MORGAN STANLEY RESEARCHJune 4, 2009Chile Retail
Investment Case: High Premium on Low Returns
We are initiating coverage of the Chilean retail sector withan Equal-weight rating on Falabella and an Underweightrating on Cencosud.
Our work suggests a fair value for Falabella that is close to the stock’s current price of CH$2,280per share, and a fair value for Cencosud of CH$1,300 per share. These fair values are equivalent to assuming thatFalabella can trade at P/E multiples of 22x and 18.5x our 2010and 2011 estimates, respectively, and that Cencosud can tradeat P/E multiples of 15x and 11x our 2010 and 2011 estimates.Currently, Falabella trades at 26x our 2009e estimate, whileCencosud trades at 21 times.
There is scarcity value to the Chilean consumer names,but we find it hard to justify the stocks’ current premiums.
Near-term, we expect earnings to fall modestly for Falabellathis year (down 5%) and steeply for Cencosud (down 30%).Our earnings estimate for 2009 is 13% below consensus for Falabella and 9% below consensus for Cencosud. For Cencosud, we think that consensus may be missing thatoperating income for Argentina should fall this year (inCH$ terms), after doubling over 2006-2008, because of slower demand and currency devaluation. (Argentina was 28% of Cencosud’s operating income in 2008.) For Falabella, wethink that consensus may be missing the margin impact of more depressed 2009 sales.
Medium-term, we forecast that Cencosud will not earn areturn on equity in excess of its cost of equity
(of ~12.5%,on our estimates), making it hard to see upside to its currentP/B multiple of 1.4x. We believe that competition will becomemore intense in Cencosud’s core grocery business, and we arenot encouraged by the recent traffic declines in both Chile andArgentina. Competition in Chile is focusing more on thelow-end segment that is the most underserved, which may leadto stagnation in the medium/high ends of the market thatCencosud serves.
Longer-term, Cencosud’s exposure to Peru/Brazil is apositive.
Peru is one of the least developed grocery/retailmarkets with significant scope for growth. Northeastern Brazil,where Cencosud operates, is much less developed than Braziloverall. However, Chile and Argentina, which combined were70% of Cencosud’s grocery sales last year, are two of LatAm’smost mature food retail markets.
We also see the high pace of management turnover atCencosud as an important yellow flag
that may signalunderlying management conflict. Cencosud faces multiplepressures currently – the economic malaise, the need tointegrate G. Barbosa and Wong (acquisitions made in 2007and 2008, respectively), and the stated desire to deleverage(net debt to EBITDA of 3.6x at ye 2008). The magnitude of management changes (10 top positions in just over a year) andthe inconsistencies on the timing of restarting the Costaneraproject (a large real estate development) suggest a lack of unityat a critical time.
We are relatively more positive on Falabella, for themedium-term.
Looking to 2010/2011, sales and profitabilitycould rebound more than we have forecasted. We thinkindustry expansion in department stores will slow materially inthe coming years. (The industry doubled space over the past 5years, and is now seeing depressed results). Recent pesostability is a plus, since ~40% of department store sales areimported. And credit is an important part of Falabella’sbusiness – it accounted for 21% of operating profits last year –which has also been hit in the current downturn. We see lessscope for competitive change in Falabella’s two core sectors(department stores and home improvement) and the retailer has the best-in-class format in each one.
However, we don’t see evidence of an imminent “turn”.
Department store sales in Chile started to soften in mid-2008and we forecast improvement from the negative (nominal) SSStrends by 2H09. But, home improvement has been Falabella’sgrowth engine in Chile retail in recent years, and is a slightlybigger business. Sales trends for HI turned negative (innominal terms) for the first time in 1Q09. Data on housingstarts and construction activity in Chile suggests that themalaise could linger, at least through the balance of this year.
Upside risks to our views/models
include a more favorablemacro environment in the region, together with stronger demand reacceleration. Downside risk to our calls includegreater deterioration in the macro/competitive conditions, inparticular the outlook for credit quality.
A quick word on Argentina:
Our model assumes theArgentine peso averages A$3.98 this year and A$4.80 nextyear, compared with A$3.30 in 2008. However, even if weassume that the peso maintains its current level through 2010,our EBITDA estimate for Cencosud in 2010 would be in linewith consensus. Heightened political/economic risk asevidenced in impressive CDS spreads suggest that stability inthe peso is not a likely scenario.