Jan 14, 2012- PureGold Price Club (After a 50% rise from the IPO, Is this still a buy or not?)

(As a trader, you don’t have to know it all, but you have to know enough to understand and trade better more than just what the charts are saying, but I suppose pure chartists will disagree with my view. Nevertheless, I wish I had paid more time to fundamentals, because combining technicals, and selecting the right stocks in the portfolio will give a real boost in the returns.  Below’s a sample working of my mind ala “Seeking Alpha”, not a thoroughly researched report you see on most foreign brokers’ reports.   I hope I don’t get banters, and just give constructive comments and criticisms please.  I’m a licensed broker and relatively “noob” research assistant in the Philippines.  If there are any inquiries related to the markets or anything I’ve written here, please write/leave a comment to me: Facelesstrader@gmail.com)

Personal Disclosures: The Author is long shares in the aforementioned stock (PGOLD).  This is not a solicitation to buy/sell.  This is written mainly as a brain-storming/nitpicking way to think about stocks and investments.  All views presented here are of the author alone, and is not related to any company or other entity’s views.

BUSINESS PROFILE – Puregold 

The Company conducts its operations through three retail formats and store brands. Hypermarkets, through “Puregold Price Club”, offers a wide variety of general merchandise and a full-service supermarket with wholesale. Supermarkets, through “Puregold Junior”, operates as a neighborhood store which offers targeted consumer items and a limited variety of general merchandise. Lastly, discounters are operated through “Puregold Extra”, which offers a limited number of goods, comprising of the Company’s top-selling stock-keeping units, that are intended to be sold quickly at prices lower than Puregold Price Club or Puregold Junior. (Source: Philippine Stock Exchange, Puregold)

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Here is a snapshot of the operational results taken from Puregold’s September 2011 Quarterly report, that was released prior to the IPO last October 5, 2011.

Assuming these numbers are all correct and not front loaded, these numbers are showing that last 3Q2011, PureGold has grown its net sales revenues by 36.3% y/y from Php19.77 Bil to Php26.95 Bil that has resulted in a 51.5% increase in their gross profits and operating income.  While the topline looks very good, what’s more astonishing is that the expenses were only up by 34.2% (almost similar to the increase in revenues) that have resulted in income before income tax of Php1.544 Bil, with a bottom line number of Php1,078 Bil after taxes are considered (185% increase in net income).

While people probably balk at that 4% return on total sales (I sure wouldn’t seeing those Php27 Bil sales revenues), perhaps it would be quite instructive to look at how Walmart (US’ hypermarket), Carrefour, Target and Costco (another wholesale supermarket) conducts its financial reports, to grasp the possibility of amazing growth that Puregold Priceclub still has (despite the 50% increase from its IPO of 12, with the current price of Php18.00) that may not be priced in.

I made a quick calculation on the on the Net Margin of these hypermarts in the US and got the following figures:

WMT – (15.59Bil/440.14 Bil) = 3.54% net margin

PVT1(Carrefour) = 0.62% net margin

Costco= 1.61% net margin

Target = 4.3% net margin

Wal-Mart is not expected to generate the type of growth rate of Puregold. The PEG ratio of the mature companies above are 1.39, 1.57, 1.00 and 1.17.

I checked the consensus EPS of brokers covering PGOLD in Bloomberg and found a median EPS  estimate of 1.134 for 2012.

The PEG ratio (Price/Earnings To Growth ratio) is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company’s expected growth.   PEG is a widely employed indicator of a stock’s possible true value. Similar to PE ratios, a lower PEG means that the stock is undervalued more. It is favoured by many over the price/earnings ratio because it also accounts for growth.(Wikipedia)

Bullish Case – 50% EPS Growth (1/3 of the 150-180% increase in Net income of Puregold’s reported data last 2011, primarily coming from the estimated 25 stores increase in store count as planned by the company for the next 4 years starting 2012)

PEG Ratio = (18/1.134) / (Assuming 50% EPS growth) = 0.3174

Bearish Case – 15 % EPS Growth (1/10th of the 150% increase in Net income of reported 9M2011 data)

PEG Ratio = (18/1.134)/15% = 1.058

*In general I believe that the market is pricing Puregold at a 15% growth rate in EPS to justify that 18 pesos is a fair market value currently, which I believe may be too low considering the prospects is larger than 15% owing to Walmart’s history as a guide.

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PureGold as a Pure Retail Play on Domestic Demand and as a Risk Aversion/Recession-Proof Stock to Hold for Mid-term Portfolios

-Positively Correlated with Higher Consumer Spending, and Higher Economic Growth

Domestic Supermarkets/Retailers (Consumer Staples), in general continue to be a very reliable stock in any type of market.  Consumer staples obviously lag most market rallies that occur based on strong economic data, as in some ways, these stocks are considered “safe haven”, boring and traditional businesses when it’s in a mature stage.  However,   I would disagree to say that PGOLD’s in a mature stage.  In fact, it’s in an expansion stage with brighter potential in the next 4 years, and starting to invest in a company that can ultimately be a cash cow giving dividends in the future is a compelling argument to hold it.

A mom and pop investor right now in US funds will most likely have WMT shares in their portfolio to weather recessions, just as how the global market perceives Procter and Gamble, Colgate Palmolive and the likes.  Which is why, when I read a report arguing that since Puregold hasn’t given any dividends, and still at its first year of listing (no trading history), that the stock deserves a discount of 15% with SMPH, I didn’t exactly agree with it.

I’ll give a check mark on EPS Growth for Pgold.  Guidance from the management is to increase from its current 100th store to another 100 stores by 2015 (or 25 stores/yr starting 2012).

To me, Expansion of Stores = higher revenues and assuming that the management’s expenses will grow at the same rate of the revenues, the earnings in theory should increase just as it has increased the past three years- whopping more than 100%.

Uses of Cash:

According to the company’ 3Q report and corporate filings, the company’s current assets amount to Php4.255 Bil last Sept 30,2011.  Cash decreased from Php1,575 Bil to Php263 Mil mainly to finance the company’s aggressive expansion all over the Philippines.  From 2011 to 2013, the company’s grocery chain will expand its store network in Davao, Rizal, Cavite, Bataan, Pangasinan, Baguio City, Ilocos Norte, Caloocan, Bulacan, Camarines Sur, Laguna, Quezon City, Legaspi City, Iloilo City, Leyte, Cebu City, Tarlac City, La Union and Albay.

It is notable that the company is able to finance most of its store expansion from its operating cash flows as well as a fair amount of leverage financing from Metro Bank (Php 1.636 Bil) , BDO (Php875 Mil) and China Bank (Php202 Mil) for a total amount of Php2,712 Mil or 26% of total assets in 2011.

Revenue Drivers (3Q2011 Results):

86.7% of total revenue comes from Hypermarkets (48 stores).  11.7% come from Puregold Junior supermarkets (20 stores).  Discounters (Puregold Extra) account for 1.7% of total revenues (9 discount stores).

Downside Risks:

1.) Failure of Execution on Store Expansion – If the increase in stores doesn’t materialize (100 extra store expansion by 2015) into the same amount of increase in revenues that PureGold Price Club has experienced for the past 3 years, any earnings estimates for 2012-2015 will be sensitive and affect the stock price immediately.

2.) SM Hypermarket Intensifies Competition Through Price War – If the net margin falls from the current 4% to a lower 3% due to intensive price competition and aggressive marketing, promotions and price war resulting to lower profits, in exchange for revenue growth.

3.)Formidable Threats – There are currently SM Investments, Rustan’s, Robinsons and Uniwide being the top market participants, apart from Puregold Price Club that is trying to capture the bulk of the retail pie, with SM Hypermarkets being one of the more potent and aggressive competitor which can lead to decreasing net margins and lower incremental revenues, if a war against market share ensues in the future, as a combination of store location, price, product selection, product quality and range offer many choices for consumers to shop from.

4.) Product Sources – Puregold currently sources its products from over 1,500 regular suppliers and the three largest food suppliers are Nestle, Universal Robina Corporation and Monde Nissin, while the three largest non-food suppliers are Procter and Gamble, Unilever and Colgate-Palmolive.  The company doesn’t have any longterm contracts with suppliers.

Please read the Disclosures of the 9Q2011 report stated by the Puregold Management here.

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Conclusions:  I don’t want to indicate any target price.  I’ve presented above all that I know about PGOLD (pros and cons), and to me, the bottom line is that if the company grows more than 15% the EPS growth rate, then this has substantial upside, even at the price of Php18.00.  However, I’ve also presented that the biggest risks lie in the net margin, competition risks and the expansionary stage execution risk.  After all the huge expenditures, if  store count doesn’t result in higher revenues, this will not impact the bottom line as much as I expect the company to do so.

Will Puregold live up to its tagline “Sa Puregold, always panalo?”  Is this a classic Walmart eating all Sari-sari stores for efficiency strategy going to work well until 2015?  We’ll see.

-Faceless Trader