Is AEON Co. (M) Bhd potentially undervalued?

Traditional wet markets or hypermarkets? Despite having their own niches, there is an increasing trend that people, especially younger ones, prefer to shop in hypermarkets. I mean, why not? Clean, air conditioned, promotional offers and well organized. You even have a trolley to shop around! You don’t have to wake up early in the morning, squeeze in and out with your own bags. Not only that, you can buy almost all of your daily products in one stop.

Today, I am gonna introduce you AEON Co. (M) Bhd, a public listed company on Bursa Malaysia.

AEON is well-established among the Malaysians as well as foreigners. Having a long history in Malaysia, AEON has managed to establish itself as a leading chain of General Merchandise Stores and supermarkets in the local market.

AEON’s stores are mostly situated in suburban residential areas, catering to Malaysia’s vast middle income group. From what I observe, properties neaby AEON have a tendency to be valued higher due to the convenience it brings and popularity. Just an advice, if you wanted to invest in a property with higher yield and potential capital gains, check if there is any AEON in the neighbourhood.

AEON is principally engaged in two business segments:

• Retailing - household products & fresh produce

• Property Management Services - income from rental

The retailing segment is AEON's core operations, made up of 86% of revenues as of 2014. It is selling necessities which we will still continue buying even though the economy turns harsh. You might then switch to cheaper products which can still be bought under AEON's roof. This is what I call recurring revenue. This is exactly the kind of company I am interested in.

AEON is also actively managing its store operations and shopping centre developments. This segment contributed about 14% of its total revenues. In 2014, AEON achieved an average occupancy rate of 94.1%, which was high!

Revenues have been increasing steadily. Net profit faced challenges in 2014. Also, net profit margins stay relatively stable.

Operating cash flows have always stayed above net profits, implying its cash generating abilities. This is because AEON runs by cash terms and have the advantages of credit terms given by its suppliers. Since it is a cash generating business, we don’t have to worry so much about its current low cash level.

AEON has managed to maintain an upward trend on its shareholders' equity which shows that the company's net worth is increasing, which is good for the shareholders. The return on equity and return on capital employed show signs of decreasing in the past 5 years but still managed to stay above 10%. Maybe the management should further increase its dividend payouts or executive share buybacks due to lower financial efficiency?

Overall, I think AEON's financial fundamentals are above average.

However, there are a few potential risks which an investor should be aware of. Firstly,

AEON operates in a highly competitive sector with other players such as TESCO, Giant, and other fragmented traditional retail stores. Price adjustments are done almost everyday so as to offer the lowest prices possible. Besides, customers have low switching costs. These will ultimately eat into AEON's profit margin.

There is another risk which I am particularly concerned about - the CEO's ownership in the company. As you all know, I always like to invest in a company which the CEO holds significant shareholdings in it. Here, Ms. Nur Qamarina Chew Bt Abdullah, CEO of AEON, doesn't hold any stake in AEON (M) Bhd. I would prefer to invest in a company managed by CEOs / Managing Directors who share the same interests and visions as us. By owning large interests in a company, the CEO's interest would be much more well-aligned with the shareholders which lead to maximisation of shareholders' value.

Another issue which concerns me is the capital expenditure of the company. AEON has to incur massive costs to acquire lands and build its own shopping malls. This posts significant disruption to its free cash flows as seen in the year 2014 and 2013 with a negative cash flow of RM307 million and RM71 million.

In conclusion, AEON has a fair business model with steady financials. Having a stable nature, I am pretty confident that AEON will be able to maintain its leading position in the future.

Source: Bloomberg

Note: This value pyramid only shows what I think about a company’s valuation as at the time of writing this particular article. Do bear in mind that when a stock is undervalued, it doesn’t mean it can’t go any lower and vice versa. Please exercise your own judgment and do not treat this as a recommendation to buy or sell.

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