Brief Equities Bottom-Up: AIS Growth Has Been Slowing as DTAC Returns to the Scene. 2019 Outlook Uncertain. and more

In this briefing:

1. AIS Growth Has Been Slowing as DTAC Returns to the Scene. 2019 Outlook Uncertain.
2. Rakuten to Covertly Cut Merchant Commission Rates?
3. ZOZO: The Kingmaker Abandons His King
4. OUE C-REIT – Beware of the CPPU Timebomb
5. UG Healthcare: Weak 2Q19 Driven by One-Off Issue, If 10% NPM Achieved in FY20 Trades at 4x FY20 P/E

1. AIS Growth Has Been Slowing as DTAC Returns to the Scene. 2019 Outlook Uncertain.

We met AIS (ADVANC TB) earlier this week at their Analyst Day in Bangkok. The recent results confirm our concerns over market growth slowing, with service revenue flat YoY. The guided 4-6% growth for 2019 may be difficult to achieve. On the mobile side, AIS is feeling competitive pressure from a resurgent DTAC (DTAC TB) and continuing gains from TRUE (TRUE TB) . While “hostilities” have eased recently (less aggressive price offers), we remain wary of the outlook for 2019. On the fixed side, AIS is making slow progress and we continue to think M&A is warranted.

There was a fair amount of discussion around 5G at the meeting, but this looks like a long term issue for AIS. Thailand has never been in the forefront on telecom technology upgrades in the past and there is plenty to do with 4G and fixed broadband still. 

Chris Hoare remains cautious on AIS in the current slowing environment, and ahead of delayed elections. Earnings forecasts have edged lower recently and that is translating to lower dividends (a 70% payout ratio to be retained for now). We remain at Neutral with a target price of THB187.

2. Rakuten to Covertly Cut Merchant Commission Rates?

Rakuten (4755 JP) has been under pressure recently from Amazon (AMZN US) and other competitors in its core online mall business and now seems to be giving more attention once again to the original Rakuten Ichiba, including a plan to cut shipping fees, although this also looks like a face-saving way to cut merchant commissions.

Rakuten is also investing in new logistics infrastructure to try and match the customer services levels of Amazon and ZOZO (3092 JP).

As part of this effort, Rakuten just announced a 9.9% stake in a logistics firm called Kantsu. The deal is part of Rakuten’s strategy to accelerate the move towards consolidated shipments of orders on Rakuten Ichiba – one of the key weaknesses of the Rakuten model compared to Amazon and Zozo.

Rakuten also just announced its year-end results this week: Domestic GMVs rose 11.2% to ¥3.4 trillion for the year ending December 2018. While GMVs rose and revenue increased by 9.2% to ¥426 billion, operating income on domestic e-commerce fell 17.7% to ¥61.3 billion partly due to higher logistics costs. For 4Q2018, operating income fell 27.3%.

3. ZOZO: The Kingmaker Abandons His King

United Arrows’ (7606 JP) decision to cancel its e-commerce services contract with ZOZO Inc (3092 JP) was not a surprise at all but could not have come at a worse time. While a move to direct operation of its online store was expected, United Arrows did not have to choose a moment when Zozo’s stock was collapsing. That it did shows how much cooler relations are between the two firms, a critical development given United Arrows was the principal reason for Zozo’s emergence as the leading fashion mall in the early 2000s.

United Arrows will still be selling through Zozotown and its president last week praised Zozotown’s capacity to bring new and younger customers to its brand. The bigger problem is that United Arrows relies less and less on sales from Zozotown each year and more from its own online store – direct e-commerce sales have increased from 20% of all e-commerce sales in FY2016 to 27% in 9M2018.

At Baycrews, another leading merchant on Zozotown, 50% of e-commerce sales are from its own online store, up 12 percentage points in two years.

A further problem is that other merchants are leaving. We reported before that Onward’s departure, while significant, is less of a threat than it might first appear given that Onward already garners 70-75% of sales from its own store so it did not cost much to leave Zozo. 

However, another big retailer, Right On, also quit Zozo last month despite the fact that more than 50% of its online sales come from Zozo and it has intermittently been one of the top 20 merchants on Zozo. Right On has struggled in recent years, so leaving Zozo cannot have been an easy decision, suggesting just how seriously upset it was.

Other merchants are likely to view these departures with some concern. Six months ago, the idea of quitting Zozo was not even a remote thought in Japan’s fashion industry but it is now a lively subject of discussion. While most merchants will stay,  the recent high profile departures will make a threat to leave look much more real, giving merchants more leverage to negotiate, particularly on Zozo’s take rates.

4. OUE C-REIT – Beware of the CPPU Timebomb

Whilst OUE C-REIT’s DPU yield and Price-to-NAV appears to be attractive vis-à-vis its peers, investors should take note of the implications of the S$375 mil Convertible Perpetual Preferred Units (“CPPU”) and its impact on OUE C-REIT’s DPU going forward.

Assuming that all S$375 mil CPPUs are converted, a total of 524.2 mil new OUE C-REIT will be issued to OUE Ltd, and the total unit base of OUE C-REIT will expand by 18% to 3,385.8 mil units.

For minority investors of OUE C-REIT, they face the risk of having their DPU yield diluted from a projected 7.1% (before conversion) to 6.2% after conversion.

 A Rights Issue to fund CPPU Redemption will be more dilutive than the conversion scenario. Assuming a Rights Issue at 20% discount, DPU yield of OUE C-REIT will drop from a projected 7.1% (before conversion) to 5.8% after Rights Issue.

Minority investors are likely to be at the losing end of this CPPU issue and suffer from yield dilution. Investors should avoid OUE C-REIT for now as the uncertainty over the CPPU conversion remains.

For investors who are still keen to take a position in OUE C-REIT, a fair post-conversion diluted DPU yield would be 6.6%, translating to a recommended entry price of S$0.465 per unit.

5. UG Healthcare: Weak 2Q19 Driven by One-Off Issue, If 10% NPM Achieved in FY20 Trades at 4x FY20 P/E

UG Healthcare (UGHC SP) showed good topline growth (+15%) but very weak bottom-line performance (-73%) in the second quarter of FY19 (financial year ending June). Weak bottom-line results were caused by delays and cost overruns in opening its latest factory expansion.

While the latest results are a setback I remain a believer in the UG Healthcare story. The eventual goal of reaching 100M SGD in revenues and getting a 10% NPM remains unchanged by the end of FY2020. Should the target be achieved the company trades at 4x 2020 P/E. Competitors in Malaysia trade at mid-teens multiples (or higher) so UG should deserve a significant re-rating the coming two years. Fundamentally, nothing has changed to alter my bear case  (0.24 SGD), base case (0.39 SGD) or blue-sky scenario (0.62 SGD) analysis. Liquidity remains an issue at less than 25K SGD/day.