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. 

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