Puregold Price Club: A Good Mix Of Defensiveness And Growth

Summary

• Puregold Price Club's modern grocery retail business is more defensive compared with most other businesses in the Philippines, as evidenced by its strong same-store sales growth in 1Q2020 and April-May 2020.
• Puregold expects its new store expansion plan to remain on track for FY2020, which will be another key growth driver for the company, on top of steady same-store sales growth.
• The company trades at 17.4 times consensus forward next twelve months' P/E, and it offers a consensus forward FY2020 dividend yield of 0.8%.
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Elevator Pitch

I maintain my Bullish rating on Philippines-listed modern grocery retailer Puregold Price Club, Inc. (OTCPK:PGCMF, OTCPK:PRGLY, PGOLD:PM), or PGOLD.

This is an update of my prior article on PGOLD published on November 26, 2019. PGOLD share price has increased by +18% since my last update, from PHP40.00 as of November 25, 2019 to PHP47.25 as of June 8, 2020. The company trades at 17.4 times consensus forward next twelve months' P/E, which represents a slight discount to its historical three-year and five-year mean consensus forward next twelve months' P/E multiples of 18.4 times and 18.7 times, respectively. The stock also offers a consensus forward FY2020 dividend yield of 0.8%.

PGOLD boasts a good mix of defensiveness and growth, which makes it an attractive investment candidate in volatile and uncertain times like these.

The company's modern grocery retail business is more defensive compared with most other businesses in the Philippines, as evidenced by its strong same-store sales growth in 1Q2020 and April-May 2020. Grocery retail is non-discretionary in nature and relatively more defensive than most other businesses. PGOLD expects its new store expansion plan to remain on track for FY2020, which will be another key growth driver for the company, on top of steady same-store sales growth. Market consensus expects PGOLD's revenue and EPS to grow by +13% YoY and +15% YoY, respectively, in FY2020.

Readers have the option of trading in Puregold Price Club shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the tickers PGCMF and PRGLY, or on the Philippines Stock Exchange with the ticker PGOLD:PM. For Puregold Price Club shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.

For Puregold Price Club shares listed in the Philippines, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Philippines Stock Exchange is one of the major stock exchanges that is internationally recognized and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $5 million, and market capitalization is above $2.7 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors who own Puregold Price Club shares listed in the Philippines include The Vanguard Group, APG Asset Management, Grandeur Peak Global Advisors and Templeton Asset Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

Strong Sales Growth Partially Offset By Slightly Weaker Profitability In 1Q2020

Similar to many other countries in the world, the Philippines has been affected by the coronavirus pandemic. As at the time of writing, there are 22,474 confirmed cases of coronavirus infections (of which 4,637 have recovered) and 1,011 deaths in the Philippines on a cumulative basis.

Parts of the country, including Metro Manila and Luzon, were placed under a partial lockdown since mid-March 2020, which is referred to as Enhanced Community Quarantine, or ECQ, in the Philippines. There has been a gradual easing of lockdown measures, with Metro Manila by transitioning to General Community Quarantine, or GCQ (relatively fewer restrictions on movement and opening of businesses compared to ECQ) for the period between June 1, 2020 and June 15, 2020.

PGOLD's modern grocery retail business is more defensive compared with most other businesses in the Philippines, as evidenced by its strong same-store sales growth in 1Q2020 and April-May 2020.

PGOLD's revenue grew +17.4% YoY from PHP34,889 million in 1Q2019 to PHP40,953 million in 1Q2020, while its net profit grew +16.8% YoY to PHP1,763 million over the same period. The company's same-store sales growth accelerated from +7.5% in 1Q2019 to +12.2% in 1Q2020. Specifically, PGOLD's Puregold-branded hypermarkets & supermarkets and its S&R-branded warehouse stores similar to Costco Wholesale Corporation (COST) saw same-store sales growth of +14.4% and +5.1%, respectively, in the most recent quarter.

Pantry stocking prior to the lockdown in March and increased food consumption at home as more people stayed indoors were the key drivers of PGOLD's strong revenue and same-store sales growth in 1Q2020. Notably, PGOLD's same-store sales growth remains elevated at approximately +40% in May 2020, and the company's year-to-date same-store sales growth for the first five months of FY2020 was around +14%. This is unsurprising given the non-discretionary nature of the grocery retail business.

Nevertheless, PGOLD cautioned at the company's 1Q2020 earnings call on June 1, 2020, it expects same-store sales growth to "normalize further" considering the "expected impact (of the coronavirus pandemic and lockdown) on the economy."

More importantly, PGOLD's strong revenue growth in 1Q2020 was partially offset by weaker profitability. The company's overall gross profit margin decreased by 60 basis points YoY, from 17.5% in 1Q2019 to 16.9% in 1Q2020. This was primarily attributable to two key factors.

Firstly, PGOLD's sales mix changed because of the coronavirus pandemic. During this period, consumers bought a larger proportion essential items such as food and cleaning materials, which had relatively lower margins compared with the other categories of products.

Secondly, the gross margin improvement for S&R-branded warehouse stores was insufficient to offset the decrease in gross margin for Puregold-branded hypermarkets & supermarkets. The gross margin for S&R-branded warehouse stores increased from 20.8% in 1Q2019 to 24.1% in 1Q2020, while Puregold-branded hypermarkets & supermarkets saw gross margin decline from 16.4% to 14.8% over the same period.

In my prior article on PGOLD published on November 26, 2019, I highlighted that "continued weak supplier support for advertising and promotions" was a drag on the gross margin for Puregold-branded hypermarkets & supermarkets, and it was a similar story in 1Q2020. Supplier support as a percentage of sales for Puregold decreased from 6.4% in 1Q2019 to 4.9% in 1Q2020.

There are both cyclical and structural factors contributing to the decline in supplier support for Puregold. Weak economic growth prior to the coronavirus pandemic and an inevitable recession post COVID-19 meant that suppliers have been cutting back in advertising and promotions to manage costs for quite some time.

More importantly, MNCs, or multi-national corporations, which account for the majority of the supplier support for Puregold, have been losing market share to their smaller domestic rivals in the Philippines, as per PGOLD's comments at the company's 1Q2020 earnings call on June 1, 2020. As a result, MNCs have reduced advertising and promotions aggressively in response to lower sales, and this is the key structural factor for the decrease in supplier support.

On the part of PGOLD, the company aims to increase its proportion of sales from house brands or private-label products to protect its margins and offset the negative impact of declining supplier support.

Decent FY2020 Outlook On The Back Of New Store Expansion Plans

Market consensus expects PGOLD's revenue and EPS to grow by +13% YoY and +15% YoY to PHP174,567 million and PHP2.72, respectively, in FY2020. Apart from steady same-store sales growth, the company's new store expansion is another key growth driver.

As of March 31, 2020, PGOLD operated 443 stores across various brands and formats. Looking ahead, the company targets to open 25 Puregold-branded hypermarkets & supermarkets, two S&R-branded warehouse stores and 10 S&R-branded Quick Service Restaurants, or QSRs, this year. In the first quarter of 2020, PGOLD has already opened two new S&R-branded warehouse stores and six new Puregold-branded hypermarkets & supermarkets.

Notably, PGOLD's new store expansion plans for FY2020 are not expected to be affected by the coronavirus pandemic. Furthermore, store cannibalization as a result of new store expansion plans is less of a worry. At the company's 1Q2020 earnings call on June 1, 2020, PGOLD emphasized that "in terms of capex (capital expenditures), we are very clear that we will execute as planned" and "we are not postponing any capex plans we have for this year." It also added at the recent earnings call that new store opening are mainly in "far flung areas where we are underrepresented."

A potential area of weakness is PGOLD's local mom-and-pop store (referred to "sari-sari" in the Philippines) clients, which are the customers of its Puregold-branded hypermarkets & supermarkets, on top of the low-to-middle income consumers in the country.

At the company's 1Q2020 results briefing on June 1, 2020, PGOLD acknowledged that certain local mom and pop store are facing "economic pressures right now" and "we can foresee that there might be some losses here in the sari-sari store business." This risk is partly mitigated by the fact that PGOLD has been focused on increasing its proportion of sales to end-users in the past few years, instead of being overly reliant on wholesaling via local mom-and-pop stores.

Valuation

PGOLD trades at 19.3 times trailing twelve months' P/E and 17.4 times consensus forward next twelve months' P/E based on its share price of PHP47.25 as of June 8, 2020. As a comparison, the stock's historical three-year and five-year mean consensus forward next twelve months' P/E multiples were 18.4 times and 18.7 times, respectively.

PGOLD offers consensus forward FY2020 and FY2021 dividend yields of 0.8% and 0.9%, respectively.

Risk Factors

The key risk factors for PGOLD include weaker-than-expected same-store sales growth, lower-than-expected profit margins as a result of supplier support being below expectations, slower-than-expected new store expansion and weakness in the local mom-and-pop store sales channel.

Note that readers who choose to trade in PGOLD shares listed as ADRs on the OTCBB (rather than shares listed in the Philippines) could potentially suffer from lower liquidity and wider bid/ask spreads.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.