The business model is simple enough: pull people into one’s
stores by offering Apple products at a slim margin and make one’s money on the
accessories, the after-sales service, and so forth. Not complicated and there
are probably only three ways to muck it up: (1) People no longer like Apple
products; (2) Apple decides to sever its relationship with Epicentre; (3) the
Singapore Dollar takes a nosedive.
The last of these is, for our purposes, the item of interest.
The USD has appreciated against the Singapore dollar. Since Epicentre buys its
Apple-branded inventory in USD, its
gross margins on Apple products have nosedived, turned negative, and made their
effects felt all the way down the income statement. Plunging earnings, plunging
share price.
Epicentre has now negotiated an arrangement with Apple whereby
its Singapore operations (80+% of revenue) may now buy Apple-branded inventory
in Singapore dollars. Its Malaysian operations (<20% of revenue) will
continue to buy in USD.
The upshot is that gross margin should improve by a minimum
of ~3.6% and that the earnings margin should therefore improve to a minimum
~4.0% . A 4% net income margin on SGP $180
million translates into an earnings yield of ~41%. And, since Epicenter pays
out 85%+ of its earnings, it seems reasonable to expect a forward dividend
yield of 35%.
There are some other factors that justify more upside to the
valuation – the announced exit from the loss-making presence in PRC, immature new
stores in Malaysia, investments in “customer-centricity” that have
been expensed – but these are immaterial to the investment case at the current share
price.
The shares are illiquid and any buyers will be competing
with the company itself.
Disclosure: I am long Epicentre and intend on buying more
shares.
I've uploaded some relevant documents here:
ReplyDeletehttp://www.scribd.com/theredcorner
Assuming it's not your home currency, are you hedging your exposure to Singapore dollars? How do you think about the currency risk of this investment and others (e.g., Japan)?
ReplyDeleteMy home currency is USD. I suppose I have two rules:
Delete1. I only buy into a currency if I think I can recycle the gains in the same market for some time -- .e. exit Epicentre and use the proceeds to buy another Singapore stock.
2. I don't buy into an expensive currency unless the undervaluation of the target equity is really so undervalued that no currency movement could undermine a 30% IRR
And the truth is that I'm of the view that the SGD is somewhat undervalued anyway, so I've persuaded myself that I'm buying these assets at further 20% discount.
"Gross profit decreased from S$12.0 million in 1H FY2012 to S$10.4 million in 1H FY2013. Gross profit margin declined from 13.0% in 1H FY2012 to 11.6% in 1H FY2013. The decline was due to lower margin contributed by Apple branded products. Apple Branded products contributed to approximately 87% of our Group revenue in 1H FY2013." Would've assumed that they would've already started seeing the impact of the policy change starting at 9/30/12 (1H FY2013 ends 12/31/12). Perhaps they still had to work through some of that higher cost inventory in the quarter ended 12/31/12?
ReplyDeleteAnd gross margin deteriorated sequentially from 12.7% in 2H 2012 to 11.6% 1H 2013.
ReplyDeleteYes, I think that's what's happening: working through the older, higher cost inventory.
DeleteI suspect that the full year 2013 numbers will be unattractive: margin improvement yet to kick in, some softening of demand in the Singapore market, exit costs from the China market, etc. There's a chance that share price will fall on volume and that may be a good/better opportuny to pickup some more shares.
sounds good. thanks for your reply!
Deletenice find
ReplyDeleteI see you've posted about a few Singapore stocks, are you focussing your research on that area at the moment or is it just coincidence?
Was on my list of stocks to look at and got around to it only recently. CSF, on the other hand, has been on my radar since its IPO. Not too many people are interested in emerging market assets so my thinking was to write them up only if I bought them.
Deletea bit late, but a few things I noticed,
ReplyDeleteMargins have been declining since 2008.
19%
17%
16%
15%
13%
and roughly 10% i think in 2013.
I cannot really identify a moat here, anyone with capital can buy products from apple and do this?
Are you really sure this is all currency? Because it looks to me that competition is also eating away at this commodity business basicly.
Couple of things going on:
ReplyDelete1) currency
2) sales mix between Apple-branded and accessory products
The sales mix has been unfavorable for about 18 months now: more low-margin Apple products (compounded by currency effects),fewer high-margin accessory products.
in the end, the only thing one has to believe for the investment to come good is that this business can earn its cost of capital. Time will tell.
No moat, obviously.
thanks for responding so quickly :)
ReplyDeleteany reason why the acesoires business is dropping off?
People are just buying this stuff online now?
The problem with no moat is, they make good money, and 2 businesses next door open up shop. And do they really need 1.5 years to get rid of inventory? Doubt that would even take 0.5 years?
I dont really see this returning to a 15-16% gross margins.
Well, I certainly understand where you're coming from and this stock is not the brightest idea I've ever had.
ReplyDeleteBut no moat also has its advantages. After all, why would 2 additional businesses open up next door if there were no super-normal profits to be had when there was just one of business?
My guess is that this business muddles through, becomes cash flow positive, uses the cash flow to buy back stock, and sees a re-rating of its stock price.
But it's so illiquid that I'm married to it now.
Would I initiate a position now if I didn't already have one? No way.