Why Padini deserves a higher valuation

Padini is a retail clothing company that I will cover a lot in this blog over time. It is possibly the most well managed retail clothing company in Malaysia. I encourage readers to read all its financial reports to learn about this company. In my opinion, Padini publishes one of the most transparent financial reports in KLSE. Padini management has always provided snippets of information regarding the direction/strategy they are taking in its forward guidance.

In the 2000s, Padini was known as a true fashion company, sort of like Bonia where customers perceive its goods to be foreign (signs of successful marketing). Ladies were all going crazy over its latest shoes and clothes. From 2010s, however, Padini shredded this premium image and became one that is lower end which promises value and savings. After going through significant transformation over the years, Padini has become a retail behemoth.

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I have probably followed Padini for more than 10 years through various business cycles eg. the commodity bull run before 2008, the financial crisis, influx of foreign fashion players and the implementation of GST. Padini is the perfect case study for any interested business enthusiast to learn about retail strategy.

Recently, this company has caught my attention again. As of 11th April 2017, Padini is trading at RM 3.04 per share with market capitalization of RM 2 billion. Valuation wise, the company’s share is trading at a P/E of ~ 13 times which is about its long term average P/E over the decade. But should Padini trade at just P/E 13?

The general stock market has been going up very strongly since the start of year 2017. Many stocks with good fundamentals have gone up 20-30% which made bargains increasingly hard to be found. Hence, it is a bit surprising to me that Padini, an outstanding company is not being valued higher by Mr. Market. Over the years, Padini has become much stronger in its competitive position through the introduction of the concept store and Brands Outlet. Where can you find an incredibly a good company that sells for RM 2 billion and produces RM 150 million net profit annually?

Padini has several characteristics of a business with durable competitive advantage/moat. If Warren Buffett were to invest in Malaysian stocks, I truly believe Padini will be one of his long term holdings. From a business perspective, Padini operates on a high volume low margin business model. One that focuses on cost leadership. In this kind of business, if you like to be successful in the long run, you need to have scale. In the last twelve months, Padini did RM 1.4 billion in sales. Just imagine for a second the negotiating power that Padini commands over its suppliers. It is scary. So, when many people were worrying about the rise of cotton price, ringgit weakening etc., I felt that those concerns were overdone. This is because Padini is not a manufacturer of garments themselves. When there is a rise of cost of production, Padini has the first right to squeeze its suppliers first before taking the cost increase.

So now that we know Padini’s revenue, who are its competitors? In the past, many have argued that the influx of foreign fashion such as Uniqlo and H&M would eat into Padini’s pie. It was such a concern that back in 2013, Padini’s share price gapped down on a local news media report regarding H&M’s highly successful grand launching. While I am not an expert in fashion, I strongly disagree with such concern. In my opinion, the foreign fashion players target a different group of customers compared to Padini. You dont walk into a Padini concept store expecting the trendiest clothes. You walk into a Padini concept store to get something that is high in utility like a simple formal slacks or a simple shirt. Thus, this is a business aspect which I think many investors understood. Both the foreign fashion brands and Padini have different product positioning which targets a completely different market segment.

If Uniqlo and H&M are not Padini’s competitors, who are the real threat to Padini’s moat? In terms of product positioning, the real competitors of Padini are Voir, Cotton On, FOS and to a small extent, TRIO by Jerasia. Voir, Cotton On and FOS run on a similar business model with Padini Concept Store. There stores are generally big box retail with multiple brands under one outlet that is at least 20000 square feet in size. In the last twelve months, Voir as a group managed to do RM 168 million in sales – that is about 10-15% of Padini’s annual revenue. While I do not have the numbers of the other big box retailer, one can always have a feel of their scale by counting the number of stores nationwide. As for TRIO by Jerasia, it is operating on a smaller store size with similar aggressive pricing. For example, RM 50 for 2 T-Shirts which I think is Padini’s forte. The concept of TRIO is impressive. However, Jerasia as a group which included Mango did RM 450 million sales in the last twelve months and the portion of TRIO revenue could be much lower than the total sales.

Hence, from this simple competitor assessment, it is clear that Padini is way ahead of its competitors. This is not to say that competitors might not catch up. It is possible but difficult. Let’s say you have RM 500 million in capital today to venture into the retail clothing industry. It is a huge uphill task. One of the prerequisite of competing with Padini in their game is to secure at least 15000-20000 square feet of spaces in popular malls such as Midvalley and Sunway. In the current business landscape, such spaces are simply not available.

This is the reason why I strongly believe Padini’s competitive advantage will last for at least another 10 to 20 years. In my future articles, I will discuss more about the common misconceptions of Padini such as the incredibly and overused “low consumer spending”, or the rising price of raw materials or the rise of e-commerce.

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