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Saturday December 17, 2011

The pride of Padini

CHANCES are you've heard a female friend squealing about the latest Vincci sale. The shoe brand, together with the other nine under the Padini Holdings Bhd stable, have through the years crept up steadily to become some of Malaysia's most ubiquitous and recognisable products.

More than that, among the investment community, Padini has made a name for itself as a well-managed, consistent performer and dividend stock.

Starting life in the backend of the apparel industry as a manufacturer and supplier of garments circa 1971, the company made the leap into retail some years later with its eponymous flagship brand.

There is much potential and opportunity for Padini, according to executive director Chan.

Thus far, growth has not eluded Padini, and it posted robust earnings in its latest quarter ended Sept 30. Its revenue reached a record high of RM178mil, which is over 30% higher year-on-year (y-o-y) and quarter-on-quarter (q-o-q). Net profit rose 47% y-o-y and 49% q-o-q to RM27mil driven by the Hari Raya and Merdeka sales, as well as rapid store expansion.

Between Oct 2010 and Sept 2011, Padini opened four Brands Outlet and two concept stores. “In Malaysia, you will find that shoppers come out in full force during big festive celebrations when the whole nation goes on sale,” Padini executive director Chan Kwai Heng tells StarBizWeek.

“It doesn't mean that because it is Raya therefore only the Muslims come out and buy. All bargain hunters come out to shop. These days, the public expects sales.”

The year-end shopping season is traditionally the strongest quarter for retailers, and Chan says this year is expected to be better since the Chinese New Year (CNY) period begins in early January. “In our experience, when CNY comes early in the year, a lot of the shopping is done in December.”

In the next six months, Padini will continue expanding into new territories. The five stores it will open are one concept store and a Brands Outlet each in Setia City Mall, Shah Alam, and Paradigm, Kelana Jaya, along with one concept store in Jusco Station 18, Ipoh.

Cotton rules

While the margins for its earnings before interest and tax have been hovering around 20%, the high price of cotton had put a squeeze on margins in the latest reported quarter.

Cotton prices were up 24% y-o-y to US$108 per pound from US$88 per pound, according to HwangDBS Vickers Research, although it has now eased to US$91 per pound.

Chan points out that Padini does not hedge cotton prices nor does it buy cotton futures. “That's not something we do as we would have to have people and resources to monitor the prices. Instead, our manufacturers know the prices and they give us a quote on the condition that we provide them the money to buy cotton.”

Over the past 10 years, Padini has been able to keep its prices fairly constant. Comments Chan: “We do not raise prices as a matter of routine. We tend to follow the market and are not the leader in this sense. In the past 15 years, many foreign brands have come into Malaysia, and they take the lead.”

Now that cotton prices have stabilised, he laments that the eurozone is starting to affect manufacturing and industrial capacity. “We just came out of the subprime crisis in 2008 and are not getting any rest with the problems in the eurozone.”

Padini's exposure to the euro zone is by way of its manufacturing in China, which Chan says has been curtailed by a looming recession in Western nations.

The slowdown has led to factories, many of which are based in the coastal regions, to reduce their capacity and workforce. “Most workers are from inland China and don't live near the coast. If you have no work for them, they leave, and when they leave, they don't come back,” Chan explains.

To circumvent this, Padini ventured further inland to source for manufacturers.

“Over the last year we have gone up into places like Hangzhou. Those areas are more stable and the prices less expensive. People don't leave either because they live there. But the disadvantage is that the inland does not have the proper supporting industries yet.

“In Guangzhou (a coastal region) for example, you can buy accessories and send your garments for washing. The manufacturers inland don't have these ancillary facilities so we have to provide for a longer period of time,” Chan says.

He adds that another thing pushing up cost is the minimum wage policy in China.

An issue which has caught the attention of Padini's fund managers, analysts, shareholders, and bankers is its buildup of inventory. Chan reasons that they bought a lot on purpose to secure the supplies.

“We are not stuck with the stocks. Most are finished basic items, not the trendy stuff, so they will be saleable. In view of China's current situation, where the factories are shutting down and lowering their capacity, you will find it harder to buy the quantities you want.”

Business acumen

As at Sept 30, Chan says Padini has RM213mil in its inventory, which is over a third of sales. “We will hold on and release it over the coming six months,” he asserts, recalling that in 1998, its inventory was over 50% of sales at RM40mil.

“In 2008 we also had high stocks worth RM160mil on sales of about RM300mil, which we pared down between 2008 and 2010. The point I'm trying to make is, we know what we are doing, and we have proven this.”

The key, Chan opines, is not the size of the inventory, but the ability to digest it. “We have high stocks but stores are consuming them on a daily basis. But what if recession hits Malaysia?', people ask me. We've gone through that before. It comes down to this: people will cut back their spending in a downturn, but shoppers will shop. Our demographic is the middle-class market and they are usually not the first to be affected by a recession. The lower-income group are.”

In fact, Chan notes, the only time Malaysians avoided the malls en masse was not during the recessions, but the severe acute respiratory syndrome epidemic, better known as SARS.

Incidentally, Padini was listed in March 1998, around the time of the Asian financial crisis.

Nonetheless, Chan insists Padini has plenty of room to grow in Malaysia.

“They say Malaysia's 26 million population is too small. But don't be mistaken. The Economic Transformation Programme's labs estimate that the retail, garment and footwear subsector was worth RM13bil in 2009. Our sales are not even a billion ringgit. If you look at it that way, there is still much potential and opportunity.”

In Padini's experience, opening stores in close proximity did not lead to cannibalisation. For instance, Padini closed its Vincci store in KLCC last year and opened another in Fahrenheit88. Despite the brisk sales at the new shop, its concept store just opposite, in Pavilion KL, was unaffected. It has reopened at KLCC in a different location, and business is even better, Chan enthuses.

Interestingly, he also sees opportunities arising from the problems in the West. “I'm speculating that there will be shortage in merchandise in this region. Think about it, if you're a brand in the US, when a downturn hits, the first thing you do is protect your homeground, because that's where your bread and butter is.

“If you're cutting down on merchandise, manpower and stores, you'll start with the countries that are far off. That is a natural tendency.”

High-growth Brands Outlet

Padini's fastest-growing subsidiary is Brands Outlet, its most affordable range. The label thrives on a low price, high volume model. Many of its clothes are typically sold on a buy-one-free-one basis.

While Chan admits that it achieves lower margins relative to Padini's other brands, he says the focus of Brands Outlet is to drive merchandise out of the store as quickly as possible.

“In Brands Outlet you don't try anything funny. Just the basics easy to sell, easy to wear items.”

Brands Outlet has grown exponentially from 2006 to a substantial earnings driver, contributing 20% to group revenue in Q1FY12. By comparison, the first concept store started in the 90s and has since expanded to over 20 locations. On the other hand, 14 Brands Outlet stores were opened in some six years.

“Its an easier business to run. You're not doing so much fashion. With Seed or Padini, you have to keep up with the trends and spend money on visual merchandising, the in-store deco. In Brands Outlet, all I need is an island and three mannequins. It costs half as much to outfit a Brands Outlet store than it does a concept store, which could easily cost RM200 per sq ft.” Chan says.

On Padini's overseas operations, none of which are run by the company directly, Chan says it is a tougher sell. “Our overseas business is not being driven, so it is less than 10% of sales.”

For one, he says the competition is much more intense. “We don't have the kind of competitive muscle to go against international retailers like Zara or Mango. When they go to China, they can get the best manufacturers, and 5,000 workers.

“Our scale is too small, the bigger manufacturers will not supply for us. We have to look for smaller manufacturers, and that's difficult. You have to nurture them, try them out, see whether they are reliable. That can be a tiring and long-drawn-out affair.”

However, he offers that if Padini were to decide to venture into foreign shores, they will do it by acquiring an existing retail chain. According to Chan, this will give it instant access to their real estate, distribution network, labour and resources, as opposed to starting a store and growing it organically.

“We are in good position to do this if we wanted to. We have cash, and because of our listing status, we can raise money through bonds or the capital market.”


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