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Padini (7052) is a retail company listed in Malaysia bursa main market. If you are Malaysian, you must at least know one thing or two about this company. In the midst of COVID-19 pandemic, Padini is one of the worst hit retail companies. As we starts to see light at the end of tunnel for this pandemic, share price of Padini has also bounced back from its bottom. However until now, Padini still has not resumed its dividend distribution. Let’s look into details together.

(Last update: 11th Mar 2021 based on quarterly report issued on 26th Feb 2021. Updates are made in red. For readers that would like to read superseded version, please free to contact by email)

Background of Padini

Padini, a well known company in Malaysia selling garments, shoes and other accessories. Although company name is Padini, it actually owns multiple brands targeting different segments, including Padini, PDI, Seed, P&Co, Vinci and Miki.

Business strategy of Padini

Retail is a highly competitive and dynamic industry. In my opinion, there are 2 key strategies leading to success of Padini today.

1. Targeting low to medium income customers. Quoting from their annual report, their products are “value of money” and “affordable clothing“. Padini has positioned themselves very well to differentiate from their strongest competitors such as Zara, H&M and Uniqlo. During sales, their price can even beat similar products selling at local morning/night markets.

2. Multi-brand stores. In early days, Padini has more single brand stores but many of them have been closed over the years. Instead nowadays, mostly you will see Padini Concept Stores and Brands Outlet Stores in the mall. These stores sell products for men, women and kids, from clothing to shoes to accessories.

Why is this working well? Imagine a scenario that the store is on sales, wife is attracted and go inside to check out for a cloth. Because of their competitive pricing, wife may end up buying clothes for kids also. How about others (like husband, parents and whoever) at the meanwhile? Probably wandering around the stores and there’s a high chance that others will end up finding a bargain to buy also because the store just has everything that can suit both sexes and all age groups, at a very competitive pricing.

Challenges of Padini

1. Low customer loyalty. It is ironic to say that their strength is also their weakness. Customers are buying their product because of value of money, so their customer loyalty is much lower compared to other brands such as Zara, H&M and Uniqlo.

2. Dynamic & competitive industry. This is exact quote from management in annual report, “the latest fashion trends need to be made available in store in the shortest time possible, at right price, before it loses appeal. The question lies who can execute this and execute it well, very time.” Threshold to enter this industry is low, over the years we have seen many rising brands and also many sinking brands. Winner is the company who can keep up with dynamic of the industry.

3. Digital retailing. This is both a risk and opportunity for all market players. Strength of Padini is on physical brick and mortar stores. Padini has been building its e-commerce for years. It is not disclosed by management how much e-commerce is contributing and I don’t think it is a lot. If consumer behavior in Malaysia is shifting significantly to online purchase, i think this presents more risk than opportunity to Padini.

4. Market size. Padini makes more than 90% of their revenue and profit from domestic market. While Malaysian market will still be growing, but the pace is going to be slow. Padini has been trying to venture into foreign market (focus is on other South East Asia countries), but I would say it is still on “experiment” stage. It is not easy to build brand recognition in a new market, however this is what company has to try to grow into next level.

Financial of Padini

Balance sheet

Padini has a very strong balance sheet. The company has been generating cash every year and have accumulated big pile of cash over the years. To cope with COVID-19 pandemic, Padini stopped dividend distribution since 2020 Q2 to reserve cash to handle this crisis. As a result, cash held by Padini is actually even higher compared to pre-COVID period. Based on the latest quarterly report ended Dec 2020, total amount of cash is RM521 million, equivalent to 79 sen per share.

On the other hand, it has RM224million of current liability and RM370 million of non-current liability. Even the cash alone (excluding other current asset) is enough to serve its current liability, there’s no doubt that financial status of Padini is very healthy.

If comparing balance sheet to FY2019, you would notice that non-current liability back then was only RM9 million, much lower than RM370 million in the latest quarterly report. What’s going on? It’s actually has something to do with implementation of new accounting standard MFRS 16, and will discuss in separate section below.

Cash flow statement

For other articles and reports about Padini, people always talk about cash owned and generated by Padini. How can Padini generate so much cash?

Back to the basic, any business always need money in two areas – capital investment/expenditure and working capital.

• Capital investment are one-time investment required to run the business, especially during initial phase, such as procurement of plant, land, equipment & machine. Many capital investment has a useful life. So to sustain the business, company will need to take a portion of profit to continue making capital investment
• Working capital, on the other hand, is money required to run daily operation. For examples, some cash are paid to suppliers before product is sold (i.e. receivable) and some cash is tied with inventories generated that not yet sold.

How much cash a company can have, depends on how much they need to put money into capital investment and working capital to keep the business running.

Cash flow statement – Capital investment

Let’s think about what kind of capital investment Padini needs. The company is not running factory, and their shops are all leased from mall operator. So they only need to invest a building as their headquarters, and pay some renovation when setting up a new store. How much would that cost? Well that depends on expansion plan of year but definitely not capital intensive.

Cash flow statement – Working capital

Padini definitely need working capital. But think about that, how soon Padini gets payment from customers? It is immediate when consumers make a payment at store. On the other hand, does company pay immediately to suppliers? No, it only needs to pay suppliers after 30 to 90 days depending on payment term. This kind of business model has made Padini do not require so much of working capital.

The biggest factor that would affect working capital requirement is on inventory.

Inventory

One point I would monitor closely on Padini is its inventory. When I say this, I mean their inventory level and also write-down/write-off of inventory.

Inventory management requires skill and experience. It should be sufficient to serve customers at any time. On the other hand, it cannot be too much as the cash will be tied-up there. Also keeping too much inventory increases risk of write-down/write-off of inventory.

While it is normal for inventory level, write-down and write-up to go up and down, I would watch out for any extreme changes. One example is during FY 2017, Padini decided to do a very high inventory write-up/write-down. But during FY 2018, a large portion of inventory write-up/write-down is reverse, giving a boost to the profit. If not taking this point into consideration, it could create misconception when interpreting financial performance from FY2017 to 2019.

Impact of MFRS-16 to Padini

MFRS-16 is related to lease. For Padini, it affects how company record their lease contract with mall operator in financial report.

Details of changes coming from MFRS-16 will not be discussed here. This has a substantial impact to financial reporting of Padini. So if you don’t have any idea, I have another article about MFRS updates here.

Let’s directly look at the latest quarterly report ended Mar 2020.

Balance sheet

Look at the the following figure, there are two new items in balance sheet – “right of use assets” and “lease liabilities“. If you have read my another article about MFRS here, you may have already understood.

Lease liabilities mean the amount of lease contract that Padini has signed with mall operator but not yet due/paid. On the other, right of use assets mean value of lease contracts that Padini has signed.

So don’t be concerned about spike in liabilities of Padini compared to year 2019. There is no huge increase in borrowing, just that lease contract is now required to be listed as explained above to fulfill requirement of new MFRS 16.

Financial highlights (Quarterly Report of 2020 Q4 / FY 2021 Q2)

• No matter what is the basis used for comparison (e.g. compared to previous quarter, compared to same period in previous year etc.), I would say financial result of 2020 Q4 is very bad. So I would not elaborate too much here. However there are still few good points to take away from the financial report.
  • Gross margin remains healthy at around 38%
  • Lower admin, selling and distribution cost, partly because of special rental rebate given by mall operator in the midst of this pandemic.
  • At least the company is still making profit rather than suffering from loss. So its fundamental and financial health are not impacted so much by the pandemic.

• With MCO 2.0 implemented in 2021 Q1, I think it is very challenging for Padini to post any good result for 2021 Q1 also.

• I think retail players and mall operators started to see the light at the end of tunnel. However I believe pace of recovery will still be gradual and it would need to wait at least until Q4 to see more apparent recovery.

• Although Padini has been distributing dividend every year, the company do not actually had dividend policy. Management mentioned in financial report that “the board does not intend to establish a fixed dividend policy at this point of time. The board strives to provide consistent dividend streams to shareholders whilst ensuring to retain flexibility of cash flows to meet its business operation needs as well as its expansion plan”. Note that Padini has stopped giving dividend to cope with COVID-19 crisis, it remains unclear when it will be resumed.

• One interesting point I would like to highlight. Due to COVID-19 pandemic, Bank Negara has reduced overnight policy rate (OPR) to ease burden of individuals and businesses. But for Padini, reduced OPR do more harm than good. Why? Because company has only little borrowing but big pile of cash. So low interest rate do not save much interest expense, but it reduces interest income received from their cash deposit.

End

• I spent quite a long section in this article on impact of MFRS 16 to Padini because it is very important for to understand MFRS 16 in order to correctly interpret their results especially for financial year 2020.

• Again I would not put too much expectation on 2021 Q1 result. With MCO restriction started to ease in Q2, probably that is the turning point for Padini. However it all depends on how well the government manage to control COVID-19 cases in Malaysia.

• Under this circumstance, I expect inventory management should be more tricky. Interestingly, not only inventory loss / write down / write off is much lower than previous year (RM0.7 million vs RM 2.6 million), Padini also recorded reversal of inventory written off and written down of up to RM1.5 million. It looks like Padini has done a good inventory management in the midst of this pandemic.

• Padini do not have dividend policy but they used to distribute dividend every quarter. However company did not announce any dividend since 2020 Q2 , so do not put too much expectation on dividend at least until second half of the year 2021. I believe it is one of the reasons putting their share price on selling pressure. Once Padini resumes its dividend distribution, that will send a very positive news to market, implying that management really thinks the worst is over.

• After stopping dividend distribution this year, the cash owned by Padini is even more compared to pre-COVID-19. With their strong balance sheet, I believe Padini can make it through the COVID-19 crisis. Compared to COVID-19, I think change of consumer behavior to online shopping is probably the biggest long-term challenge faced by Padini

In case you want to know more about dividend investing, feel free to check out my article about ultimate guideline for dividend investing here.

Disclaimer: This article is purely my notes from studying this company. This is not a BUY or SELL call. I am not a registered investment advisor nor an investment guru, please be reminded to do your own homework and invest at your own risk.