Thursday, 22 October 2020

MR DIY'S GROWING PAINS : HOW TO CHANGE THE FUTURE (PART II)


In Part I we had discussed the overvaluation of Mr DIY's IPO and its hypergrowth-related problems. 

Now let's look at the actual growth prospects, and where the exciting opportunities actually lie. 

Mr DIY's long term challenge as a business is straightforward : deliver on the promise of more growth somehow, and maintain consistent earnings growth in unprecedented times for retail operators.

In other words, the strategy needs to evolve to cope with the times. There needs to be greater efficiency, and a serious rethink when it comes to product strategy, store placement, and store size, amongst others.




Profitability is not a constant. While recouping the initial investment is great, this is not a machine that will begin paying for itself with no added capital commitments.

One key metric is Same Stores Sales Growth (SSSG), which should be self-explanatory : it's the year-on-year increase in revenues for a retail chain's existing locations. How much the store sold this year versus the last.

Even before COVID times, Mr DIY's SSSG had been decelerating fast. 


We'd take the 2020 figure as an anomaly, but it leaves a huge question as to what's next. 

Like a nation's GDP, we need incremental but sustainable growth. What's important here is not for Mr DIY to get back to achieving 6% SSSG every year - that was back in 2017 when there were much fewer stores. 

What it needs to do now is maintain positive SSSG annually, which is going to be a tall task. History is replete with instances of retailers showing massive earnings volatility as they were at the mercy of the economy as well as the shift in consumer trends.

I have little doubt on the management's team capability to do all the right things to drive SSSG. Whether it's inventory management, aggressive promos, or customer data utilisation, they know their market and customers. They are already reaping the rewards from this major listing - hopefully they still have an economic incentive to continue what they have been doing. 

If you're going to be a shareholder, throw the question back to them, the industry experts. Go ask this at the next AGM.

Given the rate of store openings and the promise of further growth, what are your SSSG targets between now and 2025? 

See if they can answer this. I'm asking the SSSG question because in the prospectus I couldn't find an elaboration on what to expect.

Having a benchmark to refer to is always useful. If the company is being promoted as a growth story,  shareholders should be able to see concrete targets. Some KPI visibility is a start, and it's not optional; it's mandatory. 

The disconnect between what is aspirational (what we want to do) and something concrete (how we want to get there) is apparent. Are we looking at 1,200 stores within two years? RM3 billion in revenues? Is the company planning to capture 70% of the home improvement retail market?

And more importantly : what is the future here? Surely it can't be simply more Mr DIY stores selling the stuff they already sell. That market is saturating quickly.

Malaysia (and Brunei) can only take in so many new Mr DIYs. But what about the new flagship brands?



MEET MR TOY





I have vastly different thoughts between Mr Toy and Mr Dollar. One of them is the key to the future, the other I think is an unnecessary distraction.

The intent behind these two brands is for Mr DIY to capture new markets. Below is the Mr DIY product mix, where the 'Others' section comprises toys and food and beverage items, and other things. 


It wouldn't be fair for me to comment on the footfalls or visitor figures to the Mr Toy outlets I've been at because of the current COVID anxieties. But the outlets clearly do not move products as fast as a Mr DIY outlet would.

As a brand in itself, Mr Toy can do decent business. Its only natural competition are either the malls or the auntie and uncle toy stores like the one you can find along the Jalan Raja Laut/Chow Kit area (if you're a KLite of a certain age and a certain lower-middle class background, as a child, this road would be your toy heaven).

In fact, a lot of the toys in Mr Toy can also be found in the auntie and uncle stores. They are predominantly imported from China.




The main issue with Mr Toy is that while cheapness is a strength, it's also a weakness.

With everything already cheap, promotional discounts may be a redundant or futile exercise. The average spend per customer may be on the high side, but toy stores do not receive as much recurring business as would a Mr DIY. 

For example, the Mr Toy branch in AEON Mall Taman Maluri, Cheras is almost as big as the Mr DIY that occupies the same floor. Is it necessary to stock so many items?

In fact, most Mr DIYs have a small but reasonably well-stocked toys section. In multiple instances, I found the same toys in both the Mr Toy and Mr DIY outlets that occupy the same mall. While that shouldn't come as a surprise, it's the duplication of resources that I'm more concerned with.

This shelf of toys is actually in a Mr DIY....

As a humble potentially would-be shareholder, here's my down-to-earth, totally unspectacular or hypergrowth-related suggestion : why can't every Mr DIY in the 'large store' category (square footage of between 12,000 to 20,000) simply have a dedicated Mr Toy section with the distinct branding? 

For starters, they currently have 125 large stores, or one in every five Mr DIYs currently operating. There's enough space there; why not try that out?

They can save on rental, drive footfalls from Mr DIY customers (call it a store-within-a-store-within-a-store, if you must), and keep the customers' kids occupied and happy. All in the same location. 

To drive sustainable growth, greater efficiency is a must. I'm simply thinking out loud solutions that don't involve the need (or urge) to open a 10,000 square-foot plus toy bazaar in every mall that exists in Malaysia. 


Mr DIY's store breakdown, by size

I can outline multiple reasons why toys is actually an extremely challenging business to be in. Just ask how the auntie uncle stores are doing, or - God forbid - go walk into any Toys R' Us branch in the Klang Valley and ask the salespeople how many customers they entertain per day.

To be fair, I don't have access to the research and I've only heard anecdotal accounts about the struggles of local toy retailers. The Mr DIY prospectus also did not go deep into the prospects of the toy industry, other than a line that said "the willingness and propensity of households in Malaysia to spend on products for babies and children provide us with an opportunity for growth" on page 86. 

I did not find a shiny Frost & Sullivan report about how rosy the toy sales trend is in Malaysia. 

To my lizard brain, declining birth rates means lower expenditure on toys in the future. It's a demographic and generational shift. It expedited the demise of the US operations of Toys R' Us. 

And if lower priced toys can feasibly drive more sales, these toys can't get any cheaper, really. I'm not knocking on them, by the way; the toys are actually pretty good. 



A quick list of the challenges:

- Cheap toys make for a low(er) margins business.

- Cheap toys hinder the potential of discounts or promotional activities (usually retailers would opt for a membership program to get repeat business).

- There is intense competition, sometimes by the same anchor malls that house these Mr Toy outlets.

- The lower quality of products is understandable, but there is a real risk of these stores (Mr Toy and the malls) carrying made-in-China toys that look and feel essentially the same. There is little differentiation.

- Inventory overload and too big a space may mean that hard-to-move products will stay in shelves for a long time, which makes for a stale product offering (in contrast, a department store's toys section is much smaller).

- Establishing a brand identity is difficult. Rather than Mr Toy being the premier 'toys at reasonable prices' store,  it may be labeled as 'just another toy store selling cheap Made-in-China products' if its offerings are indistinguishable from the auntie-uncle/department stores.

Of course Mr Toy can make tons of money if the company plays its cards right. But shareholders need to understand the overall strategy and the growth prospects in this segment, if there is one.

I'M A DOLLAR BULL


When it comes to Mr Dollar, I can immediately understand the appeal. It's simple, it's beautiful, and it's the real growth driver for a company chasing the next big growth story. But it comes with a catch.

The dollar store concept hardly needs refinement : cheap sells, and the fast moving consumer goods sell fastest when it's cheapest.

The brand identity is immediately apparent in the slogan. For Mr Dollar it's 'Always RM2 or RM5'; slightly clunky but let's not be the least fun person to talk to at parties, yes?


Impulse buying driven by the sheer cheapness of the items can lead to higher spend per transaction; without realising it, your purchases of RM2 or RM5 items can lead to a surprisingly hefty bill. 

After picking out some interesting snacks and drinks, my own basket came to RM60 in total. Yet I have no qualms about coming back soon.

Now imagine a family of five coming in to get their supply, and then imagine them coming back every week. 

The average spend per transaction is going to be far higher than RM25.20 at a Mr DIY (as of the first half of 2020), and very lucrative for the business. In a growth context, this meets my expectations. It's the kind of business I would invest in. Opening 50 new stores in 2021 is not a ridiculous target to set, in this instance.  

So here's the catch : Mr Dollar will be a welterweight up against a heavyweight.



There's Eco Shop, which already has 154 stores in Malaysia. They can do big sizes or small, shoplots or malls. 

It was even mentioned in the prospectus due to a common shareholder in both Mr DIY and Eco Shop. Yes, you read that right.

But the prospectus ingeniously omitted mention of Eco Shop being a direct competitor - or as I like to call it, an existential threat - to Mr Dollar. But ya lor, this prospectus was about Mr DIY only kan.... :)


Their promise of 'Always RM2.10' is a formidable one, and their stores tend to be crowded, especially on weekdays after work hours and on weekends (anecdotal observation again, but I have been to Eco Shop branches in KL, Melaka, and Negeri Sembilan, multiple times).

They dominate this space, and Mr Dollar wants to gatecrash this party. By 2021 they want to get to at least one third of Eco Shop's total store network. 

In order to succeed, Mr Dollar will need to be aggressive, not just with their expansion, but also product strategy. 

I do not rule out a scenario where it's literally a battle of the brands. They may end up in the same neighbourhoods, within spitting distance of each other, enticing customers to dump one store for the other. 

They will fight in the malls. They will fight in the suburbs. Winner takes all. 

But if anyone has the resources and expertise to pull this off, it would be the biggest retail home improvement chain in Malaysia. And in my view, to truly stand out, it's going to be all about the products.

To really stand out, they can champion quality Malaysian made products and snacks, and it does not necessarily have to be the cheapest confectionery available to humankind. 

They can do deals with manufacturers to repackage exclusively for Mr Dollar to make sense in an 'always RM5' context, for example. They can do placements for hip local F&B brands whose current presence is predominantly online. 

It would be a win-win : actual, cool products at a dollar store, and an exposure to physical retail for online sellers. 

While a lot of the products at Mr Dollar is quite similar to Eco Shop, there were some real standouts. Some are brands of snacks and drinks that can rarely found in other supermarkets. 

For dollar stores, cheapness will remain an emphasis, but quality can be cheap too. And differentiation matters.


By highlighting all these issues over this two-part series, I do not mean to excoriate Mr DIY or their listing aspirations. Using the rotan is not a good way to start a thoughtful conversation.

I want them to do well, and I see their potential in serving a purpose far beyond just being a cheap home improvement retailer. They do, and can do much more, to promote local products and local manufacturers. 

You want to catalyse local businesses and help boost their livelihoods and the economy? Damn, I'm in. Go for it.   

In fact, it would be quite a statement if one day Mr DIY becomes known for having a high concentration of local products that consumers are happy to buy and use. I would in turn be a happy shareholder, because their hearts are in the right place. Mr Dollar may well be that avenue.

It's a great brand but an overpriced IPO, so it's a shame. But I will still keep coming back to the stores. 

Sunday, 18 October 2020

MR DIY'S IPO IS THE ONLY THING THAT'S NOT 'ALWAYS LOW PRICES' (PART I)


The IPO is clearly overvalued, but you already know that. Reading this will not change your mind. 

The company is raising a total of RM1.5 billion in fresh funds. RM1.2 billion goes to the promoters in a massive exercise of cashing out. There's no new cash raised for working capital or business expansion.  

Public interest has been lousy, with the retail portion of the offering oversubscribed by... 0.07 times. The uncles are in the middle of a historic hot market, but they're cold about this listing.

In fact, had the company not received a peculiar exemption to have a much lower public shareholding spread of 15%, the IPO would most likely have been undersubscribed. 

But the overvaluation of this IPO is almost besides the point. What this listing does is to give the public a peek at this massive, cash rich business.

I've managed to read the Mr DIY prospectus from front to back. There are a few challenges and opportunities that are worth highlighting so you can see past the surface. I try to be as fair and factual as possible.

Over the past few weeks I had visited 15 Mr DIY stores in the Klang Valley, Negeri Sembilan, Melaka and Johor areas, plus two Mr TOY stores and one Mr Dollar store. Just living my best life, no regrets. 

I lurked the aisles and stalked the customers while practicing good hygiene and social distancing guidelines. I spent money in every store and chatted up the cashiers occasionally. 

I hope a BlackRock executive or two have done at least this small bit of on-the-ground survey to check out how things are really like. Just go old-school at least : count the number of shoppers coming and going, have a look at their basket of purchases, queue in a line to get an idea of the typical average spending per customer and popular items bought, et cetera.

Let's delve into the business strategy that got them to where they are today.

ALL ABOUT HYPERGROWTH

The Three Misters

In the past few years, Mr DIY has been all about growing its presence, network and sales at breakneck speed. To undertake this - and keep its partners and shareholders happy - it took up massive debt. This IPO is repayment time.

When done right, you can turn yourself into a dominant player with a distinct brand identity and engender longlasting customer loyalty, with all of that established in  less than half a decade. 

And the extra income generated from that extra leverage can generate huge enough cash flows for the business to (almost) pay for itself.

Lest we forget, Mr DIY is carrying a market capitalisation of RM10 billion for a business that's only been around for 15 years. The overwhelming majority of its historical income came in the last five. 

Hypergrowth can be effective, but it can also be a double-edged sword.

The hundreds of new stores being opened have the effect of boosting the topline, or revenue growth, via expansion. It's the fastest way to get to a billion ringgit (or two) in sales.

But all these stores require significant capital outlays, and revenue generation from new outlets takes time. If you're a business owner pursuing hypergrowth, it is imperative that you generate huge cash flows to repay your huge loans, and still have enough of a net profit to reward shareholders in the form of dividends. 

Borrowing money to pay dividends would simply be a dumb thing to do, eh?

Payback comes quickly in hypergrowth. Precisely because of the added capital outlay, your overall profit margins start to compress. 

Costs eats up into the profits, so to make the actual profit figure look respectable, you expand with even more store openings. You have to boost the topline even more just to keep the bottomline (net profit) growing.

Too much, too quickly is usually not a good idea, because you get seduced by the 'build it and they will come' fallacy. 

The author and hedge fund manager Scott Fearon in his book had this to say about the perils :

"(A hypergrowth strategy) can keep management from focusing on the most important task retailers have to perform : finding things that people actually want to purchase. "

"Just because the stuff on your shelves is cheap doesn't mean consumers will automatically buy it. Even the least discriminating shoppers out there have to like what you're selling".

The eventual minority shareholders of Mr DIY need to ask some very tough and frank questions about how the company expect to grow some more. But first things first : the IPO pricing.

The base question here is simple : how can we reasonably value this business at 31 times earnings and a market capitalisation of RM10 billion?

As a yield-seeking investor, I personally would prioritise these. They are sacrosanct to my long term portfolio.

Growth potential

 Dividend potential

 Fat profit margins

Irregardless of the IPO pricing, Mr DIY definitely has at least two out of three from the above. The growth promise remains fuzzy, but as you will see in Part II, there are some very enticing propositions. 

Mr DIY currently has 670 stores as of September 2020 in Malaysia and Brunei. It has a market share of nearly one third in the home improvement retailer market in terms of revenue. It recorded more than 8 million transactions per month in 2019. Monster network, monster numbers.

The company sells cheap home improvement items, and it has begun expanding into two supposedly underserved markets - toys and F&B.

The main point of this listing exercise is to pay off that hypergrowth debt. With no new funds to be raised for working capita. the cynics would just point to this being a huge cash grab, but the reality is more nuanced. 

I have no issue with this - in fact, companies go to listing with this purpose all the time. Mr DIY has enough internal funds and resources to bankroll its business expansion.

After growing so quickly, now they are raising cash at equal speed to lower their gearing, pay off their bankers, and then get used to life as a public entity with the regulatory and shareholder scrutiny that comes with it. 

Given the backing of its institutional shareholders, relationship with major banks, and that newly lowered gearing, it won't have issues taking up new loans if need be. 

The company is being promoted as a growth stock and not as a mature value stock in a maturing market. It's heavily implied that there's more room to grow beyond the 670 stores currently operating, which in case you couldn't tell, is an absolutely massive number for a country of this size and population. 

The potential for dividends is there, though we are advised not to expect much. One estimate pegs the dividend yield in the sub-2% range.

But the case for growth starts to fall apart when you consider the pricing itself.

The RM1.60 IPO price translates to a market capitalisation of RM10 billion upon listing. This would make Mr DIY the 36th largest company on Bursa Malaysia by market capitalisation (I'm using stock exchange data as of 16 October 2020).

This would make it bigger than AmBank, Genting Plantations, Gamuda, YTL IGB REIT, Carlsberg, Malaysia Airports, and IJM. If you combine the current market caps of Astro and Lotte Chemical Titan, it still wouldn't be as big as a single Mr DIY.

Is it fair to characterise Mr DIY as overvalued just because all the aforementioned titans of industry have been experiencing their own challenges? Why knock on the IPO just because the lousy stock market (for blue chips, anyway) have driven down the valuations of all these other companies?

We can now try judging Mr DIY by its individual merits, and the premise that it is actually a growth proposition. Is it still a rocket ship to Mars, or has it already arrived?

To undertake this, and for the bankers to justify that RM10 billion market cap, an independent research was commissioned. It's right there in the prospectus on page 126, issued by Frost & Sullivan.

One of the key presumptions is that the home improvement retail sector in Malaysia is expected to grow at a compounded annual growth rate (CAGR) of 10.2% between now and 2024. This figure is important to keep in mind - it's been thrown around a lot as a justification of the 'still got further growth' promise.

The basis for that figure? Unfortunately you just have to take Frost & Sullivan's word on this. Though I do have a feeling that if we were to commission a new report based on the short term economic damage done by the COVID-19 pandemic in the first ten months of 2020, the projections may be just a teeny weeny bit different. 


Or take this passage in the Frost & Sullivan report highlighting marvelous, stupendous, and continous economic prosperity for Malaysia, which means higher domestic demand and consumption, which means more walk-ins and higher spending in Mr DIY stores.  Music to my ears, really.


And then you see the fine print:


Understandably, these kinds of reports were made far in advance when the company was contemplating the IPO. But my main point stands : these are outdated projections. The numbers no longer apply. 

As for the other numbers cited in the report, I'm not sure which ones still apply and which no longer do. 

And when that's the case, I couldn't put much weight in the entire report.

The world has changed in unexpected ways. The global economy is contracting in unprecedented fashion. Jobs are lost, and unemployment is rising. Spending habits are shifting because more people are becoming unsure if they'll be able to put food on the table next month.

The threat of lockdowns means that it's unbelieveably difficult to project economic growth on a short term basis, let alone one that runs down a few years.

Given the hardship faced by the newly unemployed, it would be difficult to believe that household disposable income levels will rise this year. For the next few years? Might as well roll a dice.

Elsewhere in the report, this handy comparison was used to convey Malaysia's limitless potential in accommodating more home improvement stores.

I did not find this 'comparison' useful. Does it mean to imply that Malaysia can also eventually have 370 stores per million people in the next 5-10 years like the US, population 330 million? 

These are countries at totally different economic stages, population, consumption trends, purchasing power, and so forth. Australia is an outlier for its DIY-centric 'tinkerer's culture'. They have garages in their homes. Australians love the tool shed as much as Americans love fast food.

The USA's own home improvement market is supported by a large population. DIY home renovations is a thing, to the extent that it impacts lumber prices

If we were to compare just the emerging economies, we are only behind Thailand, whose population is more than double that of ours. And the situation in Thailand? The biggest home improvement chain over there is not seen as a growth story.

There are other metrics mentioned for Malaysia, such as retail sales per capita (ours is lower than Singapore, Vietnam Thailand, and others) and growth in retail sales of the home improvement retail sector per capita (undoubtedly a mouthful) but their growth prospects are largely predicated on disposable income rising, and rising some more.

In other words, if there are economic difficulties or stagnation in disposable income, consumer spending won't grow. The entire growth story premise/promise would be turned on its head. 

The major risk is that Mr DIY can open all these new stores but face lower sales going forward. There is a growth story in the business expansion (internal catalyst), but the economic realities (external catalyst) may be different. 

It is apparent that the IPO is priced at the top end of any realistic pricing range. But if you don't like the  price, you can always wait for later. Or don't buy it.

Source : The Edge Weekly 

I don't think that a RM10 billion valuation is anything near the realms of reasonable. But that's OK - this is not the kind of stock to rush and buy into. The free market will decide the trajectory of this stock. 

But to deliver on this promise of growth, Mr DIY has to sort out two problems they've never had to deal with before : a saturated market and ensuring the success of two new, unproven brands. 

LOCATION : TOO MUCH AND NOT ENOUGH OF

In the prospectus, this was cited as a competitive advantage:

Sounds reasonable enough, but there's a hitch. Shopping malls and hypermarkets are closing down because Malaysia clearly has no need for so many. 

Consumer trends are also shifting, and some have outgrown the need of the physical realm. Our hypermarkets are going the way of the dinosaurs, while the growth in online shopping is another rocket to Mars. 

That poses a direct threat to retailers like Mr DIY which counts on walk-in customers for its income. The physical presence is not optional; it's mandatory.

A standalone shopfront store would likely incur higher costs due to the higher square footage commitment,  landlords potentially playing hardball, and the challenge in finding just the right location. Mr DIY currently has 386 mall-based stores and 288 standalone shopfront stores.

Sounds balanced? Not really. Mr DIY's revenues are skewed towards the mall-based stores for the simple reason that malls are crowd pullers. In 2019, these stores made RM540 million more in revenues than the shopfronts. 


The problem here is straightforward.

Mr DIY and its cohorts - Mr Toy and Mr Dollar - are running out of malls to open in. In this whole country.

The trend for malls is the reverse of Mr DIY's : they have been consoldiating and closing.

Just look at how the malls have fared over the past few years, during the same period where Mr DIY recorded exponential growth.

As mentioned in the prospectus, each of these malls host a Mr DIY outlet more often than not.

AEON has a total presence of 28 shopping centres in the country. As far as I can tell, they're not in a rush to open new malls anytime soon. They are making do with what they have, and refurbs alone are costing a fortune.

Giant has been very aggressively closing hypermarkets at a fast clip, from 147 stores in 2014 to 59 last year. It just exited Sabah and Sarawak. Probably no new malls soon.

Tesco Malaysia, now the largest Malaysian hypermarket chain with 60 stores, saw a change of ownership in March. They themselves are victims of hypergrowth, with nearly RM4 billion in debt. They still have a whole bunch of prime land and excess square footage they no longer need - maybe they should go make some apartments instead

Nowadays, you can visit any of these malls or hypermarkets and boom, there will be a Mr DIY there, whether you like it or not. The store is usually the newest and/or shiniest tenant there. 

That leaves the local players like NSK and Mydin. Surprise, surprise - there are already Mr DIY stores at these locations too. 

With all these in mind, how would they be able to stick to a hypergrowth strategy then? 

Just try and comprehend these numbers.

See that? They want to open at least 100 Mr DIY stores this year, 22 Mr Toy stores, and 10 Mr Dollar stores. 

In 2021? 100 more Mr DIY stores, 25 Mr Toy stores and 50 Mr Dollar stores. 

Now, if hypergrowth was the equivalent of badly made fried rice, Uncle Roger would be all over this. 

My view is : you should know exactly how many stores you want to open in a given year, so 'approximately' or 'at least' doesn't quite cut it in that prospectus. In the same vein, shareholders must be properly informed of this. 

There is no shame in slowing down a bit, or revising projections in line with current developments - namely the reduced number of malls and the existence of a global, moderately lethal plague. People would understand. 

Having a moving target and adjusting it in real time (targeted number of stores opened) may be all well and good as a private company, but in the public markets you'd better be prepared for some very tough questions by dissatisfied uncle shareholders. 

There were 593 stores opened as at end-2019. If we are looking at 'at least' 300 stores by end-2021, that would be a 50% increase in two years. Tell me that's not hypergrowth.


So let me tell you what happens when we reach such levels of saturation. No, it's not a downbeat projection of the far future. 

It's already happening

























Malaysia (or Brunei) does not need another 500 Mr DIY stores. The company might think it does, but they would not be served well in the future by carrying this out. Neither would the shareholders.

Growth has to be sustainable. You can't go against gravity - this country only has 30 million people.

The hypermarkets tried the super-duper growth tactic already. Look what happened to them.

Retailers - particularly large chains with dependence on having a physical storefront - must change with the times. No one is immune to the forces of gravity. 

The threat to the business is very, very real.


But... it's not all doom and gloom. There is a way for the company to grow and become prosperous. But it will no longer be about just hypergrowth for the sake of cornerning the market at all costs. 

In Part II we will explore the future opportunities, the potential success of the new flagship brands and Mr DIY's real growth driver in the coming years. 

More Tales By The Pelham Blue Fund