ACE Hardware Indonesia (Initiating coverage with Outperform) - A great story… - MACQUARIE RESEARCH

Initiating with an Outperform and Rp3,500 valuation
We initiate coverage of ACE Hardware Indonesia (ACES) with an Outperform recommendation and Rp3,500 valuation/price target (DCF driven), equivalent to a FY11E PER of 27.6x. We believe ACES represents a compelling retail roll-out story that offers investors first-class leverage to rising Indonesian consumption, and we believe the stock remains very reasonably priced relative to its growth potential. Our view is materially more bullish than consensus, which has three holds and three buys on the stock (and a price target range of Rp2,450–3,100).

A retail roll-out play still in its infancy
ACES is an emerging specialty retailer of home improvement/lifestyle/DIY products in Indonesia, with a growing range of merchandise now exceeding 70,000 SKUs. The company's retail model appears to be working, with sales having grown at a robust 30% CAGR since FY04A, amidst a steady store roll-out profile that has seen its store numbers rise from 17 in FY05A to 46 at present.

We believe the growth outlook for ACES remains bright. ACES targets the mid- to high-end market, or consumers with incomes exceeding US$4,000 pa (currently c10% of Indonesia's population), and ACES expects this segment to double in size during the next five years. Furthermore, ACES's FY11E sales represent only US$1 per capita, compared to Home Depot's almost US$200 per capita in the US, suggesting that ACES is still scratching the surface of its long term growth opportunity. We believe these dynamics should allow ACES to comfortably grow sales by at least 15–20% pa well into the foreseeable future.

Competitive conditions remain benign
In addition, ACES currently enjoys a strong competitive position and faces only a modest range of local chain store competitors who are focused directly on its core segments. Longer term, the prospect of new entrants represents a risk, but we believe the prospective pie is large enough to share with other entrants, and in the meantime ACES will continue to extend its competitive head start. We also believe the business is well placed to deliver further medium-term margin expansion (with FY10A EBIT margins having already risen to 12.9% from 10.9% in FY07A) on the back of rising economies of scale. As an importer of 80% of its retailed product, ACES will also be a direct beneficiary of any IDR appreciation.

FY11E growth outlook remains favourable
ACES enters FY11E with strong organic growth momentum (20.9% sales growth in FY10A) and a continuing robust economic backdrop. In addition, the company has also recently opened a 15,000sqm store in Banten (West Java) – well above the company's 3,000sqm average store size, and the company's largest to date – which is likely to contribute positively to FY11E sales and profit growth.

Valuation remains very reasonable in our view
ACES is currently trading on FY10A and FY11E PERs of 23.8x and 19.9x, respectively. We do not view these multiples as expensive, despite this being a material premium to the JCI FY11E average of c14x, given the company's rapid growth profile, its relatively low earnings risk, and importantly, the likely duration of its excess growth window. We actually see scope for a further upward multiple re-rating in time as ACES's liquidity steadily improves, which will increase the range of investors who can purchase the stock (pushing out the demand curve).