To acquire 36 CP Lotus stores and 9.99% stake in CP Lotus (0121.HK NR)
Wumart will issue 13.7% shares to CP Lotus for acquisition of 36 CP Lotus stores and a 9.99% stake in CP Lotus. It also introduced value shareholder with another 1.1% share issuance. The tr ansaction provides Wumart with immediate entry into good locations in the greater Shanghai region as well as exposure to Guangdong, in line with its ambition to be a national consolidator with regional dominance. This step is strategically positive to its long-term development, but in the short term it w ill suffer the loss from acquired stores. Lessons from past integration could be a premium, but lack of proven track record remains a key concern. Mainta in Buy pending relevant approval.
Loss-making CP Lotus stores on higher costs
The acquired 36 stores are mostly located in Beijing and Greater Shanghai with total sales of RMB7.1bn and 310k sqm floor area. Based on our calculation, the sales per sqm by CP Lotus are c.RMB23K-24K, higher than Wumart’s RMB21K, as CP Lotus focuses more on a densely-populated area and a relative mature store portfolio. However, CP Lotus is loss making (RMB392m in 2012 and RMB47m in 1H13) on higher opex despite comparable GPM to Wumart. Cost synergies – strategically makes sense, but the key is on execution The addition of CP Lotus stores could effectively complement Wumart’s existing coverage (“growth”) and meanwhile achieve cost synergies (“margin”). While it takes time to turn around the loss-making business, cost synergies in terms of procurement, distribution and headquarter could emerge sooner. Though mgmt is unable to pr ovide a timeline on integration (1HFY14 earliest in our view), it is quite confident in its cost reduction ability.
Target price unchanged at HKD16.5; risks
We maintain our target price of HKD16.5, which translates into 27.4x FY13E P/E and 20.8x FY14E P/E. Our DCF value is based on a COE of 8.7%, beta of 1 and TGR of 2%. Risks: 1) cost pressu re, 2) competition from foreign food retailers, and 3) inability to make value-accretive acquisitions.