Brief Equities Bottom-Up: Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends and more

In this briefing:

1. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends
2. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive
3. NIO: A Survivor Among All the Chinese Start-Ups
4. Security Bank: Something Makes Me Feel Insecure
5. Thai Telecoms: Slowdown in Mobile Business Continues.

1. Sell Prada (1913 HK): Accounting Inflates Margins and Facilitates Excessive Dividends

In our first report on Prada S.P.A. (1913 HK): An expensive luxury, we explained how creative accounting was disguising their business reality.  Since then, the stock has fallen 44% and the dividend has been cut. However, we think the key issues have yet to be addressed. They report growth, good operating cashflow and a solid financial position, but in-store sales are stagnant, margins falling, inventory rising and credit quality declining. It seems that profits are being inflated in order to pay dividends, largely to the controlling family.

2. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive

After reviewing 4Q18 results and guidance for 2019, we retain our negative view of ZTO. For 2019 and 2020, we continue to expect slower top-line growth, margin compression, and a sharp increase in CapEx requirements. Our 2019-20 EPS forecasts and target price of $13.31 remain unchanged.

With help from a sharp increase in non-operating income, ZTO’s 4Q18 Adjusted EPS met consensus expectations of $0.24per ADS. But FY19Adjusted Net Profit guidance fell short of expectations, and management’s decision to withdraw quarterly guidance altogether is also disappointing.

ZTO’s gross margin fell ~370 bps in 4Q18 due to cost pressures and the rapid growth of certain low-margin businesses. We believe the same factors will continue to put downward pressure on margins in 2019 and 2020.

ZTO stated during the earnings call that Capex this year would increase by 50-100% compared to the 4bn RMB the company spent in 2018. According to management, much of the increase will go into building out ‘last-mile’ and rural infrastructure and we suspect the initial returns on these investments will be poor

3. NIO: A Survivor Among All the Chinese Start-Ups

Since its announcement on 4Q2018 results and termination of Jiading plant construction, NIO’s share price has been halved. We believe the market has over-reacted on NIO’s cashflow risk. With the expected 30-50% reduction on NEV (New Energy Vehicle) subsidies, all the Start-ups would have worse-than-ever cashflow pressure in 2019. But NIO might survive.

In China’s NEV market, NIO’s market position remains unique among all the Chinese Start-ups. Tesla is still NIO’s main competitor. NIO’s ES6 has capability to compete with Tesla’s Model Y, based on our comparison. Tesla and NIO both have to rely on external funding. The other Chinese Start-ups have to compete with traditional OEMs who have much less cash flow pressures.

NIO’s 4Q2018 financial data were in good trend. We estimate its net loss in 2019 to be further narrowed to Rmb6.1bn. With estimated Rmb13.2bn cash balance at end-Feb 2019, NIO have enough money to cover its estimated cash outflow in the next two year. And it would be able to get another round of external funding in 2020/2021, as long as its business operation ramps up as expected.

4. Security Bank: Something Makes Me Feel Insecure

Security Bank (SECB PM) trades at a premium to Asian banks on a P/Book, franchise valuation, earnings yield, and total return ratio basis.

The PH Score™ of 5.3 is neither good nor bad. (Asia median is 5.7).

In terms of fundamental traction, efficiency has eroded and interconnected profitability has narrowed. “Jaws” are negative. Funding cost growth is sharply in excess of interest income growth. On the other hand, liquidity and capital adequacy are moving in the right direction or are stable.

Asset quality seems to have dramatically improved. Headline non-performing loans are now very low due to adoption of PFRS9. These are calculated now as loans aligned to a default criteria. The bank seems to have reclassified part of “stage 3” impaired loans back into “stage 2”. “Stage 2” is comprised of assets which have experienced a SICR (significant increase in credit risk) since initial recognition, such as substandard, past-dues, and SMLs, and are not classified as NPLs. “Stage 2” represents almost 4% of the loan book versus a headline impaired or problem loan ratio of just 0.64%. In addition, unimpaired past-due loans (73% of headline NPLs) climbed 57% YoY. Charge-offs soared 47% YoY. Perhaps the asset quality is not as pristine as the NPL ratio intimates.

When we look back from 2004, we see an explosive increase in loans (+10x since 2004) coinciding with lower profitability over this period. This is not a good sign. As the bank shifts to consumer lending for growth, up 10x since 2012, we wonder whether a similar pattern will emerge.

In short, the bank resides in the bottom decile of our global VFM (Valuation, Fundamentals, Momentum) rankings.

5. Thai Telecoms: Slowdown in Mobile Business Continues.

The Thai mobile market reported another weak quarter in 4Q18, with trends deteriorating at all three operators. The weakness was partly due to the cheap unlimited fixed speed offers which were popular in 2018 but which have now been removed from the market. Growth should recover by 2H19.  With Total Access Communication (DTAC TB) having acquired spectrum in 2018, it will no longer cede market share without a struggle. That suggests competitive risks are high in Thailand, with all three operators aiming to boost market share. We remain cautious on the sector and are also worried that the government seems keen to push on with 5G spectrum auctions despite a lack of use cases.