viewed as opportunities to buy.


10 FEBRUARY 2012

Exhibit 10: P/E Ratio of Comparables Lianhua Supermarket Holdings Wumart Stores Beijing Jingkelong Company Yonghui Superstores Company Zhongbai Holdings Group Chongqing Department Store AEON Co. Wal-Mart Stores Costco Wholesale Corp Target Corp Carrefour SA Average

P/E Ratio EPS Growth 13.9 14.4% 25.7 22.5% 11.1 17.3% 33.1 39.2% 16.2 22.7% 13.9 20.9% 12.3 9.7% 13.8 11.0% 22.3 15.4% 12.3 9.1% 12.5 6.5% 17.0 17.2%

Source: Bloomberg


10 FEBRUARY 2012

Appendix 1: Income Statement (in Php Mil) 08

Net Sales Gross Profit Other Income

18,841.8 1,391.2 891.5 Operating Expense 1,985.7 EBIT 297.0 Taxes 48.2 Net Income

EPS

09

10

11F

12F

13F

24,112.4 2,219.4 785.3 2,546.5 458.2 57.5

29,108.0 3,531.0 780.7 3,326.3 985.3 232.6

36,989.7 5,437.5 992.1 4,183.7 2,245.9 690.4

49,915.1 7,487.3 1,338.7 5,425.4 3,400.6 1,070.5

58,505.0 8,775.8 1,569.1 6,247.4 4,097.5 1,289.2

129.4

131.4

510.4

1,514.9

2,349.0

2,828.9

0.11

0.11

0.40

0.97

1.17

1.41

Source: PGOLD, COL estimates

Appendix 2: Balance Sheet (in Php Mil)

Cash Receivables Inventory Other CA Ttl. CA

08 1,224.7 809.2 1,901.1 4,033.9 7,968.9

09 1,136.1 645.3 1,904.3 6,229.9 9,915.7

10 1,837.9 241.6 2,934.3 402.1 5,415.9

11F 6,002.8 307.0 3,619.7 344.3 10,273.8

12F 6,876.3 414.3 4,867.4 456.2 12,614.2

13F 8,999.7 485.6 5,705.1 530.7 15,721.0

PPE Oth. Assets Ttl. Assets

1,592.1 301.9 9,862.9

2 ,166.0 386.2 12,467.9

4 ,145.5 562.3 10,123.7

5,904.3 714.5 16,892.7

8 ,297.2 964.2 21,875.7

9 ,605.0 1,130.2 26,456.2

Accounts Payable 3,230.3 Short Term Debt 4,241.3 Other CL 1,036.6 Ttl. Cl 8,508.2

3,767.5 6,114.2 985.3 10,867.0

4,985.3 2,092.3 451.4 7,529.1

6,163.8 0.0 696.5 6,860.2

8,253.8 0.0 983.0 9,236.7

9,654.9 0.0 1,145.8 10,800.8

LT Debt Oth. Liabs Ttl liabs

0.0 220.4 8,728.6

0.0 335.3 11,202.3

0.0 546.8 8,075.9

0.0 711.0 7,571.3

0.0 968.5 10,205.2

0.0 1,156.0 1 1,956.8

Minority Int S/H Equity

0.0 9,862.7

0.0 12,467.9

0.0 10,123.7

0.0 16,892.8

0.0 21,875.7

0.0 26,456.3



10 FEBRUARY 2012

Appendix 3: Cash Flow Statement (in Php Mil) 08

09

(227.5) 129.4 192.6 0.0

(1,067.4) 131.4 376.9 (1,549.4)

(1,358.7)

(894.1)

(2,390.2) (2,321.5) (3,147.1) (2,137.3)

0.0 0.0

(870.5) (23.6)

(2,268.2) (2,214.0) (2,970.8) (2,020.1) (122.0) (107.5) (176.3) (117.2)

Financing CF Cash dividend Debt Others

2,247.9 0.0 0.0 0.0

1,872.9 0.0 1,872.9 (0.0)

(3,633.7) 0.0 (4,021.9) 388.2

3,666.5 0.0 (2,092.3) 5,758.8

0.0 0.0 0.0 0.0

0.0 0.0 0.0 0.0

Change in cash Cash (Begin) Cash (End)

661.8 562.9 1,224.7

(88.5) 1,224.7 1,136.1

701.8 1,136.1 1,837.9

4,164.9 1,837.9 6,002.8

873.5 6,002.8 6,876.3

2,123.4 6,876.3 8,999.7

Operating CF Net income Othr non-cash items Chng in wrk cap Investing CF Acquisition of PPE Other non-current assets

10

11F

6,725.7 510.4 426.4 5,769.3

2,819.9 1,514.9 574.6 730.4

12F

4,020.6 2,349.0 762.0 909.6

13F

4,260.6 2,828.9 851.0 580.7


Appendix 4: Ratios

ROE Sales Growth EPS Growth GPM OPM NPM CA/CL (X) D/E Ratio

08

09

10

11F

12F

13F

11.4%

11.0% 28.0% 1.6% 9.2% 1.9% 0.5% 0.9 4.8

30.8% 20.7% 261.4% 12.1% 3.4% 1.8% 0.7 1.0

26.6% 27.1% 140.4% 14.7% 6.1% 4.1% 1.5 0.0

22.4% 34.9% 21.1% 15.0% 6.8% 4.7% 1.4 0.0

21.6% 17.2% 20.4% 15.0% 7.0% 4.8% 1.5 0.0

7.4% 1.6% 0.7% 0.9 3.7



10 FEBRUARY 2012

INVESTMENT RATING DEFINITIONS

BUY

HOLD

SELL

Over the next six to twelve months, we expect the share price to increase by 15% or more.

Over the next six to twelve months, we expect the share price move within a range of +/- 15%.

Over the next six to twelve months, we expect the share price to decline by more than 15%.

TOP PICK DEFINITION A stock that is included in our “Top Pick” list has to meet the following criteria: 1.) It must belong to a sector with neutral to positive outlook; 2.) It must have double digit earnings growth for the current and the succeeding fiscal year; 3.) Its share price appreciation potential must be above 15% as of the date it was included in the list; and 4.) It must have an upward intermediate term trend.

IMPORTANT DISCLAIMERS Securities recommended, offered or sold by CitisecOnline are subject to investment risks, including the possible loss of the principal amount invested. Although information has been obtained from and is based upon sources we believe to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the judgment of CitisecOnline’s Equity Research Department as of the date of the report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. CitisecOnline and/or its employees not involved in the preparation of this report may have investments in securities or derivatives of securities of companies mentioned in this report, and may trade them in ways different from those discussed in this report.

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Puregold

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