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Financial Adviser: 5 Things Every Investor Needs to Know About Injap Sia's MerryMart’s IPO

It's the first company expected to go public this year,
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Grocery retailer MerryMart Consumer Corp (PSE:MM) will be the first company that will go public this year after it recently obtained approvals from regulators to raise P1.59 billion in an initial public offering (IPO).

MM will sell up to 1.59 billion new shares to the public at a price of P1.00 per share. The new shares will be equivalent to 21 percent of its total equity after the IPO.

The offering period of MM shares will run from May 27 to June 5 with a target listing date on June 15, 2020. The expected market capitalization of MM at IPO price will be P7.6 billion.

MM will be listing at a time when there is widespread fear of a prolonged economic recession due to the ongoing coronavirus pandemic.

Despite this pessimism, MM may turn out to be the catalyst that investors are looking for to improve current market sentiment.

Being a grocery stock, MM may follow the strong performance of Puregold (PSE: PGOLD) and Robinsons Retail Holdings (PSE: RRHI), which have risen by 59.1 percent and 51. 4 percent, respectively from their recent lows during the lockdown.

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MM may be more volatile than PGOLD or RRHI because of its small market capitalization which should provide more trading opportunities.

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Bear in mind that when you trade the stock, you are also investing in the business. It may be wise to spend some time understanding the business of MM and evaluate its growth opportunities.

Once you are aware of the fundamentals of the company, you will have a better handle on the risk and return that you can expect from investing in the IPO.

Here are the top five things every investor needs to know about MetroMart’s IPO:

1| Know the background of the company

Long before Injap Sia founded Mang Inasal, the Sia family has long been engaged in the supermarket business. Sia’s grandfather used to run a grocery in the early 1950s until his parents put up their own in the 1980s.

In 2009, Sia put his own supermarket business by opening two stores in Roxas City called Injap Supermart TATC and Injap Supermart Burgos under MM.

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Nine years later, in 2018, Sia decided to expand the business by incorporating a wholly owned subsidiary called MerryMart Grocery Centers where it would roll out three retail formats with MerryMart as brand.

These are MerryMart Grocery, a full-size supermarket offering a wide variety of food and non-food products; MerryMart Market, a specialized grocery that offers a larger selection of premium and imported items; and MerryMart Store, a small sized outlet that offers an innovative 3-in-1 concept of a mini-grocery, personal care shop, and pharmacy.

Since the start of the year, MM has been opening a new outlet almost every week until the pandemic outbreak in March. To date, MM has a total of seven operating stores.

2| Know the growth prospects of the company

MM is aiming to open a total 1,200 outlets with systemwide sales of P120 billion by 2030.

MM plans to do this by first opening 600 outlets in five years with 100 MerryMart Groceries and MerryMart Markets, and 500 MerryMart Stores nationwide.

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MM will employ franchising strategy to achieve this goal by converting existing traditional supermarket players in the provinces, which comprise about 50 percent of the industry and offering MerryMart stores to independent operators.

Last year, MM has already signed up two franchisees and is expecting to get more in the next two years as more mom-and-pop grocery owners will opt for competitive branding and better margins.

Early this year, the company was supposed to open 13 more stores beginning April but because of the lockdown, the scheduled openings were moved to third quarter of this year.

By Christmas season, MM expects to increase its total operating outlets to 20 from only three last year.

Next year, hopefully with a better economic situation, MM should be able to open more outlets to achieve its goal of 100 outlets by the end of 2021.

3| Know the earnings prospects of the company

MM’s earnings growth profile will change significantly this year due to the expansion of its outlets.

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Last year, with only three operating outlets, MM’s total revenues was only P2.5 billion, which increased by 18.8 percent from P2.1 billion last year.

The increase in revenues coupled with higher gross margins from 4.5 percent in 2018 to 5.8 percent enabled total gross profits to increase by 54 percent to P144 million from P93.7 million last year.

Total net income, however, fell by 31 percent to P28 million from P40.5 million in 2018 due to non-recurring pre-operating set up costs of MerryMart Grocery.

This year, assuming the 13 new outlets will open during the third quarter at an average of P30,000 revenues per square meter, total revenues of MM should increase by 140 percent to P5.9 billion.

This increase should result to net income of P82.8 million, which is 196 percent higher than last year. By next year, with all the 20 outlets operating at full year, total revenues should hit P10.1 billion.

But since MM will be aggressively adding more outlets next year, total revenues should be higher.

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Let’s say we just assume only 10 more outlets to be added in 2021, instead of 80 outlets, at average of six-month revenues, we can derive additional revenues of P2.8 billion so that MM’s total revenues will be P12.9 billion, which should double this year’s projected revenues.

At this level, MM’s net income in 2021 should hit about P185 million, which is 125 percent from this year’s estimated income.

We should note that the historical average revenues per square meter of MM’s two supermarkets in Roxas City was P69,200, but for this estimate, we only use P30,000 per square meter, which is 57 percent lower.

Over time, this average revenues per square meter should increase as traffic and per capita income improve in the provinces, which should drive its revenues and earnings to grow higher.

4| Know the price valuation multiples

By the third quarter of this year, when all the bad news in the market are already discounted in the stock prices, investors will begin looking at next year’s earnings.

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If we divide the market capitalization of MM at P1 per share IPO price by the projected net income this year at P185.3 million, we will derive PE ratio for the stock at 41 times.

Given the contraction in the economy where most of the large-cap stocks in the PSE are expected to post a substantial decline in earnings this year, pricing MM at a premium should be reasonable considering that it is one of the few companies in the basic essential sector that is expanding in time of crisis.

To put this in right perspective, we can factor the expected earnings growth in the pricing multiple by using the Price-to-Earnings to Growth or PEG ratio.

According to legendary investor, Peter Lynch, a stock is considered fairly valued if its PE ratio is equal to its growth ratio, meaning its PEG ratio is equal to 1.0, but when a PEG ratio falls below 1.0, the stock is deemed undervalued.

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Given MM’s expected growth rate of 125 percent next year, the stock’s PEG ratio is only 0.33 compared to large-cap retailers PGOLD’s PEG ratio of 2.0 and RRHI’s 2.25.

MM’s fair value based on PEG ratio of 1.0 will mean that the stock must be priced at P3.00 per share.  

5| Know the intrinsic value of the stock

The other way to value a stock aside from using PE multiples is what we call the Discounted Cash Flow (DCF) method.

In DCF, instead of using earnings as basis for valuation, we use the free cash flows. The free cash flow is computed by deducting the capital expenditure and working capital needs of a company from its operating income.

Let’s say, for purposes of this exercise, we will assume that MM will have only 30 outlets up to 2030.

By projecting MM’s future free cash flows, which we assume to grow at 12 percent per year, for the next 10 years and discount each year to the present using MM’s cost of capital at seven percent, we can derive an enterprise value of P52.5 billion.

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To compute for the target value of MM’s equity, we can simply add back its cash from its IPO’s proceeds and deduct its loan of P150 million to get P54.2 billion

At market value of P54.2 billion divided by its post-IPO outstanding shares of 7.6 billion, we will get an intrinsic value of P7.14 per share.

At IPO price of only one peso per share, the margin of safety is attractive for long-term investment.

This valuation, of course, is based only on 30 outlets using P30,000 revenue per square meter. In reality, if MM achieves its goal of 1,200 outlets in 10 years at higher revenue per square meter, the stock’s intrinsic value should be way higher.

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Henry Ong
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