Courts Asia - CIMB Research 2016-09-18: Forgotten child has not been rewarded

Courts Asia - CIMB Research 2016-09-18: Forgotten child has not been rewarded COURTS ASIA LIMITED RE2.SI

Courts Asia - Forgotten child has not been rewarded

  • At 7.8x CY17 P/E, Courts’ valuations look cheap relative to both its historical trading band and peers. Stock also offers a 4% yield.
  • Courts’ 1QFY17 quarterly net profit (S$9.4m, +56% yoy) was its highest in over three years, mostly driven by better profitability in its Singapore operations.
  • Gross margins were also at record high levels (36.1% vs. historical average of 33%), mainly due to better merchandise margins.
  • Reiterate Add with a higher TP of S$0.53 (based on 10.2x CY17 P/E, 1 s.d. below mean).

Trading below its -1s.d. level despite a stellar quarter 

  • Courts’ 1QFY17 net profit growth (+56% yoy) was among the highest in our consumer coverage and was its highest quarterly net profit in over three years. However, its current valuations of 7.8x CY17 P/E (below its historical -1 s.d. level of 10.2x and way below peers’ 22.9x) seem to suggest the market has yet to price in a recovery.
  • Continued recovery could be a potential catalyst for the stock.

Focus is now on cost and margin management 

  • The group’s focus has been on improving productivity. Examples include subleasing floor space to complementary brands and reinventing its store format to being more modular and flexible, which enables stores to quickly change their layout to suit different product seasonality throughout the year. 
  • Rents are also coming down and management continues to negotiate for lower rents across the stores in Singapore and Malaysia. As such, we believe margin improvement will continue to drive earnings growth.

Record high gross margins 

  • 1QFY17 gross margins were at a record high of 36.1% (vs. 2-year historical average of 33%). Drivers for the improved gross margins were higher merchandise margins, supported by 
    1. greater bulk purchases and 
    2. higher supplier rebates. 
  • The group also underwent an extensive product range overhaul in Singapore in 4QFY16, which has now led to a more current product range and an overall improvement in margins. 
  • A higher proportion of credit sales in Singapore also led to the better profitability.

Continued turnaround could spur a re-rating 

  • We view Courts as a turnaround story, with earnings growth driven by better margin management and cost reduction. 
  • Upside could also come from a more stable ringgit and higher credit sales (which carry higher margins than cash sales). Investors are also paid to wait with an attractive yield of c.4%.

Reiterate Add 

  • We update our historical forward P/E trading band to better reflect Courts’ current business cycle. Our selected timeframe now includes both its peak valuations in CY13 and its trough valuations in CY15. 
  • Our TP rises to $0.53 as a result, but is still pegged at the -1 s.d. level (10.2x CY17 P/E; prev. 9.6x). 
  • We believe Courts deserves to trade at least on par with its -1 s.d. level as earnings are already turning around. Peers are trading at 22.9x CY7 P/E. 
  • Downside risks include unexpectedly large credit losses.

Jonathan SEOW CIMB Research | 2016-09-18
CIMB Research SGX Stock Analyst Report ADD Maintain ADD 0.53 Up 0.500