We initiate coverage on Courts Asia (CAL) with a BUY recommendation and target price of S$1.19, implying a 48.8% upside from the current price. CAL’s impressive turnaround story and market leadership in Singapore and Malaysia makes it an attractive proxy for the growing Asia consumer market. We view a potential for significant upside ahead as CAL continues to carry out its transformation plan with a focus on improving the profitability and productivity of existing stores and further gaining market share and scale with new store openings. We forecast a 3-year (FY12-15F) revenue and EPS CAGR of 17.7% and 19.2% respectively.
An impressive turnaround. Courts Singapore (CSL) and Courts Malaysia (CMB) have been in operation since 1974 and 1987 respectively when the group’s shareholder went into administration in 2004. CSL and CMB were eventually sold off to a consortium of private equity investors and underwent a comprehensive restructuring plan, which includes the closure of unprofitable operations, store refurbishments and relocations, an overhaul of its credit infrastructure, and regional centralisation of management. As a result of these initiatives, CMB turned around from a net loss in FY08 to a net profit of S$13.2m in FY11. CSL grew its earnings 8x since FY08 to S$15.8m in FY11. Based on 2011 sales value, CMB and CSL occupy the #2 and #1 spots respectively in the industry rankings.
On the comeback trail. CSL and CMB were consolidated under CAL in 2010 as management continues with its transformation plan. We project
21 new store openings in FY13-15F, sustainable operating margins on better scale, repeat patronage and additional income stream from its credit business, and stronger product sales on favourable economic and consumption trends. We forecast net margin and ROE to be 5.7% and 17.2% in FY15F. Further catalysts include CAL’s successful foray into Indonesia and into e-commerce through its recently re-launched ‘eCourts’ website.
Key risks include
a) credit risk, as CAL’s in-house credit business contributes an additional income stream that accounts for about 15% of the company’s total revenue,
b) increased competition, heightened by the rapid change in consumer preferences, and c) space constraint, as location is a key success factor for CAL.
We initiate coverage on CAL with a BUY recommendation and a PEG-based target price of S$1.19, implying a 48.8% upside from the current price. We view CAL as an attractive consumer proxy for Asia after it successfully turned around its business. We forecast revenue and net profit to grow at a CAGR of 17.7% and 19.2% respectively in FY12-15F.
WHAT WENT WRONG IN THE PAST
A short trip down memory lane. CSL and CMB were listed on the Singapore Stock Exchange in 1992 and on the Kuala Lumpur Stock Exchange in 2000 respectively. Their controlling shareholder was Courts plc, a UK-based company which went into administration in 2004 due to falling UK sales and an unsuccessful debt restructuring exercise. The substantial costs incurred by the UK business ate into the profits of its overseas operations, which were eventually sold off individually. CSL and CMB were delisted in 2007, taken over by private equity groups Baring Private Equity Asia and Topaz Investment Worldwide for about S$84m, and were consolidated under CAL in 2010.
Poor credit infrastructure. In our view, the main underlying issue behind the losses in CSL and CMB was the insufficient credit infrastructure that was in place. Inadequate credit controls and processes led to the piling up of bad debts especially in the Malaysian and Indonesian operations.
Operational inefficiency. Under Courts plc, CSL and CMB also failed to take advantage of potential operational synergies as they were headed by two independent management teams. Benefits from economies of scale were overlooked with logistics operations that were not well-conceptualised.
Flawed incentive scheme. Furthermore, compensation for management was largely profit-based, which we think put a short-term focus on strategies and execution. The business grew too fast without foundations in credit control and operations.
THE TURNAROUND
R&R – rationalising and restructuring. Starting in 2007, CSL and CMB undertook numerous rationalisation and enhancement initiatives to improve their profitability as well as branding. These include the shutting down of loss-making operations in Thailand and Indonesia, closure of 22 unprofitable stores in Malaysia and a few in Singapore, relocations and refurbishments of other stores, and the regional centralisation of senior management team. The focus of stores in Malaysia also shifted from furniture to consumer electronics. Though consumer electronics has lower margins, they have higher turnover and draw higher traffic. To improve its branding, all stores underwent a change of façade.
Credit overhaul. The senior management team, headed by the current CEO and CFO of CAL, rebuilt the credit business. The overhaul led to a marked improvement in 180-day delinquency rates from 16.2% in Jun 07 to 7.7% in Sep 12 for CMB and from 4.8% to 2.7% for CSL. Impairment loss on receivables also improved from 7.6% in FY10 to 3.1% as of Sep 12 for CMB and from 3.1% to 1.3% for CSL. Changes and improvements made to credit operations include the following:
a) Streamlined credit approval process A proprietary electronic scorecard and processing system was introduced which houses all the information collected on credit customers. The system allows for timely and ongoing checks. The scorecard imposes stricter and more objective criteria and is reviewed every two years to keep up-to-date with consumer behaviour.
b) Centralised monitoring and collections A Credit Management-Information-System that supports both Malaysia and Singapore was set up to monitor the whole credit cycle. Other centralised facilities were also established such as two regional credit hubs and an audit unit in Malaysia, and centralised tele-collections centres in both countries.
c) Collaboration with external credit agencies Management enlisted the support of external parties to conduct counter-checks on customers and to carry out field work for collections. The group’s credit schemes were developed collaboratively using more sophisticated techniques, which link product risk and credit terms. For example, a) customers are granted shorter repayment periods for mobile, higher risk items, and b) customers aged 25 years and below are prohibited from purchasing IT products on credit.
Supply chain and inventory management. To improve operating efficiency, the group completely outsourced its logistics function in CMB to DHL while CSL only maintained one warehouse and engaged SCS Logistics as an external service provider. A direct delivery model is employed for most of the furniture purchases, whereby the suppliers themselves will deliver the products directly to the customers. Furthermore, an Enterprise Resource Planning (ERP) system automated the entire inventory system in Singapore and allowed for better management of stock. Inventory turnover improved from 6.1x in FY09 to 7.4x in FY12. The ERP system is currently being set up in Malaysia and is expected to be implemented by FY14.
Driving for scale. Management turned to retail innovation to achieve economies of scale. CSL was a pioneer for the “big box” format in Singapore through Courts Megastore in Tampines, Asia’s largest electrical, IT and furniture store. These larger retail areas opened up opportunities for the group to offer more extensive product ranges for each of its three categories and to introduce more innovative marketing schemes. With centralised management, the group’s strategy also became more regional, which enhanced purchasing and negotiating power with suppliers, gave them better access to inventory, and improved pricing competitiveness. The group’s operating margins expanded from 4.3% in FY10 to 8.6% in FY12.
Minimising capex. Better supplier relationships led to other gains for the group. The group’s major suppliers provided subsidies for new store openings and refurbishments, which amounted to as much as 84% of total capex in FY10 and 39% in FY11-12. The group also chose to locate their stores predominantly in the suburban areas, where lease costs are lower and population densities are high.
Flexible compensation scheme. The group modified its incentive scheme for management and employees to give more importance to the performance-variable portion and in turn, lower fixed costs. For its sales staff, 1/3 of the monthly salary is the base pay while the rest is commission. Staff costs as a percentage of revenue declined from 11.0% in FY09 to 8.6% in FY12.
As a result of all these initiatives, CMB turned around from a loss of S$1.3m in FY08 to a net profit of S$13.2m in FY11. CSL grew its earnings 8x from only S$2.0m in FY08 to S$15.8m in FY11. CMB and CSL occupy the #2 and #1 spots respectively in the industry rankings based on 2011 sales value. CSL has been taking market share from its competitors while CMB is capturing new markets in Malaysia.
A COMEBACK Ongoing transformation to drive earnings growth. We believe CAL’s earnings will continue to grow strongly on the back of new store openings, increasing average sales/sf, and better economies of scale. Management targets to open at least one new store in Singapore and six new stores in Malaysia annually for the next 2-3 years, adding an average of 140,000sf of retail space every year. Refurbishments and relocations aim to improve existing store performance with better store layouts, customised product mixes, and more “consumer experience” areas. CAL’s stores typically undergo refurbishments every 3-4 years to keep up with industry trends and consumer preferences.
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