Ramayana Lestari Cash From The Red Ocean
We reinitiate coverage of PT Ramayana Lestari Tbk (RALS) with a NEUTRAL rating and DCF-derived TP of IDR780 (implying a 15.8x FY15F P/E). RALS is the largest department store chain targeting the low- to mid-low income earners in Indonesia. Some of the key issues are: i) ubiquitous competition, ii) expansion outside Java is on hold, iii) lower operating margin and iv) focus on SPAR supermarkets might take away its attention from protecting the still-profitable department stores.
Ubiquitous competition
As RALS cannot differentiate itself from its competitors, it faces stiff competition from all angles. In the department store business, RALS faces local regional retailers and chronic cheap clothing imports. Furthermore, the minimarkets have been chipping away at its supermarket business as Indonesians’ lifestyle changes.
Expansion outside Java is on hold
As the commodities producing regions, such as Kalimantan and Sumatera, suffer from declining commodities prices, RALS did not open any new stores in FY14. Its low-end customers outside Java are predominantly workers in the mining and plantation areas, which are prone to downsizing. Thus, it plans to open five to six stores again in the competitive Jakarta and Java regions again this year.
Lower operating margin and cash piling-up in FY14
On the cost side, RALS has been affected by the rising salaries of its employees, resulting in lower operating margin. Also, although RALS indeed has good operating cash flow generation, with the cash piling up on its balance sheet, its asset turnover has declined every year.
SPAR supermarket
We appreciate management’s determination to revive its loss-making supermarket division. Partnering with SPAR, RALS will convert 50 of its 98 current supermarkets to SPAR supermarkets within the next two to three years. However, with management’s focus in supermarket business, there is a looming risk that RALS might lose its grip on its still-profitable fashion division.
Reinitiating coverage with a NEUTRAL and a TP of IDR780 (a 4.7% upside)
Our DCF-based TP is derived using a WACC of 12.5% and TG of 5%, which will imply a 15.8x FY15F P/E.
Risks
Losing market share outside of Java, regulation changes, and inflation rising faster than expected.
Investment Thesis
Ubiquitous competition
Fashion: Competition from cheap clothing imports and from local regional retailers.
As it cannot differentiate itself from its competitors, RALS faces stiff competition from all angles. In department store business, RALS is facing local, regional retailers and chronic cheap clothing imports. Furthermore, the minimarkets have been chipping away at its supermarket business.
The Indonesian Garment and Accessories Supplier Association (APGAI) estimates that illegal garment imports amount to IDR100trn (c.USD7.8bn) per year. Moreover, the Indonesian Textile Association (API) estimates that second-hand clothes imports amounted to IDR10trn (c.USD0.9bn). Second-hand clothes smuggled into the Indonesian market find the lower middle- and low-income consumers receptive of their low prices. The items usually come from South Korea, Japan, Singapore and Hong Kong, where they fall into the waste category.
RALS also competes with the local, regional players, such as: Hardy’s Department Store (in Bali), Sri Ratu (in Central Java), Suzuya (in North Sumatera), and Yogya (in West Java). Indeed, in FY14, RALS closed its two stores in the West Java region (Bandung and Tasikmalaya), reduced two stores in Central Java (Semarang, Pekalongan) and another in West Java (Bogor). In FY13, RALS closed its store in North Sumatera (Medan), East Java (Sidoharjo), and Blok M (Jakarta).
Supermarket: competition from minimarkets
Indonesians are embracing a modern life-style rapidly. For example, in Jakarta and Surabaya (which is Indonesia’s second biggest city), 7-Eleven stores have become something of a gathering spot for the young people, with their motorcycles often seen crowding the parking area as they hang out and eat snacks with their friends.
Not only do these minimarkets provide convenience and socializing opportunities, some also provide cheaper products compared to Ramayana’s supermarkets. As such, Ramayana’s supermarkets are a money losing business, which the company is now trying hard to improve by engaging and partnering with SPAR International, the reputable Dutch multi-national retail chain with operations in 37 countries.
Expansion outside Java is on hold
As the commodities producing regions in Indonesia, such as Kalimantan and Sumatera, suffer from declining commodities prices, RALS did not open any new store in FY14 as its low-end customers outside Java are mostly workers in the mining and plantation areas, which are prone to downsizing.
Since FY10, sales contributions from commodity producing regions (such as Kalimantan and Sumatera) have declined. As such, Java’s contribution has been rising since FY10, reaching a stable level at 61% as at FY14. With the weakened IDR against USD, more remittances from overseas Indonesian workers will prop up sales contribution from the Java region.
For the foreseeable future, management has reiterated that its focus is on the conversion to the SPAR supermarket business. RALS aims to convert 50 of its 98 current supermarkets to the SPAR format within the next two to three years. And it plans to open five to six new Ramayana stores in the competitive Jakarta and Java regions again this year, yet we only forecast three stores opening per year going forward.
Lower operating margin & cash piling up
Lower operating margin. On the cost side, RALS has been affected by the rising salaries of its workers, resulting in lower operating margin. Furthermore, the operating margin declined to 3.7% in FY14 due to more discounting/promotion by RALS. It was aiming for total gross sales of IDR8.5trn in FY14, but fell short of it, reaching gross sales of IDR7.9trn in FY14. For FY15, management aims to achieve IDR8.5trn again.
Lower asset turnover
It is good to have strong operating cash flow each year, but the cash piling up on RALS’ balance sheet has caused lower asset turnover each year. We believe to further compete well in the low-end customer segment, RALS should have used its cash and clean balance sheet to further strengthen its department store supply chain, which will enable it to sell faster at discounted prices while maintaining stable margins from more efficient operation and higher bargaining power with its local suppliers. That way RALS would be able to stave off the competition from the chronic cheap clothing imports.
Reduced capex, shifting focus to supermarket business. On a closer look, the increased cash on RALS’ balance sheet in FY14 is due to reduced capex from not opening a single store in FY14. Going forward, we expect RALS to open three new stores per year. RALS also benefitted from its negative cash conversion cycle days from managing its payables better in FY13 and FY14.
SPAR supermarket
In early March, RALS opened three new SPAR supermarkets in Bogor, Cibitung, and Cibubur. Partnering with SPAR for an initial 3-year agreement for a fixed annual fee, RALS aims to convert 50 of its 98 current supermarkets to the SPAR format within the next two to three years. RALS will be the one running the SPAR supermarkets, which will have a different product mix from RALS’s current supermarkets. The conversion to SPAR supermarkets will increase fresh produce to 25% from 11%, F&B to 45% from 43%, and reduce non-food items to 30% from 46%.
Expected benefits from SPAR supermarkets
Management expects the conversion to new SPAR supermarket will improve gross margin 250bps to 12.5% along with 30% better yield to IDR1.7m/sq m. In the worst case, we believe RALS will benefit, to some extent, learning from SPAR management on modern warehouse operation, procurement scheduling, merchandising selection, and human resources management, applicable to its department store operations.
Some clear risks from running the SPAR supermarkets
With management’s current focus on the supermarket business, there is a serious risk that RALS will lose its grip on its still-profitable fashion division. Secondly, some locations of RALS’ supermarkets are close to the traditional markets, which also offer fresh produce, some at lower prices. Thirdly, the look and design for SPAR markets are more suited for the middle income segment. It is yet to be seen whether the very price-sensitive, low-end customers indeed want to shop at SPAR after the euphoria of new store opening evaporates.
The SPAR concept, if well executed, will move RALS to the right, further into Quadrant 4, due to higher margin from improved product mix, which is realistically difficult as the low-end segment is very price sensitive and RALS is besieged by the aggressive minimarkets. We believe, to compete well in the low-end segment, RALS needs to move to Quadrant 1, focusing on and improving its still-profitable department store business to sell faster at discounts with stable margins benefiting from larger scale, staving off competition from the cheap local imports and local regional retailers.
Business Overview
RALS is the second largest department stores, trailing only Matahari Department Store (LPPF IJ, BUY, TP: IDR22,000), targeting the low and middle income segments. Given that its target focus includes the low-end segment, RALS’ revenues are sensitive to the Indonesian economic conditions. Last year’s fuel hike in Nov 2014 adversely affected RALS’ low-end customers, as evidenced by the weak 1.0% and 0.6% Same Store Sales Growth (SSSG) in last Nov and Dec 2014. With the effect of increased 2015 minimum wage, we forecast 4.5% SSSG in FY15.
We still think that RALS should have sold its supermarket business, rather than partnering with SPAR International, as it will take herculean efforts to increase the declining operating margin of RALS’s supermarket division.
Key Risks
As RALS’ low-end customers outside Java mostly work in the plantation and mining areas, prone to downsizing due to declining commodity prices, RALS has decided not to expand outside Java this year. Should the local regional retailers expand and some of RALS’ customers migrate to the middle income segment, RALS will lose its market share outside Java.
RALS is vulnerable to any regulation changes to protect more traditional markets as some of its locations are in the proximity of traditional markets. Should inflation rise faster than expected, as its low-end customers are very price-sensitive, its sales would be very adversely affected by the erosion of its consumers’ purchasing power.
Company Profile
PT Ramayana Lestari Sentosa Tbk (RALS) operates the second largest department store network in Indonesia. It targets the medium-range to low-end market segments. Its extensive network of 116 outlets is spread all over Indonesia. The department store business contributes c.70% and the supermarket business contributes 30% of its total gross sales.
