Brief Equities Bottom-Up: China Construction Bank: Not Strategically Dear and more

In this briefing:

1. China Construction Bank: Not Strategically Dear
2. Indonesia Property – In Search of the End of the Rainbow – Part 6 – Intiland Development (DILD IJ)
3. Pan Pacific/Don Quijote: Bringing Joy into Shopping
4. Mercari: Why Mercari Is Likely to Be a Winner in the Cashless Wars
5. Notes from the Silk Road: Xtep Int’l Holdings (1368 HK): Time to Run (Away) For Now

1. China Construction Bank: Not Strategically Dear

China Construction Bank (601939 CH) FY18 results reflected stability and some encouraging signs of positive fundamental momentum. The highlights were a positive “underlying jaws” of 220bps, fortified Capital Adequacy, enhanced Provisioning, and firmer net interest spread and margin. Liquidity remains prudent with credit and deposit growth both expanding by mid-single digits. In addition, the top-line exhibited solid growth with funding expense growth (an issue elsewhere) only mildly in excess of interest income growth. Sharply higher asset loan loss provisions reflected the ongoing battle with troubling systemic asset quality challenges.

CCB is committed to becoming a core comprehensive service provider for smart city development, in alignment with government strategic targets. In terms of technology, AI robots (in wealth management, for example), Intelligent Risk Management Platforms, Biometric verification plus a public and private “cloud ecosphere” are evolving. Big data is developing with data warehouse integrating internal and external data; with enterprise data management and application architecture; and via working platforms. CCB is wedded to IoT, blockchain as well as big data in industry chain finance, via internet-based “e Xin Tong”, “e Xin Tong” and “e Qi Tong”. The bank has a strategy of Mobile First, provision of internet-based smart financial services, booming WeChat banking, and integration of online banking services that combines transactions, sales, and customer service.

Automation and “intelligence” is the bedrock of risk management: the key area today of what is a highly leveraged system. Here, CCB is integrating corporate and retail early warning systems and unifying the monitoring of different exposures. Management launched a “new generation” retail customer scorecard model, elevating the level of automation and “intelligence” of risk metrics. In addition, the bank is attaining greater recognition and control of fraud. Regarding the remote monitoring system, CCB is adapting to the fast development of information, network and big data technology, by building a monitoring system with unified plans, standards, software and hardware.

2. Indonesia Property – In Search of the End of the Rainbow – Part 6 – Intiland Development (DILD IJ)

In this series under Smartkarma Originals, CrossASEAN insight providers AngusMackintosh and Jessica Irene seek to determine whether or not we are close to the end of the rainbow and to a period of outperformance for the property sector. Our end conclusions will be based on a series of company visits to the major listed property companies in Indonesia, conversations with local banks, property agents, and other relevant channel checks. 

The sixth company that we explore is Intiland Development (DILD IJ), a property developer that focuses on landed residential, industrial estates, high-end condominiums, and offices in Jakarta and Surabaya. DILD has a good track record in building and operating high-end condominiums and offices. But the property market slowdown, tighter mortgage regulations, and rising construction costs took a massive toll on the company’s balance sheet and margin.

DILD shows the worst operating cashflow performance versus peers. The operating cashflow is running at a massive deficit after the property market peak in 2013, driven mostly by worsening working capital cycle. Both consolidated gross margin and EBIT margin are also trending down over the past five years, showing the company’s inability to pass on costs. The biggest margin decline is visible in the offices, landed residential, and condominiums. 

The total net asset value (NAV) for company’s landbank and investment properties is about IDR10.5tn, equivalent to IDR1,018 NAV per share. Despite an attractive Price-to-Book (PB) valuation and a chunky 65% discount to NAV, DILD still looks expensive on a Price-to-Earnings (PE) basis. Analysts have been downgrading earnings on lower margin expectation and weaker than expected cashflow generation that cause debt levels to remain high.

Consensus expects 16% EPS growth this year with revenues growing by 22%. We may see further downgrades post FY18 results as 9M18 EBIT only makes up 51% of consensus FY18 forecast. The government’s plan to reduce luxury taxes and allowing foreigners to hold strata title on Indonesian properties should bode well for DILD and serve as a potential catalyst in the short term. Our estimated fair value for DILD is at IDR 404 per share, suggesting 14% upside from the current levels.

3. Pan Pacific/Don Quijote: Bringing Joy into Shopping

• Japanese Retail is in a secular decline: There are areas in retail that are worse affected than the rest
• Falling foot traffic: The biggest problem for Japanese retail
• Don Quijote’s recent history and growth potential
• Attracting shoppers from multiple store formats helps Don Quijote to expand its target market
• Don Quijote is least affected from slowdown in Chinese tourist spending
• FamilyMart UNY store conversions to contribute to revenue and EBIT growth over the next five years
• New store openings to cap at 25 per year because of UNY store conversions
• Valuation: Market unjustly penalized Don Quijote for the UNY acquisition
• Change in retail landscape to help make Don Quijote the “DON” in Japanese retail

4. Mercari: Why Mercari Is Likely to Be a Winner in the Cashless Wars

While we have been sceptical about Mercari Inc (4385 JP)‘s efforts in the US, we have always appreciated the domestic business and have only been put off by the rather demanding multiples. After speaking to the company, we continue to like the domestic business and feel that recent initiatives to broaden the user base are likely to be successful. In addition, while we still feel that there are numerous question marks about whether the business model can work in the US, we have come around to a more positive view on the company’s execution there. Lastly, we believe Merpay’s edge in the cashless wars is underappreciated and the fall in the share price is starting to make the stock attractive.

We discuss the details below.

5. Notes from the Silk Road: Xtep Int’l Holdings (1368 HK): Time to Run (Away) For Now

Xtep International (1368 HK) has announced a placing and top-up subscription of new shares event, creating a capital base which is 9% larger. 

XTEP states that they have considered various ways of raising funds and consider that it would be in their best interests to raise equity funding through the placing and the subscription. 

With the share price down 16% since the placement, we examine what this means for the company’s fundamentals and shareholders. We believe the results will prove to be mixed for management and shareholders alike. We highlight how we expect the stock ranking to react, given we the placement was only a few days back and this is yet to reflect. This special situation analysis may surprise you with the conclusions.