s Services Sector Midas Investments Research Retail Industry This report is published for educational purposes only by students competing in the CFA Institute Research Challenge. Puregold Price Club, Inc. 29 November 2012 Ticker: PGOLD Recommendation: BUY Price: PHP 32.20 (USD 0.79) Price Target: PHP 40.16 (USD 1.00) Exchange Rate Pure consumer play outpacing market on defensive USD/PHP: 40.88 growth Figure 1: Share Price Performance We recommend a BUY for PGOLD, the Philippines‟ fastest growing grocery retailer and the only pure, direct and broad-based domestic consumer play in the market, at a price 35 target of Php 40.16, a 24.72% upside from current price of P32.20. Our positive outlook is 30 based on growing and resilient domestic consumption that is captured by an EDLP (Every 25 Day Low Prices) Strategy targeting low to middle-income consumers bringing in traffic of 20 18 million each week. Through the Tindahan ni Aling Puring (TNAP) reseller program, it 15 is the only major retailer to focus on the widely popular traditional sari-sari store. By 10 acquiring membership shopping club S&R, it also captures a growing niche of high-income 5 consumer spending. With aggressive store expansion underway, we forecast sustainable long-term growth for this defensive stock. 0 Focus on domestic consumption driving resilient earnings against volatile global financial system: As the only pure direct and broad-based domestic consumer play on 5-Jul-12 5-Jan-12 5-Jun-12 5-Oct-11 5-Oct-12 5-Feb-12 5-Sep-12 5-Apr-12 5-Dec-11 5-Mar-12 5-Nov-11 5-Aug-12 5-Nov-12 5-May-12 the local market, PGOLD‟s stock price has outpaced the Philippine stock market by PGOLD PSEi (rebased) MSCI (rebased) 77.2% (see Figure 1) driven by revenue growth of 39.69% (2012E) on the back of 16% growth in domestic consumption. With consumption expected to continue to YTD 1m 3m 12m grow by 8% annually through 2016, we forecast same store sales growth (SSSG) to grow by a five-year CAGR of 6.41%. As a defensive stock, PGOLD‟s earnings Abs 79.2% 7.5% 10.1% 111.1% growth is cushioned from risk surrounding Western economies with 70% of product Rel 50.3% 3.0% 1.5% 77.2% revenues from essential spending on food items and 90% of customer revenues Source: PSE, MSCI Asia-Pacific expected to come from low-income consumer segments and traditional re-sellers. The surge in the local economy has benefited the S&R format, which is expected to boost consolidated net margins to 5.58% (from 4.83% in 2011) with its high-margin product Figure 2: Market Data portfolio. Market Capitalization P 89,078,281,250 Aggressive national roll-out catalyzing revenue growth: By adding 51 stores outside Metro Manila this year alone, Puregold revenues are slated to grow by 39.69% in Shares Outstanding 2,766,406,250 2012. Four-year revenue CAGR of 23.6% is expected on the back of aggressive Free Float 34% expansion raising total store count to 260 by 2016 (See Figure 2). A key catalyst will 52week Price Range P 14.98 - P33.00 be expansion into the unsaturated and attractive market of Visayas and Mindanao where we calculate a potential of 91 hypermarkets to be added. With a hypermarket Ave. Monthly Volume 78,233,692 opening in Palawan today, it has already begun operating its first store outside of the Beta 0.81 island of Luzon. Scalable asset-light model translating to strong margins and abundance of free cash: PGOLD has a scalable asset-light model that relies on property leasing and third-party logistics from suppliers. Fixed Asset Turnover is seen to improve from 6.49 to 10.96 (2011-16E), showing potential for growth. This translates to impressive ROE and profit margin at 21.95% and 8.85% respectively, both above industry averages. PGOLD generates an abundance of free cash enough to meet the expected yearly annual capex of Php 3.46B allocated for expansion from 2013 to 2016. With issuance of additional debt, special Dividend Payout Ratio (DPR) at 2016E is 43.82% on top of the actual DPR of 14.91%, giving a total DPR of 58.73% Valuation confirms BUY rating: FCFE analysis indicates a price of Php 40.16 at a 24.72% upside from current price, supporting our positive long-term outlook. PER analysis with Asia-Pacific grocery retailers indicates a discount of 20.75%, confirming the attractiveness of PGOLD. Investment risks include: execution of VisMin expansion and competitive risks from SM Retail. In Php mil 2009 2010 2011 2012E 2013E 2014E 2015E 2016E Revenues 24,112 29,108 38,988 59,541 81,273 100,718 122,258 148,707 458 985 2,216 4,682 7,985 10,899 14,465 19,097 EBIT Net Income 132 510 1,545 3,156 5,384 7,423 9,919 13,160 Ratios EPS N/A N/A 1.10 1.29 1.95 2.68 3.59 4.76 Profit Margin 0.56% 1.97% 4.83% 5.58% 6.62% 7.37% 8.11% 8.85% Cur. Ratio 0.93 0.76 1.10 1.11 1.24 1.28 1.37 1.47 ROA 0.96% 5.28% 11.29% 7.47% 9.64% 10.77% 11.80% 12.75% ROE 11.28% 29.48% 21.74% 12.24% 16.10% 18.50% 20.34% 21.95% CFA Institute Research Challenge November 29, 2012 Business Description Figure 3: Expansion Plans Puregold Price Club, Inc. (PGOLD) is the Philippines‟ fastest growing grocery retail chain. 300 Since establishing its first store in 1998, it has reached a total store count of 151 stores as of 260 250 234 Nov. 29, 2012. In a matter of 14 years, it has overtaken established retailers in terms of store 208 count and revenue to be the second-largest grocery retailer in the country. Behind the 200 182 156 company‟s remarkable growth (see Figure 3) is a strategic customer focus on low-income 150 consumers and sari-sari stores. 100 100 62 41 50 Store Formats and Locations PGOLD‟s operates in four store formats: 74 hypermarkets (Puregold Price Club), 56 0 supermarkets (Puregold Jr. and Parco), 15 discounters (Puregold Extra) and 6 membership shopping clubs (S&R) (see Figure 4 and Appendix 8). These are strategically located in key commercial districts and residential areas with access to major transportation hubs. All stores Puregold Price Club Puregold Jr. are geographically located in Metro Manila and Luzon except for a single S&R outlet in Cebu. Puregold Extra S&R Expansion to VisMin is forecasted to begin by 2013 (see Appendix 9). The first hypermarket Parco outside the Luzon island in Palawan is already in operation. Source: Company, Team’s Estimates PGOLD has a highly-scalable asset-light operations model with direct-delivery outsources logistics to suppliers and third-party agents, and minimizes warehousing and distribution costs. Figure 4: Store Format Overview Hypermarkets function as warehouses for supermarket and discounter formats. The different store formats allow PGOLD to quickly enter new locations with minimal upfront costs. Hyper- Super- Dis- Broad Customer Focus through “Tindahan ni Aling Puring” Type of Store market market counter PGOLD is the first and only modern retailer to strategically target sari-sari stores and other re- No. of Stores sellers as customers through the Tindahan ni Aling Puring (TNAP) program. By selling to (as of 74 37 15 sari-sari stores, PGOLD penetrates the DE market which comprises 90% of the Philippine 11/29/12) population. TNAP provides rebates, delivery services, training seminars, and even travel Average Net 1,500- 800- 300- incentives for its members. From its beginnings in 2005, TNAP has grown its member base Selling Area 7,800 1,500 700 (sqm) from 30,000 to 220,000 by 2012, representing around 20% of the growing number of sari-sari No. of SKUs stores in the country (see Appendix 10 and 11). Re-sellers contribute 35% of PGOLD‟s annual 30-50 8-10 1.5-2 (in „000s) revenues (see Figure 5). Source: Company Data Strategic Acquisitions Complete Spectrum of Consumer Segments By acquiring S&R Membership Shopping and Parco Supermarkets last May 2012, PGOLD covers the entire spectrum of consumers. S&R membership shopping club which currently boasts of 215,000 members taps the high spending power of the AB socio-economic class. Parco, a supermarket chain with 19 stores, will be integrated and rebranded to PGOLD‟s Figure 5: PGOLD Revenue Breakdown supermarket format Puregold Junior. This will strengthen Puregold‟s reach to households by Consumer Segments belonging to the CDE socio-economic classes. Growth Drivers: Same Store Sales Growth and Store Expansion PGOLD‟s robust revenue generation is heavily supported by competitive pricing, high-margin products, and steady domestic consumption through population growth. Its EDLP strategy keeps PGOLD store pricing attractive over local competitors, thus fueling an estimated 6.41% annual same-store sales growth from 2012 to 2016. The company has set its organic growth rate at 25 stores per year for the next 5 years. PGOLD‟s 2011 IPO and 2012 notes issuance which raised P2B and P5B respectively will Source: Company Data accelerate growth through acquisitions on top of organic expansion within the next 5 years. Experienced Ownership and Management Team Puregold Price Club, Inc. was founded by Lucio Co, an experienced entrepreneur with businesses in different industries spanning from retail to consumer finance.