ACE Hardware Indonesia

Ace trumps!

Initiate coverage with BUY, TP of Rp 2,550

ACES, the home improvement and lifestyle retailer, has a strong presence in Indonesia and is well placed to benefit from Indonesia ’s economic growth momentum. With 45 retail outlets throughout Indonesia , the company is set to post 19% earnings CAGR in FY09-12F, with the operating margin expected to reach 13.7-13.9% by FY11-12F, supported by: 1) strong housing demand growth, 2) increasing demand for higher margin business-lifestyle products. Our DCF valuation using a WACC of 12.7% gives rise to a TP of Rp2,550 – 20% upside. It also implies 20x PE11F and 3.5x PBV 11F.  Yes, the valuation is rather high, but we feel it is justified given the company’s strong profitability with a ROE of 20% (higher than its peers). Other positives are the savvy management, a healthy balance sheet, and the fact that ACES sells unique products (the company has a product range of 65,000 items under 16 principal departments). BUY.

Housing demand expected to grow by 4% p.a.

The reduction in mortgage rates by banks along with the more flexible financing terms offered by developers should support not just residential and condominium sales in Jabodetabek, but also demand for home improvement products. This augers well for ACES, a leading home improvement supply company. As of June 2010, the cumulative supply of residential property since EOY 1997 in Jabodetabek reached 354,000 units, +3.3% YoY, with the sales rate relatively steady in the past 2 years at 84%. Meanwhile, around 11,800 additional units are expected to enter the condominium market by 2012, with the pre-sales rate of ongoing projects in 2Q10 up to 71% (69% in 1Q10), thanks to greater affordability. We assume around 12,000 residential and 3,000 condominium units are sold in the middle and upper segments (ACES’ target market) each year with an average of around Rp 100mn/unit spent on renovation and decoration. Hence, if ACES can attract 50% of that amount, it would mean additional revenues of Rp 350-400bn from new customers, many of whom might remain as loyal customers. As of June 2010, 356,649 people had already joined ACES’ membership program with average spending per sale of Rp 700,000-730,000/ member. Against such a backdrop, the company plans to add 15,000sqm p.a., thereby supporting the forecast revenues growth of 18.6-19.2% for FY10-11F with SSG of 10% in both FY10-11F.

Location, location, location

Six new stores were opened in 1H10, adding approximately 24,105sqm – that’s about 23% of the existing operating space, or the most aggressive expansion since 2008. Going forward, the company plans to keep adding 15,000sqm - or equal to 3-4 stores every year. This is expected to cost the company around Rp 75bn p.a. in capex (including working capital) and generate returns of Rp 14.1mn/sqm in FY10F before increasing to Rp 14.9mn/sqm in FY11F.  The focus of expansion is still in Java.  This reflects the fact that 58% of the population in Indonesia with strong purchasing power live in Java. As of June 2010, ACES’ Same Store Sales Growth reached 9.4%, while the SSSG in Central Java was a very brisk 25.9%.  Yet the “out of Java” stores are more productive. Of the 11 provinces in which ACES has stores, East Kalimantan has the highest productivity of Rp 14.5mn/sqm.  Thus, going forward, “out of Java” areas will continue to offer opportunities for ACES, especially since: 1) Nominal GDP per capita growth in areas like East Kalimantan is very strong (CAGR of 21.1% in 2003-2005), and 2) certain provinces should see growing purchasing power as commodity prices regain their strength.

Expanding margins

ACES has benefited from economies of scale. As a result, its operating margins have expanded from 7.8% in 2006 to 13% in 1H10 backed by: 1) zero percent import taxes (in some cases) thanks to AFTA (note that 50% of its imported products come from China; 2) a stronger bargaining position with suppliers as it needs more inventory for its newly opened stores. Looking ahead, we expect the operating margins to increase by at least 20bps annually, as the company plans to increase its product range. In particular, it plans to push sales of lifestyle products. Note that ACES has 3 product categories: home improvement, lifestyle and most recently toys. As of June 2010, 66.1% of sales still come from the home improvement category, followed by lifestyle (33.7%) and toys (0.2%). Yet the highest gross margins are for toys and then lifestyle products. But after 10 years, the management expects toys to account for only 10% of total sales. Hence, the catalyst for improving margins in the mid-term shall be higher sales of lifestyle products, whose contribution is expected to increase to 40-50% of total sales.  Besides adding more lifestyle products, the company will also increase promotional activities.

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