Listed and primarily traded on the Indonesian Stock Exchange as well as being traded over the US OTC markets (OTC:ACEHF), ACE Hardware Indonesia (AHI) is the master franchise holder of the ACE Hardware brand in the country, appointed by ACE Hardware Corporation in the US. The firm is part of the Kawan Lama Sejahtera Group, the #1 commercial and industrial supplies company in Indonesia.
AHI is the #1 player in the home improvement and lifestyle market in Indonesia, with 131 stores across numerous major cities in Indonesia. Its direct competitor, Best Pongs, operates <10 stores in the country. The company targets the middle to middle-upper class, and a part of its growth strategy is to open new stores at major cities (e.g., Jakarta) to create touch points with its customers. In addition, AHI has >80k SKUs to allow the firm to meet the diverse demands of the Indonesian consumers. This, however, has translated to high inventory days. Going forward, the firm plans to address this by targeting to reduce its SKUs by 25%.
In 2010, AHI entered the toys retail industry via the opening of its 1st “Toy Kingdoms” store. Currently, it has 24 “Toys Kingdom” stores across Indonesia.
#1 player by far in its target market
AHI is the #1 player in the Indonesian home improvement market by far, with 131 stores across the country. In contrast, its closest direct competitor, Best Pong, operates <10 stores in the country. AHI's stores are primarily located in major economically developed cities in Indonesia. This includes the largest 5 cities in the country, including Jakarta (36 stores), Surabaya (8) and Bandung (8).
AHI's extensive and dominant presence across the country provides several tangible benefits for the firm as it grows its presence in the country.
Firstly, its leading branding in the country allows the store to improve its bargaining position with landlords when negotiating on store rental. This position is strengthened further as AHI usually locates its toy retail outlets near its home improvement stores, which increases the rented space.
Secondly, its dominant market position allows the firm to develop a strong understanding of the consumer preferences of the home improvement products. This allows the firm to introduce products which caters to the consumers and also allows it to negotiate from a strong position with its suppliers (with regard to pricing, credit etc.), which are likely to be reliant on AHI to penetrate the Indonesian market given its dominant presence.
Going forward, AHI will continue to open new stores. However, we note that it has slowed the pace of new openings in the last two years, from 19/14 in FY13/FY14 to 8/13 in FY15/FY16. As AHI targets primarily comparatively economically developed cities in Indonesia, we believe over-aggressive openings of new stores tend to hurt SSSG, reflected by the falling SSSG (see figures below).
We believe AHI has learnt the impact of aggressive expansion slowing down SSSG, as seen from its slowing down of new store openings in FY15 and FY16. We think the company could potentially expand at the pace demonstrated in FY15 and FY16. As of March 2017, AHI has already opened 2 new stores, in Bandung and Tangerang, which we think is on pace with the last 2 years. The slowdown in new store openings would have a positive effect on sales cannibalization from new stores and could allow SSSG to improve to FY14 levels (i.e., around 3%) in the next few years.
Favorable demographics supporting the growth of the Indonesian home improvements market, benefiting AHI
As the #1 player in the sector, AHI is expected to benefit from the growth of the Indonesian home improvement / lifestyle retail market.
With a population of approximately 258 million, Indonesia's population is the 4th largest globally and amongst the youngest. Approximately 42% of its population is between 0-24 years, with a median age of 29.9, both of which are supportive of residential housing demand.
Furthermore, its urbanization rate is only 53%, versus that of neighboring countries such as Singapore (100%) and Malaysia (74%). While urbanization rates would likely gradually increase, the sheer size of the Indonesian population suggests that a 1% increase would increase the population in cities by >2 million. This suggests further growth of the home improvement market over time, as more people move to cities and stimulate demand for housing in Indonesian cities.
The Indonesian household size has shrunk from 4.0 per household in 2002-2006 to 3.9 currently. This is higher than other Asian countries such as Singapore (3.5), China (3.1), Thailand (3.1) and Hong Kong (3), suggesting that Indonesia's households could shrink further to increase demand for houses. With further urbanization and rising affluence leading to changing mindsets, we expect household size (person per household) in the country to reduce further but the number of households to increase.
Cumulatively, the effects of the above imply more households in Indonesian cities. This would imply higher demand for home improvement outlets, as Indonesian consumers would need products such as home appliances (e.g., microwave, refrigerators), home storage solutions (e.g., racks) and lighting. We believe AHI is addressing this demand from consumers in the cities and will continue to grow its presence as the market becomes larger.
Secondly, the urban consuming class is expected (by McKinsey) to grow by 5 million annually by 2020, supporting growth of the modern retail industry as well as residential demand. Furthermore, the Indonesian government has implemented a set of balanced housing regulations since 2011 to decrease the housing backlog in the country. Under these regulations, developers need to develop luxury houses, medium-cost houses and low-cost houses in a 3:2:1 ratio. For apartment development, developers have to provide low-cost apartments amounting to at least 20% of total floor area of luxury apartments when building the latter.
The cumulative impact of the above two factors could increase private residential demand in Indonesia. Java, being the key economic development region of Indonesia, is likely to benefit more from the economic growth of the country. Coupled with increasing footfalls in retail malls as consumers become more affluent, there could be increasing demand for AHI's home improvement products.
Lastly, Indonesian consumers are increasing more optimistic, measuring by the uptrend in the Consumer Confidence Index since August 2015, partially supported by improving commodities (e.g., coal, palm oil) prices.
Improving consumer confidence has a positive effect on spending at retail outlets, benefiting retailers in the country.
Further growth opportunities as AHI expands into other parts of Java
AHI has also started looking at opening new stores at cities beyond Jakarta. It has opened new stores in Bandung and Tangerang in 2017, both of which have enjoyed healthy economic growth in recent years, which supports demand for residential properties and the retailing industry.
We think this will position AHI well for future development of these regions as the firm builds its brand equity and grabs consumer mindshare in these areas. We also like the fact that the company will be looking to open smaller stores, as this reduces start-up costs, minimizes breakeven period and lowers working capital requirements.
Strong operating cash flow generation supports organic growth and consistent dividend payments amidst its expansion
Strong operating cash flows allow AHI to open new stores via internal resources and also provide consistent dividend payouts to shareholders. This has also allowed the firm to have a strong balance sheet, which provides flexibility for growth via M&As, should the firm decides to pursue the avenue. As of September 2016, the firm has net cash of IDR501 billion. The firm has a policy of paying dividends to its shareholders at least once annually.
In view of AHI's consistently strong cash flow generation ability, we opine the firm is likely able to continue its dividend payouts to shareholders, and yet, at the same time, continue its organic expansion plans whilst maintaining a healthy balance sheet.
Strategy of opening smaller stores generates higher sales/sqm, and also, slowing down of new stores opening minimizes cannibalization
Using figures from AHL's annual reports and other research sources, we have noted that its store sizes are decreasing, from an average of 2,627 sqm in FY14 to 1,934 sqm in FY16. We also note that the company plans to have smaller sizes for its new stores going forward. We think a smaller store size generates higher sales/sqm and potentially improves operating margins (all else remained constant).
In the past few years, AHI has focused on opening new stores in Jakarta. As a result, its new stores were physically close to existing ones and cannibalized sales of the latter, resulting in a weakness in Same Store Sales Growth (SSSG). Going forward, the company plans to slow down its new store openings to reduce cannibalization, and also plans to open stores in other parts of Java, beyond Jakarta. We believe such a strategy would be beneficial to the company, as it improves SSSG, which could potentially have a beneficial effect on AHI share price.
Experienced management team leading AHI's operations
AHI has an experienced management team which has been with the firm for >10 years.
Its CEO, Mr. Prabowo Widyakrisnadi, has been with the firm since the opening of the first ACE Hardware store. Since then, the firm has opened more than 100 stores to become the #1 player in the industry, establishing his credentials with regard to leading the firm's growth in the future.
Furthermore, we like the fact that AHI's merchandising director, Ms. Tarisa Widyakrisnadi, started her career with the firm as a merchandise purchaser before rising through the ranks to the management team. Currently, she is responsible for managing the merchandising operations and introducing new products to the Indonesian market. We believe her transition to the management team from a junior position illustrates her capability and track record.
AHI sources >80% of its merchandise from overseas markets, and thus, has exposure to FX risk. Recognizing this, the company has adopted a policy of spreading out its payments to suppliers, making a 30% payment upfront and the remaining 70% upon delivery.
Sharp increase in minimum wages in Indonesia
>40% of AHI's operating expenses are related to wages. Furthermore, a significant portion of its workers are paid minimum wages. Hence, changes in minimum wages (which have been increasing in the last few years) affects the firm's profitability adversely.
Recently, the Indonesian government has initiated efforts to improve the transparency of minimum wage increases. We think this benefits retailers such as AHI, who will be able to estimate wages more accurately and price their products better.
Slowdown in the Indonesian economy
Retail sales in Indonesia have displayed a relatively strong correlation to the country's economic growth. Hence, should the Indonesian economy experience slow growth (arising from various factors such as falling commodities prices), consumer spending could potentially be tempered, resulting in slowdown in AHI's SSSG and thus its revenues and profitability.
Low inventory turnover
Historically, AHI has experienced high inventory days, partially caused by its strategy of holding >80k SKUs in its store. However, the company has commenced plans to address this issue by opening smaller stores (which reduces inventory in store), and targets to reduce its SKUs by 25%, from 80k to 60k. This effort should likely increase inventory turnover, reducing its working capital requirements and thus increasing FCFF, assuming all else is constant.
Using market data as of 22nd March, 2017, AHI share price has fallen approximately 22% since July 2016 and currently trades at 21.1x FY17E P/E, which is below its five-year mean forward P/E. With its favorable middle-term prospects (strong operating cash flow supporting organic expansion, allowing the firm to benefit from the country's retail development), the share price pullback could potentially create an entry opportunity. More importantly, January 2017 SSSG was 2%, building on the 5.0% SSSG achieved in January 16. Furthermore, the firm's revenue during the month was IDR445.6 billion, implying 8.9% YoY growth, suggesting that its new stores were contributing strongly towards sales growth. We think the strong SSSG and sales contribution from new stores could potentially have a positive effect on its share price.
Note: Please note that the presented target price of 900–950 per share is in IDR (trading currency of the underlying share in the Indonesian Stock Exchange).
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