Migros (BIST:MGROS) has recently underperformed the broad market despite the retailers specifically showed recently during the same timeframe. On a ytd basis, the shares fell by more than 12% while gains in the Turkish equity market benchmark index BIST 100 exceeded 5%. The underperformance is mostly due to the short FX position risks and the fears that the company would post a loss higher than expectations.
While accepting that Migros does face a number of challenges in the near-term, there is good chance that it could be the turnaround story in Turkish retail sector. Back in 2011 the company adopted a new growth strategy which is based on small sized convenience-stores. This strategy will pan out well as small sized stores have broadly outperformed traditional ones on sales by generating a higher sales density, since Turkish consumers visit stores frequently resulting in smaller basket sizes. As a result of this have seen the number of new store openings increasing in the recent years (the annual average 150 since 2001 versus 70 before 2011) while average store area decreasing (to 600m2 from 1000m2). The majority of the new stores are in the form of discount markets (branded as M-Jet) as might be guessed.
Migros is to face heavy competition from other discount stores such BİM (BIST:BIMAS). BIM is still perceived as the cheapest retailer according to the consumer surveys. However, we have seen the price differential between Migros and BİM coming down below 20% from above 40% in four years. Migros have introduced a line of private label items in order to lower the average price index. Basket size growth in Migros would be somehow slower than annual inflation rate this year, however, this would be offset by a higher traffic growth. Thus, we believe Migros will hit double-digit sales growth amid an expansion phase. Note that Migros is operating with a relatively higher EBITDA margin (+6%) versus BİM (below 5%).
Migros has successfully managed to improve its operating efficiency with higher sales to number of employee figures. I believe there is still room in Migros for further improvement. That being said, Migros also may be considered as a mean and lean company when compared to BİM regarding the number of employees per 100m2 of sales area (2 versus 2.4). With the minimum wages raised by 30% as pledged by the government, efficiency has gained importance for retailers, as a significant part of the employees in retailers are minimum wage workers. At this point Migros has an advantage over its peers.
At the end of 2014, the company carried a €835 million of financial loans in its balance sheet. Restricting euro-denominated debt has remained as the key challenge for the company in 2015. This also has built a supportive case for bearish views on the stock. Further deprecation of the lira against the euro for sure will have an impact on the bottom line through higher financial expenses. Nevertheless, risks related to this, in my view, are overblown. The company is expected to experience a total cash outflow of approximately €650 million over the next seven years, that would generate TRY280 million of financial expenses per annum with the assumption of 5% currency depreciation each year. Given the current valuations against its peers, this appears to be already priced in.
The following is our DCF analysis for Migros. Our estimated revenues figures below are based on 7% basket size growth, 1.75% traffic growth, and 3% sales are growth, averagely, over the course of next three years. Our terminal value includes a long-term growth rate of 5%. We discounted the free cash flow for the next ten years with an average WACC of 14.9% which is derived from a risk-free rate of 9.5% (2-year average of 10y Treasury bond yields), equity risks premium of 5.5% and an unlevered beta of 0.9x (for EMEA retailers). Our analysis offers a fair value of TRY19.5 which implies 27% upside from the current stock price. Ultimately, with its turnaround story, limited risks and potential to the upside, Migros is a “buy on dips” kind of play.
Update
06/10/2016
Migros acquired 95.5% of Tesco’s Turkish subsidiary Kipa’s shares for 302.3 million liras ($134 million). Tesco-Kipa operates through 49 hypermarkets, 31 shopping centers, 120 supermarkets and 3 gas stations. By paying roughly 0.1 P/BV for the acquisition, Migros manages to increase its total sales are by more than one third. As Tesco has faced significant challenges recently, the deal is considered as dirt cheap, however, a buy at the rock bottom price for Migros which also help the company to pull out even better financial performance in the upcoming period.
With the help of bullish emerging market sentiment, Migros shares reached our target price of TRY19.50 in only 32 trading days on 4/13/2016, outperformed the benchmark equity index BIST 100 by 14%. Total return was 31% in USD terms. We recommend investors holding the stock to be more cautious as the recent rally in Turkish stocks is likely to slow amid high valuations.
More information about the stock performance since recommendation is given at the table which will be periodically updated.
For more investment tips and ideas in Turkish stock market, send an e-mail to oguz (at) turkishmarketnews (dot) com.
