Post analyst briefing, we remain cautious over the broader economy underpinning 7-Eleven’s near-term outlook. Maintain NEUTRAL with a MYR1.36 TP (3% downside), pegged to an unchanged target 23x P/E FY16F EPS. Despite this, its structural growth remains firmly intact. Store expansion remains on track as SSSG contracted 3% YoY amidst a 10-year low in consumer confidence.

Briefing bites. i) Expansion fueled revenue growth as same-store sales growth (SSSG) fell 3.1% YoY, ii) YTD period under review saw a 10-year consumer confidence low and the goods and services tax (GST)-related distortions, and iii) YTD 3Q gross profit margin rose 1.5 ppts on 7-Eleven Malaysia’s (7-Eleven) improved merchandise mix. Translated into earnings, it fell 7.3% YoY on the back of expansion related costs.

More updates. i) management estimates a neutral earnings impact from the scraped MYR41m combined distribution center (CDC) plan and did not rule out the possibility of disbursing the MYR41m or 3.33 sen per share as a special dividend, ii) impending minimum wage hike has a potential 4% impact to bottomline, and iii) encouraging merchandise mix and new promotions with 115 new store keeping units (SKUs) launched.

Store expansion and refurbishment on track. 7-Eleven has added 29 net new stores in 3Q15, bringing total number of outlets to 1883. On refurbishment of its outlets, a total of 162 stores have undergone the renovation process YTD 2Q15. Hence, we believe that it is on track to deliver its target of 200 new store openings and 200 store refurbishments for FY15 (see Figure 4).

Forecasts and risks. We make no changes to our forecast. Key risks include: i) the inability to pass through costs associated with the hike in minimum wage due in Jul 2016, ii) intense competition from other convenience stores, and iii) drop in cigarette demand may indirectly impact impulse purchases in-store.

Maintain NEUTRAL. Maintain NEUTRAL with a MYR1.36 TP, pegged to an unchanged target 23x P/E (in line with its regional listed peer average) to FY16F EPS. Our corroborative DCF-based valuation suggests a MYR1.48 TP (see Figure 6). While faced with challenging near-term operating conditions underpinned by broad economy factors, its structural growth remains firmly intact. This is reflected by its store count per population vastly trailing other countries in the region.

Briefing Highlights

Our key takeaways from the analyst briefing are: i) 7-Eleven YTD 3Q sales of 6.7% growth YoY outperformed the total market, which experienced a marginal decline. It was achieved through expansion of new stores as SSSG fell 3.1% YoY. ii) this was amidst a double whammy of low consumer confidence (see Figure 1) and GST-related distortion resulting in 3-4% lower sales value through reduced cost and iii) YTD 3Q gross profit margin increased 1.5 ppts to 30.6% on the back of 7-Eleven’s initiatives to focus on its health and beauty products as well as a higher gross margin on fresh food. Translating into earnings, it fell 7.3% YoY on the back of burgeoning startup costs and depreciation charges related to its new store expansion. While we anticipate for macroeconomic headwinds to underpin 7-Eleven up till 1H16, the Price Control Anti-Profiteering Act 2011’s (PCAP) allowance for repricing in Jul 2016 may prolong soft consumer spending throughout 2016. However, its expansionary plans hold it in good stead as and when it recovers alongside the broader economy under management’s capable execution.

Scraped MYR41m CDC likely to have neutral impact. Management believes the overall impact to earnings would be neutral whilst retaining strategic capabilities despite scraping the MYR41m CDC in favour of leasing from third party warehouse providers. In addition, they did not rule out the possibility of disbursing the MYR41m or 3.33 sen per share as a special dividend. Based on their cash in hand (MYR182m as at 30 Sep or 14.8 sen) and strong cash generation properties – projected FY15 operational cash flow almost 2x capex requirements, 7-Eleven is financially capable to undertake such an exercise.

Impending minimum wage hike is a potential 4% impact to bottomline. In Jul 2016, the minimum wage rates are expected to be implemented coinciding with the Price Control Anti-Profiteering Act 2011’s (PCAP) allowance for more flexibility in repricing. The net effect of this is highly anticipated given an increase in costs associated with minimum wage hike is estimated to consist close to 4% of FY16F earnings withholding any cost pass through initiatives. The effectiveness of the reprice and the consequent successful cost pass through is amidst: i) an expected recovery but still fragile consumer sentiment (see Figure 1), and ii) slower aggregate domestic demand as projected by RHB at 4.4% in 2016F (2015F: 5.1%). Merchandise mix and new promotions. 7-Eleven introduced 115 new SKUs in 3Q15, in its effort to improve merchandise mix with a focus on exclusivity and its house brand. Among the new SKUs launched were Steamed Pau (1 Sep) (see Figure 2) that grosses higher margin than the average fresh food. Its new promotions include MYR1 Explosive Deals (see Figure 3) and monthly deals. We believe these fresh promotions boosts desired foot traffic into 7-Eleven stores, with an aim of capitalising from trickle down impulse purchases as a result.

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

7-Eleven Malaysia (7-Eleven) owns, operates and franchises a chain of convenience stores under the 7-Eleven brand name. It is the first and largest 24-hour convenience store operator in Malaysia.

Recommendation Chart

Source: RHB Research - 1 Dec 2015