Mercator (MELR SV, MELR.LJ)

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1 (MELR SV, MELR.LJ) Change of ownership in the forefront Analyst: Petra Lesjak Recommendation statistics Current Previous Contact: +386 (0) Sell (131.0, April 14 th 2011) Accumulate (171.5, January 5 th 2010) Key data Target price (12M) ( ) Upside/(downside) (%) Curr. price (as of 12 th of April) Market cap ( m) week range ( ) Average daily turnover ( m) Free float (%) 41.5 Primary stock exchange Ljubljana SE Audit KPMG Next results published 18 th of May 2011 Internet site Forecasts and ratios A* 2011E 2012E 2013E Sales ( m) 2, , , ,143.8 EBIT ( m) EBITDA ( m) EPS FPF per share N.A *non-audited, adjusted for X-O P/E EV/EBITDA Divid. yield (%) P/FCF N.A. N.A Share price performance (%) 3M 6M 1Y 2Y SXRP; EU Retail M&A action, better than expected 2010 and optimistic future plan Since the beginning of 2010 we have been witnesses to several unsuccessful attempts by Slovenian commercial banks, Unofficial bid Price per which own approximately 34% of offers in March share Group, to sell their share of the largest 2011 Slovenian retailer. In the beginning of 2011 the Agrokor 195 EUR largest owner of Group, Pivovarna Mid Europa 170 EUR Laško d.d., put for sale 23% of the largest Partners Slovenian retailer, with 34% market share in Warburg Pincus 165 EUR Slovenia (summary of annual report 2010) and Source: Finance growing participation in ex-yugoslavian markets. Although according to unofficial data there were several bidders on 31 st of March the management of has made a public announcement to all shareholders regarding its support of an international tender offer for sale of controlling block of shares (at least 50%) of group. Until the end of March, Group reported only a summary of annual report with condensed annual financial data for 2011 on 2 nd of March reported consolidated sales in amount of EUR 2,781 mn, a 5.2% annual growth. The number was well above expectations and was mainly due to increase of revenue in foreign markets. Sales from foreign markets increased by 21% mainly due to acquisition of retail activity of Croatian Getro and companies Pantomarket and Plus Commerce in Montenegro. Meanwhile sales in domestic market fell by 2.9%. Slovenian market still represents the largest segment for group, but in 2010 it only represented 60.9% of group sales in comparison to 66% in Group EBITDA margin continued to decline from peak in 2006 and 2007 and reached 6.1% in Net income amounted to EUR 30 mn, an increase of 43.9% from previous year and exceeded company s estimates for 2010 by 39%. One reason behind this can be identified in decreased depreciation of fixed assets as group changed accounting practices somewhat, making EBITDA the most comparable number. However without a detailed financial data we cannot gain further insight into performance of the group. As breakdown of data regarding 2010 financial results is not yet available, we base our recommendation on trailing 12 months data for 9 months of In presentation of group for financial partners a too optimistic financial plan is outlined according to our view. After 5.2% growth in sales in 2010 they see sales of EUR 4,21 bn in 2015, an increase of approximately 51% in 5 years, EBITDA of EUR 241 mn (a 5.7% EBITDA margin) and net income of EUR 100 mn in This would be primarily achieved through growth in foreign markets, while their capex plans are EUR 125 mn in 2011 and 2012 and 155 mn p.a. until 2015 in comparison to record capex of EUR 313 mn in 2008, 159 mn in 2009 and 116 mn in Source: Bloomberg, 13 th of April, 2011 KD Banka d.d., Neubergerjeva 30, 1000 Ljubljana, Slovenia

2 Valuation multiples *left column: EV/EBITDA; right column: P/E. Source: own calc. Operational data (EUR m) *column: nom. sales; curve: nom. EBITDA. Source: own calc. Profitability & debt management *column: debt/equity; curve: ROE; curve: interest coverage. Source: own calc. Growth performance *black curve: net income (g), orange curve: sales (g). Source: own calc. Margins *left column: NPM, right column: EBIT margin. Source: own calc company s estimates remain optimistic Company targets for 2011 are ambitious on the basis of better than expected result in 2010 they anticipate a 5% growth in sales in 2011 (down from 8% growth expected for 2011 in last year). Main driver of sales growth will be increased foreign markets exposure, as share of domestic sales in the group revenues is seen to decline form 62% in 2010 to approximately 45% in They also expect the EBITDA margin to remain on the levels from 2010 and then slowly deteriorate to 5.4% in 2014 with EBITDAR margin increasing steadily in every year, due to planned monetization of real estate. We are somewhat less optimistic as we believe that increased competition in domestic and foreign markets should put some pressure on sales estimates. In addition, we find relatively high gross margin of almost 28% in 2010 hard to maintain especially as has made a commitment of not increasing prices for end consumers on account of own margins. We believe that has room for savings in costs of sales but still see deterioration in EBITDA margin to 5.5% in 2014 and to 5.4% from 2018 onwards. Valuation model & estimates review We arrive to our target price by equal weighting of (1) Implied EV/EBITDA, (2) DCF and (3) Peer comparison analysis. Following are the main assumptions that affect the target price, in order of their relevance to final target price (from most to less important): We see future growth in sales significantly below that anticipated in. We set sales growth at 5% annually until Until then, will increase its presence in the ex-yugoslavia markets and expend its business activities in two new countries, which would imply presence in nine different countries. From 2016 onwards we see sales growth declining to 4% annually. We set capex only slightly above annual depreciation and below company expectations, as we see Group as already highly leveraged and therefore not in the best position to incur any new debt. As already stated we perceive s gross margin as very high and we are not certain if it is sustainable on that level. We also expect a deterioration of EBITDA margin to 5.4% in It is also necessary to stress that due to accounting changes in depreciation and amortization of assets, EBITDA margin is the most appropriate ratio for comparison between periods. In order to achieve better comparability with its European peers we have incorporated the monetization of real estate in our peer comparison and implied EV/EBITDA model, in terms of reducing long term debt by approximately 500 m EUR. We did not use EBITDAR margin in our forecast or valuation models. We did not include monetization effect in our DCF analysis as we see the execution as uncertain; we believe that this is not necessary since we derive our valuation mainly from EBITDA margin. Should we incorporate monetization, we should use EBITDAR margin as the basis for forecasts. presents three scenarios in case of real estate monetization of assets is used for reduction of financial debt of the group. Net effect of EUR 250 mn, EUR 500 mn or EUR 750 mn is expected. As we see monetization process itself and its effects as uncertain we use median scenario but apply it only to (2) Implied EV/EBITDA and (3) Peer comparison analysis. WACC is set to 8.7% reflecting higher risk of the markets where is present. Main upside risks to our estimates are better than expected performance in foreign markets, monetization that would result in lower indebtedness and higher capex potential. Main downside risk include higher than expected margin pressures, delays in monetization of real estate, delays in growth in foreign markets and reduced purchasing power on domestic market together with increased competition from discount retailers (Lidl and Hofer). KD Banka Equity Research Page 2

3 Historical & forecasted income statement Income statement 2008a 2009a 2010T TM 2011e 2012e 2013e 2014e 2015e Net sales (EUR mn) 2, , , , , , , ,466.0 Gross profit (EUR mn) in % of sales EBIT (EUR m) EBIT margin EBITDA (EUR m) EBITDA margin Pretax income (EUR mn) Effective tax rate (%) N.A Net income (EUR mn) Forecasted balance sheet Cash & Cash Equivalents 2008a 2009a 2010a 2011e 2012e 2013e 2014e 2015e ST financial assets AR Inventories Other current assets Total current assets Net fixed assets 1, , , , , , , ,997.2 LT financial investments Other non-current assets Non-current assets 1, , , , , , , ,116.0 Total assets 2, , , , , , , ,848.6 AP Other ST liabilities ST borrowings Current liabilities 1, , , , , ,182.4 LT borrowings Other LT liabilities Minority interests Equity Total liabilities & equity 2, , , , , , , ,848.6 KD Banka Equity Research Page 3

4 Forecasted cash flow statement 2008a 2009a 2010a 2011e 2012e 2013e 2014e 2015e CFO CFI N.A CFF N.A Change in cash Capex estimates Net capex in fixed assets (EUR m) N.A a 2009a 2010a 2011e 2012e 2013e 2014e 2015e Net capex/sales (in %) Depreciation & Amortisation(EUR m) Depreciation/net fixed assets (in %) Reinvestment ratio (in %) KD Banka Equity Research Page 4

5 Valuation method 1: DCF analysis WACC Wd 62.3% We 37.7% RFR 5.0 % ERP 4.5 % When applying WACC, we use current market values of debt to equity. Tax shield is equal to expected effective rate of 20%. Applying a WACC of 8.7% for 10-year period and into infinity, we arrive at a current fair price of EUR month target price (increased by cost of equity) is therefore EUR PV of terminal value (after 10-year period) using a 2.0% growth in perpetuity represents 63% of total value of operations. Other premium 0.5 % beta 2.0 Cost of equity 14.5 % Cost of debt 6.5 % WACC 8.7 % 2011e 2012e 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e EBIT*(1-t) Depreciation& Amortisation Capex WC Inv FCFF Discounted FCFF Discounted value of operations Discounted terminal value Total value of operations 1, Cash & ST financial assets 35.1 LT financial investments 61.8 Other current assets 0 Value of company 1, Financial debt 1,095.6 Minority interests 0 Other LT liabilities 85.0 Other ST liabilities 3 Value of equity Current fair value of share month TP Sensitiv. Matrix 1 Long-term growth in FCFF Sensitiv. Matrix 2 Long-term EBITDA margin Long-term WACC 9.71% 9.21% 8.71% 8.21% 7.71% 1.00% % % % % Long-term WACC & 2.0% terminal growth rate 9.71% 9.21% 8.71% 8.21% 7.71% 4.96% % % % % KD Banka Equity Research Page 5

6 Valuation method 2: Implied EV/EBITDA model We use average pan-european food retail sector 2011 EV/EBITDA of 6 as the basis for implied EV/EBITDA model. Model was chosen as it is does not account for possible biased LT growth rate of the industry players but rather lies on the foundation of fair EV/EBITDA in the industry in Fair valuation multiple chosen may still be arbitrary but it does remove some of other shortcomings of DCF analysis. Due to differences in use of leverage, especially leasing between and its European peers, we adjust the leverage of for the amount that is to be unlocked in case of monetization of real estate (approximately EUR 500 mn). As states in his presentation there are three scenarios of outcome in case of real estate monetization. A net effect of EUR 250 mn, EUR 500 mn and EUR 750 mn. Assets would be used for reducing financial debt of the group. As we see monetization process itself and its effect as uncertain, we use medium scenario but apply it only to (2) Implied EV/EBITDA and (3) Peer comparison analysis. After adjusting the enterprise value for current balance of cash, investments, debt and other liabilities, we arrive at current fair price of EUR 128. WACC is set at 8.7% as for DCF analysis. 12-month target price is set at EUR e 2012e 2013e 2014e 2015e EBIAT EBITDA in last year Depreciation& Amortisation Fair valuation multiple (EV/EBITDA) Capex Terminal value 1,097.2 WC Inv PV of term. value FCFF PV of first 5 years Discounted FCFF Enterprise value 1, KD Banka Equity Research Page 6

7 Valuation method 3: Peer analysis P/B P/S P/E Next year P/E EV/sales EV/ EBITDA Divid. yield at Koninkljike Ahold Metro AG Tesco Carrefour SA Delhaize Group Median relevant peers * 7.0* 4.0 Value at median multiple * EV is adjusted for EUR 500 mn of financial debt that can be reduced by monetization of real estate. Mcap (b EUR) ROE Gross margin EBITDA margin Sales Growth Sales (b EUR) Debt/ equity Koninkljike Ahold Metro AG Tesco Carrefour SA Delhaize Group * Although s main competitor on ex-yugoslavian territory is retailer Konzum, the low liquidity of its shares and its status for parent holding Agrokor distort multiples of Konzum so we decide not to use it in comparison. We compare to a group of European peers that operate in primary mature European markets with growing exposure to emerging markets. We see Metro as the most appropriate peer, due to sales orientation to eastern European markets, higher debt levels and also comparable EBITDA margins. As a good peer in terms of orientation to emerging markets is Carrefour. We adjust Enterprise value of by reducing financial debt by EUR 500 mn in order to ensure better comparability to its peer that use leasing finance to greater extent and incorporate planed reduction of debt in case of real estate monetization. An adjusted debt/equity of would amount to 74.3%. Due to this and changes in amortization and depreciation expenses due to accounting changes we see EV/EBITDA as the most appropriate multiple. We prefer EV multiples as they account for the financial indebtedness of the companies and thus ensure better comparability of companies with different debt levels. We set peer TP as equal weighted average of EV/EBITDA and EV/Sales of Metro AG and Carrefour and set current fair price at EUR 140 and 12-month target price at EUR Final valuation and risks Final 12-month TP is set as an equal-weighted average of DCF (from EBIT), peer and implied EV/EBITDA model. We set the final 12-month TP at EUR reflecting about 23% downside from current price. Our view does not incorporate a tender offer in case of successful ownership takeover. Valuation method Target price Weighting scheme 1. DCF from EBIT /3 2. Implied EV/EBITDA /3 3. Peer analysis /3 Final 12-m TP KD Banka Equity Research Page 7

8 Appendix 1 Analyst Certification The views expressed in this report accurately reflect the personal views of undersigned analyst about the issuer of the security. The undersigned analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. The recommendation has not been disclosed to anyone prior to public release. Petra Lesjak Important Disclosures This publication has been either approved or issued by KD Banka in order to promote its investment business. KD BANKA is a licensed bank and is a member of Ljubljana Stock Exchange, Inc. 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Rating definitions Buy Accumulate Hold Reduce Sell >+15% from current price of recommendation +5%< from current price of recommendation<+15% -5%< from current price of recommendation<+5% -15%< from current price of recommendation<-5% <-15% from current price of recommendation Our target prices are established by determining fair value of stocks, taking into account additional fundamental factors and news of relevance of the stock price (such as M&A activities, major forthcoming deals, positive/negative share/sector sentiment, news) and refer to 12 months from now. All fundamentals are to be understood relative to our current fundamental valuation of the stock. The recommendation does not indicate any relative performance of the stock vs. a regional or sector benchmark. KD Banka Equity Research Page 8

9 Historical recommendation and target price Date of recomm. Recommendation Target price Close price 1. April 14 th, 2011* Sell EUR EUR January 5 th, 2010 Accumulate EUR EUR April 11 th, 2009 Reduce EUR EUR August 26 th, 2009 Reduce EUR EUR * On June 18 th 2010 transfer of coverage was made from Matjaž Maletič to Simon Krajnc. On April 14 th 2011, transfer of coverage was made from Simon Krajnc to Petra Lesjak. Investment banking relationship There was no investment banking relationship with the issuer. Published by KD BANKA d. d., Neubergerjeva 30, 1000 Ljubljana, Slovenia. Phone: +386(0) KD BANKA Homepage: On Bloomberg please type: KDBP <GO>. Copyright KD BANKA, d. d. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of KD Banka, d. d. KD Banka Equity Research Page 9