Hi all, I've been looking at SRY for a little while and decided to write up a brief report on my thoughts.
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Most investors love a good story. One that has the potential to get people excited; a story that mixes bright future prospects with a sound entry price. If over time the investment thesis broadly plays out, early investors subsequently benefit from both earnings growth and P/E expansion (i.e. future investors pay higher multiples on a growing earnings stream). This is arguably the ultimate double whammy in terms of return generation. We believe ASX listed Story-i (ASX: SRY) now presents as this type of opportunity, one that we review in detail today.
As has been increasingly common at the smaller end of the market of late, SRY was backed into the shell of Pine Capital (ASX: PCD) in early calendar year 2015. Shares were effectively issued at 20c while a small amount of new capital was concurrently raised at the same price. Nearly 18 months on, the business name has changed (to Story-i) and management has delivered quite reasonable growth across both core and new business divisions. Despite this, the share price has collapsed some 68 per cent to about 6.5c today. This leaves SRY at a market cap of just $9m.
While there may be several reasons for this, we tend to think the selloff relates to both (1) a small number of legacy holders, who presumably have little knowledge of and enthusiasm for an ‘unknown’ business, exiting the stock, and (2) general mistrust of ASX listed businesses whose core operations exist in SE Asia.
SRY was established in 2010 when founder and current Executive Director Michael Chan opened its first store in Indonesia with an initial focus on retailing consumer electronic products. Key brands of products sold include Apple, Samsung and Lenovo. SRY’s Retail Division now has 19 stores across Indonesia and Vietnam, comprising:
- 6 ‘iConnect’ branded stores: retails multi-branded products and accessories, and
- 13 Apple authorised reseller stores, branded ‘Story-I’: focus on Apple products and accessories
- 2 ‘Geekzone’ stores located within Story-I stores: focus on higher margin services and repairs
Rather than just sit in its box of being a focused retailer/distributor, SRY management has organically built three other complementary business divisions since listing. Today, the business structure is as follows:
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SRY’s Education division was born out of a desire to leverage existing supplier agreements and in house IT capability to deliver a bundled package of hardware, software and managed services to Indonesia’s enormous education market (260,000 schools, 60% of which are private fee paying institutions). According to SRY management, “The Education division has experienced a strong flow of inquiries since the signing of BPK Penabur (ASX release 30/10/2015), the largest private Christian education group with forty-five school campuses. In addition to driving device sales, this division has become its own profit centre with customization fees, software reseller contracts, and recurring hosting and maintenance income.”
The above strategy neatly overlaps with another of the company’s newer divisions in its Enterprise Division. This business unit focuses on servicing the multi-national corporation (MNC) and Small to Medium Enterprise (SME) markets with a bundled offer that generates revenue through hardware sales, software reseller fees, implementation fees, and recurring hosting service charges with software user fees.
As is evidenced by recent contract wins (ASX releases April - June 2016) with Mazda (manufacturing), Mitsubishi (retail and manufacturing), PT Media Nusantra (media), PT Indosiar Visual (media) and PT Bank DBS Indonesia (banking), this division is swiftly gaining operational traction. The addition of large MNCs as significant customers provides the company with further credibility, while concurrently adding breadth to SRY’s business as it further integrates its retailing, distribution and recurring IT services businesses.
Though these enterprise sales cycles are typically larger and longer, management note that such sales provide long term recurring income through both hardware replacement sales and subsequent annuity-like hosting and software related income streams.
While only early stage, SRY has also entered the online retail space through its E-commerce division. This division complement’s the group’s bricks and mortar presence.
In aggregate, SRY is successfully building an integrated business model that encompasses:
Product and accessory sales > Customisation > Host, Maintain & Service > Upgrade
At a macro level, we see the emerging middle class of countries such as Indonesia and Vietnam (albeit from a lower base) as a powerful long term thematic. It is our view that SRY’s retail division is well placed to benefit from this trend. While the aggregate population of targeted geographical areas is about 400m, we estimate the core target market of middle income and affluent customers is closer to 160m. To provide further context of what is currently happening in this market, Indonesia added 12.8m smartphone users in the 6 months to March 2015. That’s a lot of retail sales and we feel SRY is well placed to capture a small yet growing portion of this pie.
A further interesting development within the retail division is the roll out of the ‘store-in-store’ concept. We see this is a sensible, capital light way (relatively speaking) of expanding the retail footprint and increasing brand awareness.
As recently as last week, SRY announced the evolution of this strategy after partnering with two significant retailers, Gramedia and Lotte Mart. Gramedia is Indonesia’s largest chain of bookstores, with 115 stores located across the country. This concept will be deployed to 37 of these locations which Gramedia has dubbed ‘IT Experience Zones’. The first phase of the roll-out, which is expected to commence in the coming weeks, involves the opening of nine Story-i branded ‘store-in-store’ outlets located in Jakarta.
South Korean conglomerate Lotte Mart (LM), a public company whose market cap exceeds A$7.6bn, has also entered into an agreement with SRY. LM plans to initially open four Story-i branded Apple retail outlets within Lotte Mart hyper-markets in Jakarta. Both announcements follow the April 2016 ASX release indicating this concept would also be introduced in one of SE Asia’s largest retail ‘megastore’ chains, Courts.
We see the growth of both the Enterprise and Education divisions as strategically significant over the long term. In effect, this takes SRY from being an exclusively focused retailer to being an organisation that is much more deeply embedded in its customer’s operations. To a degree, this drives recurring revenue and increases the stickiness of the customer base.
Pleasingly, much of the business activity outlined above is starting to be reflected in the numbers being reported by the business. SRY has grown year on year revenue and earnings since 2012, reflecting not only store footprint growth but also sound like for likes sales growth. Management are confidently forecasting EBIT of $2.5m for FY2016, up 31.6% on the $1.9m achieved in FY2015. After accounting for tax (paid in Indonesia at ~25%) and interest payments, we believe SRY is on track to deliver NPAT of about $1.7m in FY16 and ~$2.5m in FY17. As such, we note SRY is currently trading on a forward P/E of less than 4x. Looking further ahead, driven by an ongoing store rollout, growth in like for like sales and growth in Education and Enterprise, we see revenue more than doubling by 2019. Given likely margin expansion, discussed further below, we therefore expect earnings to more than double over the same time frame.
The company has also improved margins along the way: EBITDA margins have more than doubled from just 4.7% in 2012 to a forecast 10.2% in FY16 (FY15 8.9%). This suggests SRY’s scale is incrementally improving and we expect that over time the business will more efficiently fractionalise its fixed cost base. As a result, we see margin expansion continuing in the near to mid-term. Looking further ahead, we also believe the higher margin enterprise and education divisions will assist in driving total group margins higher over the next 3 to 5 years (as these divisions became a larger portion of group revenue).
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As is evidenced by the below chart, despite offering growth rates of circa 30% per annum in the near term, SRY continues to trade at extremely low earnings multiples.
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Given the substantial differences in size, scale, geographic exposure and business maturity, it is obviously difficult to directly compare SRY with larger, more established listed peers that operate domestically (primarily). It is nonetheless instructive in that it may give some insight into where SRY could potentially be priced in the longer term should it be successful in executing on its growth strategy. As it stands, if we were to price SRY at a 40% discount to its much larger ASX listed retail peers, the company’s ‘value’ would sit somewhere between 14c and 15.5c per share. This compares favourably to the current market price of just 6.5c.
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When considering SRY’s larger domestic peers, one further point worth considering is this: if SRY does indeed gain greater traction in the year/s to come, the company would potentially become a takeover target. The case for a well-capitalised listed retailer looking for an entry point into what will become a much larger market would be a strong one.
Two further key numbers that require attention are receivables and cash flow. We consider these concurrently as the build-up of one (receivables) has adversely impacted the other (operating cash flow) in recent times.
Receivables accounts for a high proportion of both assets and equity and is split into two roughly equal buckets of capital: half Apple (this amount actually represents rebates to be provided to SRY at a future date), half business to business enterprise customers. These customers are understood to be on more favourable payment terms of up to 60 days. So while SRY has to pay suppliers such as Apple and Samsung promptly for the product they sell, SRY’s business customers have 2 up to two months to pay SRY. To a degree, this effectively creates a lag effect when it comes to cash flow. Given SRY is effectively owed cash by large MNCs, we see the risk of non-payment as actually quite low.
Importantly, we note that SRY is beginning to turn the corner on this front and generated positive operating cash flow in the first half. This is even after a considerable lift in working capital during the half, where a small decrease in receivables was more than offset by an increase in inventory (store footprint increasing) and a considerable reduction in payables. With all else being equal, net of this change in working capital, cash generation would have been closer to ~$2m for the half. Ultimately, we believe this trend will continue to improve, which should lead to an even stronger 2H result in terms of cash generation.
Our initial view on SRY management is positive and reflects what we perceive to be a proactive style; one that is delivering growth through various channels. The board and senior management collectively own ~19% of the company, which in our view acts to align their interests solidly with minority holders. We believe the appointment of a CEO with decades of IT experience (with the likes of Microsoft and Dell) in Yulius Halim was a sensible move. This is particularly so given our view that this skill set complements the existing retail and IT operational experience of founder Michael Chan well.
As is probably obvious from the above commentary, we are now long SRY with a moderate portfolio position. In noting our positive view and valuation range of 15c to 18c per share, we do however acknowledge a number of risks that exist. We perceive these to be:
- * Sovereign risk: while operating in developing nations with substantially larger growth runways than those present in Australia has its upside, this doesn’t come without risk. Risk is somewhat elevated given the less developed nature of SRY’s core SE Asian markets (economically and otherwise)
- * Execution risks: While the number and breadth of growth opportunities apparent is a positive, delivering profitable growth is often harder to manage in practice
- * Bargaining power of suppliers is high: when reviewing this company, one of Porter’s five forces came to mind immediately. The bargaining power of key suppliers like Apple and Samsung is high and as outlined above, at a minimum this impacts the company’s terms of trade. Ultimately, the presence of a small number of powerful suppliers reduces profit potential for any industry. It is for this reason that we see SRY’s move into complementary support and IT services as a particularly shrewd move.
- * Foreign exchange risks
- * Liquidity: many investors value (and pay a premium for) liquidity. At a market cap of just $9m and daily trade volume averaging ~60,000 shares, SRY is rather illiquid. This may present as a risk for some (note this risk works both ways, especially if the business keeps delivering).
- * Apple and other suppliers decide to go straight to market with their own retail presence: while this presents as a longer term potential risk, even in developed markets Apple has more of a ‘flagship’ mentality. This lends itself to a small number of large locations, rather than the inverse. This leaves considerable room for other nimbler providers to concurrently provide a strong consumer electronics retail offering (JBH being a useful domestic example).
- * Capital raising at depressed prices dilutes upside for existing shareholders
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