Smartkarma Originals

Forensic Accounting Analysis on

By | Smartkarma Originals

This insight has been produced jointly by Shifara Samsudeen, ACMA, CGMA ​and Supun Walpola ​at LightStream Research ​

This report investigates potential downside risks to’s shareholders extending from its accounting and corporate governance practices. Our accounting diagnostic review identified several red flags pertaining to revenue quality, off balance sheet liabilities and undisclosed investees in the company’s financials and notes to financial statements. 

We have concerns about the quality of’s revenue. Our analysis shows that c.15%-20% of JD’s revenue is coming from accrual accounts, but this is not reflected in the financial statements since the company is moving its accounts receivables off balance sheet in a “factoring-like” arrangement through a related party.

We also think that the company may be indirectly assuming the solvency risk of some of its related parties like JD Digits and JD Logistics Properties Core Fund L.P (JD LPC) but this liability is not recognised in the balance sheet. The size of these “indirect” liabilities seems quite large;’s exposure to JD LPC’s debt is currently c.35% of the company’s net cash.

We are also not satisfied with the depth of the company’s disclosure on its equity investees. Equity investees are responsible for c.40% of’s net loss but there is little to no disclosure about them in the company’s financial statements.

Moreover, we believe that the impact of’s accounting issues are exacerbated by its weak corporate governance practices. The company’s founder, CEO and chairman, Mr. Richard Qiangdong Liu, has extensive influence on the company through his c.79% voting power, which puts minority shareholders at risk. We also observe that the company often adopts the Cayman Island’s corporate code instead of instituting the typically stronger corporate governance practices recommended by the NASDAQ exchange. 

We don’t see the impact of these accounting and corporate governance issues materialising in the short-term. However, we find the potential income statement and balance sheet impact of these issues to be large enough for investors to pay close attention.

LightStream Research • Equity Analyst • (Opens in a new window) ⧉

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Corporate Governance In Japan

By | Smartkarma Originals

If effectively implemented, the Japan Corporate Governance Code, the Japan Stewardship Code, the Engagement Guidelines and the CGS Guidelines would also represent a sea change in the role of Japanese boards in terms of management selection, management compensation, and capital deployment. If. This is largely a ‘soft” law rather than a hard regulatory change, limiting the regulator’s power to address minority rights.

There is a need to see improvement in governance, independence, board structure, and capital stewardship by a very large number of companies in Japan. Enhancement of diversity on the board will enable increased effectiveness and also strengthen companies’ governance structure.

Investors are calling on companies to hire outside board members and tackle cross-holdings. The TSE-mandated Corporate Governance Code seeks at least two independent outside board members for listed companies and preferably a third, a majority, and provides an example of “at least one-third independent directors”. But these examples, and other much-needed changes, remain inadequate.

One of the fundamental problems with the combination of the Japanese Corporate Governance Code and the Companies Act, and the lack of liability of directors for their own decisions, is that they can hang their hat on irrational economic arguments and there are no repercussions. 

Investors want better “governance”, however, international investors seek more than improving the box-ticking form prized by many Japanese companies. Analysing non-box-ticking ESG/governance is difficult. It is difficult to track and analyse. And even if box-ticking is evident, it is not necessarily true that doing so will raise long-term equity returns. It is possible it will raise costs, which would lower profit growth – this may be good for society, it may not be good for valuations.

International investors are more concerned with improving information access, management responsiveness to investors, and management efforts to make companies become better economic engines. International investors would like to see companies concentrate on their business rather than see them run long-short funds (i.e. hold cross-holdings) with investor capital, hold excess cash, or invest in real estate as an alternative source of income.

A Consultation Paper reviewing the TSE cash equity market – first mentioned in December 2018, followed by a Market Consultation, culminating in four documents posted on the FSA’s website last November – make it clear to the TSE, governmental, and regulatory authorities that existing governance and stewardship levels don’t cut it.

For now, there’s a lot of technocratic navel-gazing.

Quiddity Advisors • Pan-Asia Catalysts/Events • (Opens in a new window) ⧉

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China Semiconductor Progress & Opportunities Review 2020

By | Smartkarma Originals

Since the launch of China’s ‘Made in China 2025’ strategic plan in 2015, billions of dollars have been invested to bolster the country’s self-sufficiency in ten key technology sectors. Five years on, we review the accomplishments, challenges and, in some cases, downright failures from the perspective of the semiconductor industry. We examine in particular China’s efforts to develop their own supply of DRAM and NAND chips and opine on both their progress and the risks they pose to the leading incumbents.

While China’s memory ambitions attract the lion’s share of the limelight, we think it’s important to look at the broader semiconductor ecosystem. To that end, we examine China’s progress terms of silicon wafer manufacturing, foundry and semiconductor equipment manufacturing. 

Our conclusion is that the the best investment opportunities relating to China’s semiconductor push may be found in lower-profile, less glamorous segments of the broader ecosystem. Here’s where we think they might be. 

Note: This Smartkarma Original is a collaboration between Jim Handy and William Keating. Jim contributed the initial sections on the background to China’s semiconductor investment plans, DRAM, NAND and their impact on the incumbents while the remaining sections were contributed by William.

Ingenuity • Semiconductor & Technology Specialist • (Opens in a new window) ⧉

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Private Credit Opportunities in Emerging Markets – Focus on India

By | Smartkarma Originals

Private credit is booming across emerging markets, after rising as a formidable asset class in Developed Markets (DM) post Global Financial Crisis (GFC).

In this Smartkarma Original, we assess the private credit space across emerging markets (EM) and demonstrate India’s attractiveness as a top destination for private credit opportunities. Within India, we pick Edelweiss as our top recommendation to participate in the private credit space through public equities. Edelweiss – Edelweiss Financial Services (EDEL IN) – is likely to not only benefit from the booming private credit space but is also transitioning from fund-based business model to fee-based business model, which should unlock significant value for the company.

This Smartkarma Original is divided into two parts, Part 1 and Part 2. Below is the Part 1 of this Original and it focuses on the private credit theme covering below topics:

  1. Introduction to Private Credit
  2. Private Credit: Prefer Emerging Markets (EM) vs Developed Markets (DM)
  3. The Menu of Private Credit Opportunities across EM
  4. India – Among the Most Attractive EM Markets for Private Credit

The Part 2 of this Smartkarma Original is a follow-on insight, titled as “Edelweiss – A Turnaround Idea Shifting from Fund-Based to Fee-Based Business Model”. It discusses our investment thesis on Edelweiss – our Top Pick for benefiting from the booming private credit space in India.

What’s Original:

  • Insights into why private credit is better than traditional balance-sheet driven funding for certain credit opportunities across EM.
  • Compare and contrast various private credit investment opportunities available across EM for institutional investors and why India stands out as a compelling opportunity.
  • Estimate the size of the Total Addressable Market (TAM) of such private credit opportunities in India to demonstrate the high growth potential

• India Focused Equity Analyst • (Opens in a new window) ⧉

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Investing into China’s Growing Onshore Bond Market

By | Smartkarma Originals

In this Smartkarma Original, we dig into the onshore bond market of China, covering key topics include historical background, market structure, market segments and key participants, growth drivers, evolving trends, market dynamics around foreign participations and challenges for foreign investors. The Chinese onshore bond market is a complicated one. This Smartkarma Original does not attempt and cannot cover all areas in the market, but is expected to highlight the most important areas that global institutional investors need to know in their decisions to make investment in this gigantic and rapidly-growing market. 

What’s Original?

The China onshore bond market, with outstanding notional value of RMB95.7trn, is now the second largest in the world. However, foreign ownership of onshore bonds is outrageously low at just 2.3%. In this Smartkarma Original, besides exploring the key facets of this market, we discuss the key trends in the future and the main challenges faced by global institutional investors.

This Smartkarma Original draws views from rating industry, institutional investors and the banking industry and local resources to provide a comprehensive picture on the development of China’s onshore bond market. More importantly, we look at the market from the perspective of investors, which is different from the perspectives of the issuers and investment banks.

We believe there is no way to stop the growth of China’s onshore bond market and more will be done by the regulatory authorities to improve the appeal of the market to foreign investors – this is a market that foreign institutional investors simply cannot afford to ignore.

• Equity Long-Short Analyst • (Opens in a new window) ⧉

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Thailand: A Two-Player Retail Market? – CPALL and Berli Jucker

By | Smartkarma Originals

In this next part of a Smartkarma Originals Series on ASEAN Retail, we look at Thailand and specifically two companies including CP All PCL (CPALL TB), the operator of over 11,600 7Eleven stores in the country, as well as cash & carry operator Makro and, Berli Jucker (BJC TB), a relative newcomer and owner of number two hypermarket operator Big C Supercentre.

In this report, we take a deep dive into both CP All PCL (CPALL TB) and Berli Jucker (BJC TB) having had face to face meetings with the management of both companies in Thailand, as well as visiting a number of their stores in Bangkok.

Both companies are pushing forward with innovative strategies in their own sub-segments, with CP All PCL (CPALL TB) gradually increasing the size of its convenience store offering and adding to the services side of its revenue mix. It is also exploring some higher-end offerings, with a greater range of ready-to-eat options in a new clean shiny environment.  

Big C rapidly pushing out it’s Mini Big C offering, with larger size convenience stores, more like mini-markets, targetting top-up shoppers in residential areas. It has also introduced a new Big C Food Place concept targetting more affluent customers in urban areas. Its other major business is consumer packaging and consumer supply chain, which are stable growth businesses with significant synergies with its retail business. The company’s aluminium can business has growth potential given a switch from other packaging mediums to cans.

The other major player in Thailand is TESCO through its TESCO Lotus stores. It operates around 400 supermarkets and hypermarkets and 1,500  Tesco Express convenience stores and recent newsflow suggest that it is looking to sell those assets together with its 74 Malaysian stores for a price tag of US$9bn.

A potential front-runner to buy those assets is Berli Jucker (BJC TB), which would further transform that company’s business towards being a purer retail play and the number one player in the hypermarket space by a significant margin. Should this transaction take place, it would likely narrow the valuation gap between the two players, though CP All PCL (CPALL TB), would likely continue to trade at a premium, given its higher ROE and pure retail status.

In terms of upside, both companies look attractive versus there 3-year average PER multiples. CP All PCL (CPALL TB) trades on a forward PER of 25.9x FY20E versus a three year average PER multiple of 29.4x implying upside of 13.5% or a target price of THB85.00. Berli Jucker (BJC TB) looks even more attractive, trading on a forward PER of 21.8x versus a 3-year mean forward PER of 30x implying upside of 37% to a target price of THB56.70.

CrossASEAN Research • ASEAN Insight Provider • (Opens in a new window) ⧉

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Minimarkets: Mini Is the New Big

By | Smartkarma Originals

In a Smartkarma Originals Series of Insights on ASEAN Retail, we seek to determine which retail formats are winning out in the battle for consumer attention. The Indonesian grocery retail industry is changing over the past decade. Traditional retail share, which is dominated by over 5mn Warung (traditional mom-and-pop shop), is declining from a dominant 90% to 80% (including cigarettes). FMCG companies that we speak to gave us a rough range of 20-30% of sales derived from modern retail outlets. This change is driven by the rapid growth in the minimarkets, a duopoly that are expanding 3,000-4,000 outlets per year at its peak.

In this insight, we will discuss the reason to minimarket successes, the players in the industry, impact from e-commerce expansion, and the minimarket growth potential going forward. We also spent time speaking with Nielsen to understand the latest consumer behavior and made several visits to different minimarket, supermarkets, and hypermarkets, as well as Warungs to understand the dynamics offered by each format. 

The minimarket concept is grown locally and were first seeded by two of the most prominent FMCG players in the market Hm Sampoerna (HMSP IJ) and Indofood Sukses Makmur Tbk P (INDF IJ) back in 1990s. Knowing the Indonesian shopping habits in the traditional mom and pop shop (Warung), the minimarket is created as an improved version of the local warung, focusing on daily necessities (egg, rice, oil) and the fastest moving goods (instant noodle, cigarette, bread).

Our channel checks with the neighbors suggest that key reasons for them to go to minimarkets are: 1) convenience / location, 2) pricing / promotion, 3) queue time, and 4) less temptation. With a smaller more nimble format, minimarket can open literally anywhere in the neighborhood, close to the residential area. The duopoly structure between Alfamart and Indomaret give them a lot more bargaining power compared to the super/hyper. Minimarkets have been able to secure cheaper prices even compared to hypermarkets that often offer bulk discounts. 

The minimarket share is currently led by Indomaret (INDF affiliated company). As Alfamart started to streamline their expansion to lower down their debt level, Indomaret is currently leading with over 17k outlets nationwide. Alfamart is lagging behind at 15k outlets and has cut back expansion to below 1,000 stores since 2018. The biggest barriers to entry is location. With Alfamart and Indomaret seemingly present at every corner, it would be hard for any new brand to penetrate the market.

With Indonesia entering the digital era, and online retailing is rapidly gaining share (between 4-6% of retail sales based on various sources), the minimarkets can both benefit and lose from the aggressive expansion of the e-commerce giants. The easiest benefit to tap from the e-commerce player is through cash payment handling. Top C2C e-commerce Tokopedia for example accepts all types of payments, including cash, from all major minimarket outlets. 

As the e-commerce players are looking for new source of growth, the third largest e-commerce is branching out to directly supply goods to over 5mn Warungs across the country. The initiatives are popularly known as the Mitra (partner) program. The Mitra program aims to cut the distributor and wholesaler role by providing an online ordering system through the Mitra program app. The Mitra program unfortunately can be a threat for minimarket growth going forward as it empowers the traditional Warung with better product selections and cheaper pricing. 

Other than the Mitra program, the e-commerce players also offer wider selection of FMCG products in their platform at very lucrative prices as traffic puller. In the past 12.12 National Online Sales (Harbolnas) day, we can see up to 80% discounts on some of the FMCG products.

A bulk of the discussions below will be on Sumber Alfaria Trijaya Tbk Pt (AMRT IJ) as we have very limited information from Indomaret’s operation. Indoritel Makmur Internasional (DNET IJ) owns 40% of Indomaret and does not consolidate their books. DNET is a holding company owned by the Salim Group that has stakes in the KFC franchise Fastfood Indonesia (FAST IJ) and Sari Roti Nippon Indosari Corpindo (ROTI IJ).

AMRT is on track to achieve 8% SSG in FY19, a major recovery from the decade low 1.5% in FY17 and 5.5% in FY18. As AMRT streamlines their store expansion, cutting store openings to 400-600 stores per year over the next 3 years, we expect SSG to remain strong and hovers between 5-10% coupled with 2-3% spatial growth.

AMRT’s EBIT margin has been slipping from 2.7% in 2014 to 1.8% in FY18 as opex growth exceeds SSG. To fully pass on fixed costs increases, we estimate that AMRT needs to book at least 7% SSG. FY19 is the first year since 2014 for the SSG to exceed the 7% mark, hence the year to expect EBIT margin to improve. Given the steep seasonality, 9M19 consolidated EBIT margin is recorded at below 1%. A big chunk of the supporting incomes from suppliers’ rebate will come in the fourth quarter of the year.

AMRT’s fee-based income has been growing by more than 40% Cagr over the past 5 years, contributing to more than 30% of EBIT. As more services are added, and as consumers adopt digital transactions, AMRT’s fee-based income growth still has a long way to go. 

Negative FCF has been a problem in the past where net gearing reached 1.3x in FY17 and net interest expenses make up more than 60% of EBIT. As AMRT streamlines their store openings and close down non-performing stores, we saw a big jump in FCF in FY18 that allows AMRT to deleverage their balance sheet. AMRT paid almost IDR3tn worth of debt in FY18, reducing their net gearing ratio to 0.4x in FY18 and to 0.2x in FY19.

We expect SSG to moderate to 6% level while store expansion is kept at 2% addition every year, resulting to a total of 8% revenue growth until 2022. This, coupled with 10bps expansion in GPM every year, and 8% opex growth is on track for 17-19% EBIT growth per year. We expect fee-based incomes to continue its high teens growth trajectory, lifting net profit growth to 21-25% over the next three years. Risk to our numbers is working capital and economic growth. A 1-day swing in the company’s cash cycle affects its working capital by about IDR200bn. 

We have a buy recommendation with 19% upside to our blended target price.

CrossASEAN Research • ASEAN Insight Provider • (Opens in a new window) ⧉

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Ace Hardware (ACES IJ) – Lifestyle Express Train

By | Smartkarma Originals

In a Smartkarma Originals Series of Insights on ASEAN Retail, we seek to determine which retail formats are winning out in the battle for consumer attention. The third company we look at is Indonesia’s home improvement and lifestyle retailer Ace Hardware Indonesia (ACES IJ), which is now the biggest market cap listed retailer at over US$2bn. This insight entailed multiple visits and conversations with management, as well as a number of store visits. 

ACES has a strong historical track record but continues to expand its network by +10-15 stores a year, with a long way to go before Indonesia reaches anything like saturation point. It already had 187 stores across Indonesia but does not see any problem reaching 300 stores in the medium term.

The company has a well-balanced product mix between home improvement and lifestyle products, with the latter growing marginally faster and yielding slightly higher margins. 

The company has also started to open strategically located smaller sized Ace Xpress stores to cater to consumers needs for faster moving products closer to home. A visit to one of these stores revealed a wide selection of products across 17 departments, with 8,500 SKUs versus a normal store which sells around 32,000 SKUs.

The company continues to reduce the total number of SKUs, with a target of 60,000 in total by end 2019 and a focus on faster moving products. It holds around 80% of its inventory on display at the store level, with only 20% held in its distribution centres at any one time. It holds regular monthly promotions and BOOM sales to keep its inventory levels in check.

Ace Hardware Indonesia (ACES IJ) commands one of the highest PE multiples in the sector, trading on 26x FY20E PER, given a strong track record in terms of SSSG and profitability. Management tends to guide conservatively, which means it has consistently beaten its own guidance. The company has demonstrated a strong corporate governance record over the past few years. Ace Hardware Indonesia (ACES IJ) trades on a forward FY20 PER of 26x versus Mitra Adiperkasa (MAPI IJ), which trades on 16x FY20E PER. Mitra Adiperkasa (MAPI IJ) is forecast to see FY19E-21E EPS CAGR of +20.5% versus Ace Hardware Indonesia (ACES IJ), which is forecast to see FY19E-21E EPS CAGR of +9.1% but this difference is growth is compensated for by a strong corporate governance track record, its pure retail status, and a good record on the company’s guidance for investors. Mitra Adiperkasa (MAPI IJ) is also seeing some holding company discount, given it has been selling stakes in its various business to private equity investors.

At current levels, the stock looks fairly valued but should be bought on weakness, given its strong track record.  The recent inclusion in the MSCI Emerging Markets Index will create support for the share price. Our forecasts are below consensus as we have adjusted sales lower for next year following recent more cautious management guidance. Home Product Center (HMPRO TB) in Thailand trades on higher valuations of 30x FY20E PER, with similar growth rates, making Ace Hardware Indonesia (ACES IJ) look attractive from a regional perspective. 

CrossASEAN Research • ASEAN Insight Provider • (Opens in a new window) ⧉

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Matahari Department Store (LPPF IJ) – New Dawn

By | Smartkarma Originals

In this Smartkarma Originals series of Insights on ASEAN Retail, we seek to determine which retail formats are winning out in the battle for consumer attention. The second company we look at is Indonesia’s biggest department store Matahari Department Store (LPPF IJ). After a thorough channel checks, which include store visits, discussions with the management, and comparing the actual product prices, we also dissect the company’s financials and present every angle that can have significant impact on share prices. Finally, we conclude with a fair value and a recommendation for the stock.

LPPF occupies a little bit over 1mn sqm of space with its 162 outlets located in 75 cities across the nation. The department stores are divided into five main sections: men’s fashion, women’s fashion, shoes and cosmetics, children’s fashion and toys, and household items. 36% of LPPF sales are derived from directly purchased goods, while the remaining 64% are from consignment items. 26% of LPPF stores are located in the Greater Jakarta region, 35% in Java ex-Jakarta, and the remaining 39% are located in the outer islands. We find that the stores located in the outer islands and the rest of Java offer more competitive advantages than the ones in the main cities.  

LPPF recently signed an exclusive distribution license for OVS (Italian children’s fashion) and 361 Degree (Chinese sports shoes). The company opened 5 specialty shops (mono stores) for 361 Degree in Jakarta and Surabaya and 2 shops for OVS in Jakarta. Aside from the two brands, LPPF opened a flagship 300sqm Nevada store as a pilot project to diversify into the specialty space.

We did a quick survey online for two basic items, men’s long-sleeved white shirt and basic blue jeans, in top online and offline retail shops. Much to our surprise, LPPF’s prices on the two items are lower than Ramayana Lestari Sentosa (RALS IJ) despite LPPF’s more premium positioning. However, the lower prices came after a 50% discount on the MSRP.

LPPF has a central distribution center (DC) in the Greater Jakarta area that supplies to all of its stores across Indonesia. 90% of its goods are supplied locally. Strong cashflow generation, led by high proportion of consignment sales, and little exposure to forex are the main key defining trait for LPPF. At 35% gross and 11% net margin, LPPF remains as the country’s most profitable department store. Even with the massive impairment last year, LPPF’s profits was still almost double RALS and was 50% higher than Mitra Adiperkasa (MAPI IJ)’s  entire operation. However, LPPF has lost more than 70% of its market value in the past two years and more than 85% since its peak value in 2016 preceding CVC’s last stake divestment. 

Coincidental or not, many of the management’s past promises and strategies were altered after CVC’s last bit of divestment in 2016 and the SSG performance took a quick turn. Average SSG before CVC’s divestment (1Q13-4Q16) was recorded at 9.6% while the average SSG after divestment (1Q17-2Q19) was recorded at 0.3%. The company also made a IDR770bn investments into related party e-commerce venture that weighed on sentiments. A recent related party asset takeover from parent company Multipolar (MLPL IJ) confirms investors’ worry on cash outflow to the group and highlights CG issue. 

There is hope among investors as the Lippo Group is actively restructuring its businesses, starting from the son John Riady taking over his dad’s official seat at Lippo Karawaci (LPKR IJ). Kitchen sinking, if any, should already be concluded in FY18. If we assume a 50% payout to FY19 earnings, it is a solid 9% dividend yield on the current stock price. Taking a middle ground between DCF and DDM puts together a blended target price of IDR5,600 per share, a 47% upside to yesterday’s closing price, implying 10x 19PE. BUY.

CrossASEAN Research • ASEAN Insight Provider • (Opens in a new window) ⧉

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Alternative Data – An Evolving Weapon for Active Managers (Shiseido, Kose, Pola Orbis)

By | Smartkarma Originals

Negative Shiseido, Kose and Pola Orbis

We analysed the top five Japanese cosmetics companies predominantly focusing on fundamental investment research principles. And based on our analysis we are negative on Shiseido, Kose and Pola Orbis, with the last two names being our top picks to short. We consider Shiseido to be short term neutral but believe the name is over-owned and growth deceleration exposes the name to significant downside risk from flows.

Our long-term views on individual companies are mainly based on fundamental investment research principles and we have used POS data to track any changes in the trends behind our fundamentals based long term view. The frequency of POS data is much higher than traditional IR data and POS also breaks the data into extremely granular levels, meaning the information derived from POS is far more than what the traditional IR provides. Therefore, using POS we have developed systems to monitor the changes in our investment thesis at micro levels and also at a much higher frequency. Furthermore, we have also used POS data to forecast the company performance in its upcoming earnings. Lastly, the analysis of POS data helps us mitigate any surprises and potentially turn trend reversals to our advantage.

We provide our detailed views on Shiseido, Kose and Pola Orbis below.

LightStream Research • Equity Analyst • (Opens in a new window) ⧉

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