ACE Hardware Carrying Too Big Of An Oversized Bag
It is a good home improvement retailer, but at the current share price, exceptionally high inventory days and weak 9M15 SSSG, we believe it is overvalued. Weak 9M15 results. ACE Hardware, Tbk (ACES IJ) 9M15 sales were at 71% and 69% of our and consensus sales forecasts respectively. Likewise, net income accounted 72% and 69% of our and consensus’ net income estimates respectively. At 227 days, 9M15 inventory days is too high especially when comparing to its peer Mitra10 which incurred 109 inventory days during the same period. Although not an apple-to-apple comparison, Mitra10 is a good enough proxy for ACE as both retailers have overlapping home improvement products; Mitra10 is the building materials/home improvement retailer subsidiary of Catur Sentosa Adiprana.
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Weak same-store sales growth (SSSG). Despite ACE recording positive 1.6% monthly SSSG in September, we believe the negative 1.3% 9M15 SSSG is way below that of Mitra10’s 11% in the same period. Although Indonesia’s economy might recover next year, we believe the cannibalisation among ACE’s stores would continue to pose a downside risk to our 3% SSSG in FY16 assumption for ACE. Downgrade to SELL. We consider ACE a good home improvement retailer but considering its current share price, very high inventory days and weak SSSG, we believe the stock is already trading above its fair value. As such, we downgrade ACE to SELL (from Neutral) with the same DCF-based IDR640 TP, which implies 18x/16x FY16F/FY17F P/E. Key risks are: i) further weakening of the IDR against the USD might erode ACE’s gross margins, ii) changes in importation regulations, and iii) faster cannibalisation among ACE’s stores.
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It will be probably difficult for ACE’s SSSG to be higher than 5% in the coming years due to cannibalisation risk among its stores. Persistent increasing inventory days. It is ACE’s strategy to keep opening stores in order to saturate the market and maintain its dominance. However, this strategy has resulted in persistently higher inventory days, even during times when the economy was normal, ie FY11-13. Although the monthly SSSG in September was already a positive 1.6%, it is hard to imagine ACE’s SSSG rebounding higher than 5% in the coming years. This would be due to the cannibalisation among ACE’s stores, which could result in even higher inventory days.
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Revising our forecasts. To reflect the increasing inventory days of ACES, we adjust our FY16/FY17 inventory days assumption to 221 days/215 days from 183 days/162 days respectively earlier on. The change in inventory days assumption does not affect net sales, gross profit and EBIT. However, net income is slightly affected. This is because higher inventory days results in lower cash balances and, hence, lower interest income from cash on hand. We assume a risk free rate of 8.25%, a market risk premium of 5%, equity beta of 0.8 and TG rate of 5%, which results in an implied WACC of 12.2%.
