Value Investors Club / PUREGOLD PRICE CLUB INC (PGOLD PM)

Description

Puregold Price Club (PGOLD) is the second largest grocery chain in the Philippines with 15% of the modern grocery market (leader has 22%). The company estimates that modern trade accounts for ~30% of the total grocery market, so PGOLD has ~5% of the overall slice, giving it a fairly long runway to grow. The group operates 507 stores across the country - 271 hypermarkets, 100 supermarkets, 67 discounters, 22 club warehouses (Costco business model), and 47 QSRs that total over 600k sqm of retail area.

Investment thesis:

Strong tailwinds for modern grocery retail - i) increasing disposable income, ii) urbanisation, iii) below average penetration of modern grocery space (~46sqm per 1000 people, and to calibrate our base rates, this is ~50% of Thailand, 44% of Malaysia and 29% of China)
Business model that taps into both ends of the consumer spectrum, only one of the big 3 that caters to the low income group. Able to do so without diluting its brand equity by creating a totally new brand and concept for the high income group (top 4% of the population) called S&R which is a club warehouse like Costco in the US. Quite resilient to fluctuations, the high end segment of the population are quite insensitive to prices and due to rising inflation, I believe the middle segment will seek to spend more economically
Consolidation trend through M&A: Top 3 guys only have 50% market share of modern retail in 2022, up from 37% in 2010. In the Philippines, major retailers are constantly primed for acquisition, especially for provincial family-owned supermarket chains (3-10 stores) which PGOLD has demonstrated their acumen to pay rational prices and integrate seamlessly
Founder-CEO family has 56% (7% direct and 49% indirect) and the bulk of his wealth is tied to PGOLD's stock price, hence he has significant skin in the game. Since the IPO, he and his wife (Vice-chairman) haven't raised their salaries which are US$118k and $47k respectively (https://philnews.ph/2015/04/13/puregolds-lucio-co-is-the-philippines-poorest-paid-billionaires/). However, his reputation is not the best as there were rumors that he built his wealth through smuggling (although now he donates to the marine police which could be to ensure no one else can smuggle now that he has become legitimate

Overall, for a company growing 15.5% sales, 19% EBIT and 11% EPS CAGR since IPO in 2011, in a good situation where its gaining market share + entire market is growing and at trough multiples, 3.4x EBIT and 9% FCFy in FY22 seems extremely cheap.

History of Puregold:

In a very brief nutshell:

1998: Opened its first hypermarket in Mandaluyong,
2004: Launched its loyalty program, growing at an average of 3 stores per year from 2002-2006
2008: Introduced a new format called Puregold Jr Supermarket
2010: Operating 62 stores and launched another format, Puregold Extra (discounter)
2012: Acquired S&R membership shopping (was named Kareila) which had 6 membership shopping warehouses - entrance into the high-end segment
2013: Acquired 15 stores and opened 40 Puregold and 2 S&R
2018: The group operates 208 hypermarkets, 104 supermarkets, 29 extra, 13 minimarts, 16 S&R, 38 QSRs for a total of 408 stores

Two brands to tap into opposite ends of the consumer - Puregold and S&R:

Puregold (Hypermarkets, supermarkets, and discounters) - 61% of sales and 55% of EBITDA

Puregold focuses on retail customers with average monthly income of PHP 12-80k ($235-$1600) and small mom & pop shops called "sari sari" stores
They have a unique loyalty program from these sari sari stores, TNAP, which has over 350k active members at the end of 2018 and supplies to over 480k sari sari stores. The company estimates that ~30% of Puregold-only sales are to these resellers and they are the only one of the big 3 that taps into this market as they are the price leader
With Sari-saris being the majority of the market, a Third Bridge expert in 2017 said PGOLD is situated in a very nice spot in the market as they cater to both modern and traditional trade (transcript attached)
Supply chain: 88% of inventory is delivered directly to the stores by suppliers, only require 3 days of lead time. For the 12% of suppliers who are unable to deliver directly, they offer the option to drop the goods at a 2 outsourced 3PL facilities which will be forwarded to their stores - no cost advantage but usually more reliable
Target to open 20-25 new stores per year

S&R Membership (Club warehouses and quick service restaurants) - 39% of sales and 45% of EBITDA

S&R serves the wealthy and aspirational segment with monthly income over PHP 80k ($1600+) which would put them in the top 4% of the population
Acquired in 2012 for PHP 16bn ($315m) at 16.5x P/E. And in 2021, it generated ~PHP 4.5bn in net profit
Like Costco, customers must be a member (PHP 700 / $13 annual fee) to shop at S&R, reaching 864k members as of Sep 2019.
60% of the products are imported, primarily from the US, and SKUs are in bulk sizes
Their 37 QSR are just to make the environment more conducive for families and hanging out, sell American food mainly pizza, hot dogs, burgers and fried chicken. Very small, only 7% of S&R sales (1.5% of total sales)
Company guided that it will open 2 new S&Rs and 8-10 QSRs every year, and at current GDP, estimate the saturation is 40 S&Rs as this format will only appeal to Metro Manila area
Currently a duopoly with Landers which entered in 2016 and has a 24% market share vs S&R's 76%
Personally, I've never had the chance to visit a Costco so I have to trust this reviewer who says "S&R is a membership store here in the Philippines. When you go inside S&R you would think you are Costco, it looks exactly the same! Same shelving. Same products. Everything is the same, except in most cases it is smaller than the average Costco, and the product selection is not quite as good."

Consolidation and M&A

Since 2012, the big 3 players have done a number of acquisitions to consolidate the market. They seem to believe that if the industry becomes less fragmented, the grocery players will have more leverage on the suppliers and will reduce margin pressure during times of high inflation
Since 2011, Robinsons (RRHI) acquired 11 companies, Puregold has 5 and SM bought 2.
As seen above, PGOLD typically pays 8-10x P/E for traditional grocers, Kareila (now S&R) was a unique opportunity as it was the only club warehouse business
Management's preferred targets are provincial family-owned supermarket chains with 3-10 stores and with next generation owners who don't want to manage the business
Market has taken unkindly to the fact that PGOLD raised PHP 4.6bn ($91m) in Jan 2019 through a share placement but have not deployed it yet - company said they are in talks to buy a regional chain that is "more than 10 stores" in Q3 2019 earnings call but they told me they would rather forgo a deal than overpay because the founder has almost 50% of the company.

Personally, I don't think the company should be penalised for being prudent instead of having a buying growth at all costs mentality.
On the other hand, the company couldn't give me a good rationale why they issued the new shares at PHP 45 when the share price was 48-49 (~7% discount to market price), which is a negative for me

Competitive intensity - How is the landscape and who are the main players?

The big 3 (45% of the modern grocery retail) - Since it is said that a picture speaks a thousand words, above is my attempt to map out their footprint in the modern grocery retail space

Small versus Large format: Broadly speaking, both SM and Robinsons like smaller formats like convenience stores while Puregold is going for larger scale formats and club warehouse strategy - Who is correct? I'm not sure although data seems to say that convenience stores have been growing at a faster pace than hyper/supermarkets in emerging markets.

Good study by Mckinsey on the shortcomings of hypermarkets in EMs vs the success they have seen in Europe (maybe not anymore in recent years) - Characteristics of countries where hypermarkets prospered: i) good road networks, ii) high or growing car ownership, iii) large middle class with decent wages and stable employment, iv) sufficient room at home to store groceries in bulk
Leaning on Eric's experience in this sector, he thinks there are no international rules for grocery on which format will win, the key is to focus on the core population, be disciplined in pricing by reinvesting any profits back to the customer, and have positive like-for-like growth

SM, the market leader, mainly caters to the middle segment. Robinsons also targets the middle but also has brands that tap into the upper class. Finally, PGOLD targets the low income group through the Puregold brand and high income group using S&R
Competition amongst the 3 is fierce but not irrational as SM and Robinsons want to maintain 19-20% GPM and they view Puregold as the price leader hence its 17% GPM. Due to PGOLD's higher asset turnover, lower rent and operational efficiencies, EBIT and NPM are 50-150bps higher than the other 2

So everything is fine on the competition front?

Not entirely... while competition among the big 3 has been under control (actually PGOLD has been gaining market share steadily), the problem is competition against the provincial supermarket chains (think 5-10 stores)
As PGOLD continues to expand outside of Manila, they realised the other 50% of the modern retail market weren't going to just roll over and surrender their lunch
Like how the European hypermarkets experienced firsthand, cost advantage from scale and better supply chain can be negated by competition who do not pay taxes (corporate tax rate is 30% in the Philippines)
Just as SM and Robinsons are price followers when PGOLD is around, in provincial areas, PGOLD is typically the price follower to the small supermarket chains
In a normal inflation environment, grocers can pass on inflation to consumers. During periods of high inflation (like 2018 when PHP depreciated 5% against the USD and shortage of rice which accounts for 9% of the country's CPI, leading to 5.2% inflation vs 2.6% for 10M2019), these smaller supermarket guys either increase prices slightly or don't increase prices, thus PGOLD stores in those regions will be unable to raise prices as much as those in Manila where SM and Robinsons are present, which is one of the reasons GPM declined from 17.3% in FY17 to 15.8% in 2Q19
Why do I think the probability that the situation will improve is higher than the situation continues to deteriorate?

Consolidation in modern grocery retail - explained in the above section

Increasing share of modern grocery retail in proportion of the entire grocery retail market - Currently 32% and it is expected to increase by 1-2ppts every year. If we take an outside view, the modern grocery space per 1000 population is fairly low compared to other developing countries like Malaysia and Thailand (China seems to be an anomaly which is probably a level that will never be reached in Philippines)
Greater tax compliance - When Philippines becomes more developed, I would expect the grey market to be gradually eroded through more stringent penalties and better tax monitoring systems, thereby eliminating the biggest advantage of these provincial supermarkets

Valuation

Catalyst

Special dividend or implementation of a formal dividend policy

Acceleration of their repurchase plan

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			2022	2023
Price:	28.00	EPS	3.1	3.22
Shares Out. (in M):	2,880	P/E	9.1	8.7
Market Cap (in $M):	1,370	P/FCF	0	0
Net Debt (in $M):	-478	EBIT	225	236
TEV (in $M):	892	TEV/EBIT	3.4	2.4