Earnings to reach new heights from 3Q14F BUY
CPALL stands by targets. It expects SSS growth of 3-5% in 2014 (vs. -0.3% in 1H14), lifted by the return of its very popular stamp promotion that will run from late July to November 2014. SSS growth will improve moderately in 3Q14 on better consumption sentiment, rising public and private spending and the return of foreign tourists. It will then grow sharply from 4Q14-2015. It is on the way to adding ~700 stores this year, already adding 387 in 1H14, exceeding its earlier target of 600. Gross margin will continue to expand upon a better product mix and business synergy with MAKRO (gradually recorded since 1Q14), mainly from joint negotiations with suppliers.
Potentially lower costs and no FX risk from new debentures in Aug 2014. Of its total LT liability of Bt180bn, Bt90bn is in baht-denominated debentures (tenor of 3-10 years; fixed rate at ~4.8%) and Bt93bn is in LT loans (THB loan of Bt82bn and US$ loan of Bt11bn; tenor of 2-7 years; floated rate at ~5.5%). To refinance the LT loans, CPALL plans to issue new debentures of up to Bt40bn (tenor of 3-10 years), with a simple average cost of funds of 4.4%; actual cost will be known after the August 18-21 subscription (Figure 1). This will help lower its funding costs, close its FX exposure, and give its financial structure some flexibility by adding a call option for the portion allocated to retail investors (portion not yet finalized). Our sensitivity analysis suggests that on the new Bt40bn in debentures, each 25bps fall in cost of funds below our assumption of cost of funds at 5.5% on its LT loan increases its earnings by 0.5%.
Upside from faster-than-expected deleveraging. CPALL holds 98% of MAKRO and may consider increasing MAKRO's free float if MAKRO share price moves above its investment cost plus financing cost and opportunity cost, which could happen when MAKRO delivers the performance CPALL expects. On operational improvement alone, we estimate CPALL will be able to repay LT liabilities of Bt180bn within 10 years. Our sensitivity analysis indicates that each repayment of Bt10bn (5.5%) on the principal of its LT liabilities would reduce interest expenses and raise our earnings by 3%.
Maintain BUY with mid-15 DCF PT at Bt58. We trimmed earnings by 5% to Bt12bn in 2014 and 3% to Bt16bn in 2015, mainly reducing SSS growth to 2.5% in 2014 (vs. -0.3% in 1H14) and 5% in 2015. We reiterate our view that 2Q14 will be this year's bottom. It will start to enjoy new highs for earnings from 3Q14F from better SSS growth and margin and no more fees from the MAKRO acquisition, which have been recorded since 3Q13. We also expect CPALL to deliver the sector's highest 3-year EPS growth of 24%. Key risks include changes in SSS growth, execution of store expansion and competition.