MR D.I.Y. needs no introduction. I am 70% sure that you have bought something from one of its stores. Let's jump in to the key things to know about the largest Malaysian IPO so far this year.
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The MR D.I.Y flywheel gets easier after establishing itself as the leading home improvement retailer way ahead of its peers.
As at 2019, MR D.I.Y. had a market share (by revenue) of 29.1% in the Home Improvement Retail sector in Malaysia. One Stop Superstore, the number 2 player as identified by Frost & Sullivan, had a market share of 0.9%. MR D.I.Y. is more than 30 times larger than its next competitor.
When MR D.I.Y. onboarded Creador (the private equity firm led by Brahmal Vasudevan) as its investor back in 2016, its market share was 15.5%. Over the last 4 years, the business has almost doubled its market share, transforming its market leadership in 2016 into market dominance in 2020. Let's explain how this happened by understanding the flywheel effect here.
Step 1: Sell products at attractive price-to-quality value proposition.
Frost & Sullivan did a comparison of the same branded products or similar products available across the largest home improvement retailers. Their data demonstrated that MR D.I.Y. is true to its tagline of "Always Low Prices", with prices generally lower at a MR D.I.Y. store compared to other stores. (You may find the data points on page 136 of the IPO prospectus.)
By offering products at attractive price-to-quality value proposition, consumers will choose to visit MR D.I.Y. over the other store, hence generating cash and profits for MR D.I.Y.
Step 2: Reinvest cash and profits into opening more stores and/or more locations.
Instead of kicking back and relax, MR D.I.Y. expanded its number of stores aggressively. It has almost tripled its store count in less than 4 years, from 244 stores in 2016 to 674 stores as of 6 September 2020.
By increasing its number of stores and locations, MR D.I.Y. is more physically accessible to consumers, as a retail business. When consumers see MR D.I.Y. popping up in their neighborhood shop lots and malls, the business is able to execute Step 3.
Step 3: Grow its brand to become top-of-mind brand for home improvement.
MR D.I.Y. marketed itself as the convenient go-to-place to shop for value-for-money home improvement and consumer products. The mass media advertising on radios, prints, billboards and social media. The music jingle you hear when you pass by or shop in the stores.
As a result, when consumers decide to shop, they will head to MR D.I.Y. as the top-of-mind brand. The consumption volume and footfall MR D.I.Y. attracts to its stores, allow it to execute step 4.
Step 4: Lower per unit cost of sales with its increased economies of scale.
The business is able to lower cost and improve terms on 2 key fronts - the cost of the products it sells and the rents it pays for retail stores.
By purchasing products in high volume, it can obtain lower costs and better terms from its suppliers. By leveraging its top-of-mind brand to attract customer footfall, it can negotiate better rents and commercial terms with landlords.
Continually repeat Step 1 to Step 4.
You get the idea, lower prices ->more stores -> stronger brand -> lower costs -> lower price -> more stores ….. By constantly turning this flywheel, MR D.I.Y. is able to generate industry leading GP margins of more than 40%, while offering customers products at prices generally lower than its competitors.
The flywheel only gets easier, and its economies of scale moat will continue to widen.
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Fantastic business economics allows its IPO to be priced at more than 30x Price-to-Earnings (PE) multiple.
Let's think like your local neighborhood hardware store Chinaman owner, and do some back of the envelope calculation.
The average capex for a new store excluding inventory is around RM600,000.
The payback period for new stores opened in 2017 and 2018 is less than 2 years.
Management expects the same for stores that are opened in 2019.
Note: Payback period is calculated by aggregating monthly average EBITDA (after adjusting for cash rentals) for new stores opened in that year starting from the month of opening such stores, until such period that the sum exceeds the average capital invested per new store opened in that year.
Each stores generate around RM300,000 EBITDA annually (excluding cash rentals).
This is computed by dividing the average new store capex of RM600k by payback period of 2 years.
IPO price of RM1.60 indicates a purchase price of RM14.9 million per store.
Its indicative market capitalization of RM10,042.5 million divided by 674 stores as at 6 September 2020.
The EBITDA (excluding cash rental) yield on your investment is around 2%.
RM300,000 divided by RM14.9 million multiplied by 100%. Do note that this yield is before rent, hence actual yield could be lower. Should there be no new stores growth, you will be receiving less than 2% return on your investment.
Factoring in future growth, the annual yield on your investment is around 3% (equivalent to a price multiple of 33 times).
There are 2 parts to growth - same store sales growth (SSSG) and growth in number of stores.
Historical SSSG were 6.5% in 2017, 4.5% in 2017, and 1.8% in 2018. Hence, SSSG in the future will not substantially improve the yield on your investment. Growth will need to come from new stores.
The number of stores will grow 34% between 6 September 2020 to 31 December 2021, an additional 231 new stores. Assuming, future MR D.I.Y. stores, new retail concepts MR TOY and MR DOLLAR have the same economic ability to churn out the same fantastic business economics (in terms of EBITDA and payback period), the business will grow its annual EBITDA (excluding rental) by RM69.3 million (RM300k x 231 store) up to 2021. RM69.3 million dividend by the IPO market cap of RM10,042.5 million, indicates an additional yield of 0.7%.
We think its IPO price of RM1.60 is at fair value. The reference price multiples as at Last Twelve Months ended 30 June 2020 are as follows:
- LTM PE of 36x
- LTM Proforma EV/EBITDA of 23x
- LTM P/FCF of 28x
For a business with a fantastic flywheel model and economics, MR D.I.Y. deserves the premium in valuation. RM1.60 is a fair entry price to subscribe to the IPO shares and invest for the long term. However, do not expect supernormal returns on your investment
There are red flags and concerns noted from the IPO prospectus. Take your own judgement call on these.
(A) The total IPO offering is 941,490,000 shares or 15% stake on the enlarged number of shares post IPO, and the breakdown as follows:
- 753,090,000 existing shares to be sold by existing shareholders to Institutional Investors. Existing shareholders are exiting around 12% of their pre-IPO stake, by offering 753,090,000 existing shares to Institutional Investors.
- 188,400,000 new shares are issued to mostly Retail Investors (85.7% of the offering), with the IPO proceeds being used to pare down borrowings and pay for IPO expenses.
- This IPO is clearly more of an exit event for existing shareholders, than a fundraise for the next phase of growth.
The appetite of Institutional Investors will determine the final IPO price. That is fair play to allow the market to decide what is the appropriate IPO price. However, do note that these Institutional Investors typically have a lower return requirement that a Retail Investor will seek out for.
(B) 6 months share sale moratorium is only applicable for the remaining controlling stake held by the founder's family, via Bee Family Limited.
- Hyptis / Creador, remaining 15.2% stake (959,873 shares) post IPO can be sold of the market with the written consent of the Joint Bookrunners. (otherwise there is a 6 months restriction period post IPO)
- Platinum Alphabet / Gan Choon Leng and Tan Gaik Hoon remaining 6.9% stake (433,842 share) post IPO can be sold of the market with the written consent of the Joint Bookrunners (otherwise there is a 3 months restriction period post IPO).
- There could be huge liquidity flow to potentially deter share price from moving up substantially.
(C) Existing shareholders have paid themselves in favorable manner prior to the IPO.
- RM90 million cash spent on purchasing MR D.I.Y. in Brunei, which consist of 4 stores. This was also partially funded by borrowings. This is equivalent to RM25 million per store. Compare that to the IPO pricing of RM14.9 million per store.
- RM500 million in cash dividend was paid out to shareholders in the last financial year prior to the planned IPO. This dividend payout was partially funded by borrowings. That is a 5% dividend yield on the proposed IPO price of RM1.60.
Near to mid term dividend payout will definitely not be of similar yield. IPO prospectus noted a dividend payout ratio of at least 40% of net profit (equivalent to RM93 million, based on LTM net profit).
Given an estimated Net Operating Cash of RM550 million and planned capex of at least RM150 million in 2021. Estimated 2021 FCF will be around RM400 million. These cash will most likely be conserved to invest into their technology-driven distribution center and warehousing facilities.
(D) A long list of related parties transactions and conflicts of interest were disclosed in the IPO prospectus.
A key one being, controlling shareholders hold controlling interest in entities for MR D.I.Y. branded retail operations elsewhere including Thailand, Singapore, Indonesia, Philippines, Cambodia, Laos, and more. They have also licensed the use of the brand to third party for retail operations in India.
These overseas operations are not consolidated into the current to-be-listed entity. And these shareholders' controlling stake allow them to approve potential acquisitions of these foreign operations at premium valuation in the future.
Do take a read in the IPO prospectus from page 190 to 203 for the complete list of related parties transactions and conflict of interest.
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