Courts Asia - DBS Research 2017-11-13: Headwinds Ahead

Courts Asia - DBS Vickers 2017-11-13: Headwinds Ahead COURTS ASIA LIMITED RE2.SI

Courts Asia - Headwinds Ahead

  • 2Q18 below expectations on lower credit sales in Malaysia.
  • Further headwinds in Malaysia.
  • Slash FY18F/19F earnings by 23%/31%.
  • Downgrade to HOLD, with lower S$0.36 TP.




Downgrade to HOLD on weaker outlook. 

  • We downgrade Courts Asia (Courts) to HOLD with a lower TP of S$0.36. We see weaker outlook for earnings on a tougher credit environment in Malaysia.
  • The adoption of Consumer Protection (Credit Sale) Regulations 2017 from 1 Jan 2018 will potentially reduce margins and sales growth in Malaysia. Due to headwinds ahead, we reduce our earnings projections and turn neutral on the stock. The stock is trading at fair valuations at 9.7x FY19F PE.


Weakness in credit sales in Malaysia. 

  • Courts Asia recognised a higher impairment at S$6.8m vs S$5.2m last year, largely led by Malaysia. The 180 days or more delinquency rate reached 7.9% in Malaysia, up from 7% in the previous quarter. Going forward, the new regulation will enforce a maximum interest rate cap of 15% on credit sales from Jan 1 2018. 
  • As profitability from Malaysia credit sales currently yield over 20%, we see lower gross margins ahead from lower profitability and reduction in credit sales as product prices become more competitive. 
  • Courts Asia is also rationalising its store count in Malaysia in response to this. With Malaysia expected to be a drag on sales and gross profit margins on lower product yields, we have lowered our FY18-19F earnings forecast by 23%/31%.


Valuation

  • We downgrade to HOLD as we expect more moderated earnings going forward. 
  • Our target price is S$0.36, based on 10x FY19F PE, pegged to near -1SD of its historical average valuation.


Key Risks to Our View


Interest rate increase and regional consumer sentiment.

  • Courts Asia’s credit business is sensitive to changes in interest rates. Interest rate increases would raise working capital financing costs, leading to lower credit yield spreads. As a regional retailer of consumer products, Courts is sensitive to wealth and domestic consumer sentiment changes in the markets where it operates.



WHAT’S NEW - 2Q18 below expectations 


Dragged by Malaysia’s credit sales: 

  • Courts Asia's 2Q18’s earnings came in at S$1.5m (-75% y-o-y) on the back of S$176m (-1.4% y-o-y) revenue, below our expectations. The lower revenue was led by a decline in Malaysia credit sales and partial closure of Courts Megastore at Tampines (for renovation) during the quarter. 
  • Singapore sales grew 5.9% y-o-y to S$125m while Malaysia sales declined 20% S$44m, mainly from the drop in earned service charges. Indonesia sales grew 17% y-o-y to S$7m. 
  • Same store sales (SSSG) in Singapore was 5.1% higher even with the Courts Megastore closure but Malaysia’s SSSG disappointed, declining 32.4%.

And lower profitability: 

  • Lower credit sales and price promotions in Singapore resulted in lower gross margins (34.2%, -1.7ppt). Along with higher opex (S$54m, +3.3% yo-y), EBIT came in at only S$6.8m (-44% y-o-y), below our forecast. 
  • Impairment was also higher at S$6.8m vs S$5.2m last year led by Malaysia as a result of the more challenging credit collection situation in Malaysia.

Muted earnings outlook: 

  • This set of results was disappointing as net profit was less than half of our estimate. The key was lower sales with similar cost structure as previous year resulting in lower margins and earnings. 
  • The difficult credit environment in Malaysia is a concern. The 180 days or more delinquency rate reached 7.9% in Malaysia, up sequentially from 7% in the previous quarter. 
  • Indonesia continues to be loss making (EBIT) after opening 9 stores and requires more time and further operational scale to achieve EBIT breakeven. We do not see Indonesia breaking even soon as even without the central costs, store operations are collectively loss making.

Consumer Protection regulations in Malaysia negative for Malaysia credit sales: 

  • Malaysia has adopted the Consumer Protection (Credit Sale) Regulations 2017, and will enforce a maximum interest rate cap of 15% on credit sales from Jan 1 2018. This will affect profitability going forward given that c.70% of Malaysia’s sales are credit and service charge revenue. 
  • Margins on credit products are currently yielding over 20% and this rule will essentially reduce profitability by more than 5 ppts. This however opens up a new market to target the lower income, which means selling prices will be more competitive and should lead to lower product yields as well. It has already introduced a low interest rate product on a trial basis in response to this development.

Store expansion less aggressive: 

  • Following Consumer Protection regulations and tougher credit collection environment, Courts will rationalise its stores in Malaysia as it seeks to tighten credit granting and mitigate receivables risks.
  • We do not expect store expansion to be aggressive especially in Singapore as there is more scope for better store productivity and omni-channel strategy on the back of the online trend. Indonesia has already ramped up to 9 stores.
  • We believe it should strive to achieve operational efficiency before opening more stores.

Slash FY18-19F earnings by 23-31%: 

  • We lower our earnings projections by 23-31% to reflect the weak 2Q18 results and the weaker credit environment in Malaysia going forward.
  • We have reduced our FY18/19F sales forecast and gross margin assumptions by 3.7/7.8% and 0.7/0.4 ppt, in line with the slower sales and lower margin environment in Malaysia.

Downgrade to HOLD, TP lowered to S$0.36: 

  • With the earnings forecast reduction, we lower our TP to S$0.36 pegged to 10x FY19F PE. The stock currently trades largely in line with our fair valuation at 9.7x FY19F PE. 
  • Downgrade to HOLD on weaker outlook.




Alfie YEO DBS Vickers | Andy SIM CFA DBS Vickers | http://www.dbsvickers.com/ 2017-11-13
DBS Vickers SGX Stock Analyst Report HOLD Downgrade BUY 0.36 Down 0.490



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