CLSA Ace Hardware (ACES IJ) earnings upgrade – Property proxy

Analyst Swati is upgrading her earnings by 10-23% for 2010-2012CL. This home improvement retailer has no head on competitor. Competition comes indirectly from retailers and building material suppliers.

The strength of Ace Hardware is contributed by exclusive rights to distribute a lot of their products. For example, if you want a popular Webber grill, you can only get it at one of the Ace Stores. In fact, they have so much faith in understanding the Indonesian market that more than 95% of their products are not on consignment now (dropped further from the previous 10% level) which translates into the higher margins (but also higher risk as they take inventory exposure).

Additional growth will come from its new toy stores (this year to open three). Currently, there is no major toy store chain in the country so Ace Hardware’s efforts into this segment is promising. In addition to the 5-6 regular stores, Ace will open three toy stores this year.

This little gem (market cap of US$312m) is trading at 12.4x 2011 earnings and deserves to rerate as the company establishes firm track record (IPO in late 2007). Indeed, a lot of upside is in store for Ace Hardware.

Key highlights of the report:

Indonesia’s middle class is surging. The proportion of households with disposable incomes will increase from 30% to 40% by 2012.
Indonesia’s largest DYI store, ACE hardware is expanding rapidly, opening stores in strategic locations such as popular malls creating barriers of entry for competitors. It has pricing power as it is a one-stop shop for products not conveniently available elsewhere.
We revise up our forecasts by 10-23% and believe ACE can potentially double its store space in next five years. We forecast 21% revenue and 16% net profit cagr for next five years. Home Depot in the US achieved hockey stick growth from 1994-2005, averaging 20% for the period.
Our revised price target is based on DCF of Rp2,500/share implying 1 PEG and 18.8x 2011CL P/E. Chinese retailers are trading at 19.7x 11CL P/E and Indian are trading at 30x 2011CL P/E.