Why Free Cashflow for AEON Credit is not that important

Readers of my blog would know that I put a lot of importance on cashflow in my investments. Why? Companies that are not able to generate enough cashflow consistently may run into debt trouble as their businesses would be dependent on cash from other sources for survival. Similarly, as an investor, if you are relying on dividends, capital repayment etc., these cash should come from free cashflow not other forms of cash it generates from unless it is a sale of business or assets. I am really against companies which raised a substantial amount of cash for business expansion but at the same time issuing large dividends as these are inefficient way of managing cash.

Sometimes though, there are some exceptions especially for businesses which rely on one-off large investments into growing their businesses - companies like Genting when it raised funds for expansion in Singapore or Malaysia Airport for the expansion of the KLIA2. Once these projects are completed, the free cashflow should be back to normal or in fact improved.

Another type of business which the cashflow is not that relevant as a benchmark are all the lending organizations - and this include AEON Credit (which is the easiest among the lenders to evaluate on in fact). AEON Credit has two main sources of income - short to medium term lending for hire purchases (such as electronics equipment, motorbikes etc. or even personal lending) and credit card loans. As AEON Credit is not a deposit taking financial institution, it gets its funds from borrowings and its own capital (from profits and fund raising). Unlike the normal businesses, lending organizations make their money from receivables. To illustrate that, let me provide an example from the balance sheet of AEON Credit.

From above, look at the financing receivables - they are basically loans or amount owing from its customers (for credit cards etc). Then I highlighted the equity (which is its own capital which it gained and raised from) and the borrowings which it gotten in order to be able to lend out again. As you can see, from the financing receivables, AEON Credit's receivables grew at a furious pace increasing more than RM600 million over 9 months or grew more than 40% from its total in 20 February 2012. It shows that it is aggressive and doing very well as a lender - if I deem loans growth as doing well. To be able lend, AEON Credit must also be able to borrow as it is not a deposit taking company. Hence, we are seeing its borrowings grew at a similar pace as well.

Turn that scenario into the cashflow report of AEON Credit. What we have learned are different from other types of businesses. The business for Top Glove for example, it borrows mainly for factory expansion, trade financing requirements. Its free cashflow are the net cash amount for its business which is selling gloves as well as the costs for factory expansion. As for AEON Credit on the other hand, its business is dependent on loans. Without loans growth, it is then shrinking. Hence, for the period when AEON Credit was growing at a fast pace, its cashflow statement looks like below. Operating cashflow negative while investing cashflow is almost irrelevant. On the other hand, it is getting more borrowings itself which causes the financing cashflow to have a substantial net increase.

What does that tell of the company? Read the performance review below. While the receivables growth is important, almost another important benchmark is the NPL. Note that its NPL dropped from 1.94% to 1.81%. While this is a good number, usually during a period of high loans growth, this is quite normal as fresh loans are normally healthy. Seldom, you will see bad debts in new loans and quite a substantial percentage (more than 25%) of AEON's receivables are new loans.

Another important benchmark for a lending organization such as AEON Credit is the Capital Adequacy. As in the name, basically the authorities are saying to be able to lend, you cannot depend entirely on borrowings (or deposits for deposit taking banks) alone. You need to put in, raise your own money or build enough reserves, hence the Capital Adequacy Ratio (CAR). However, the CAR for AEON Credit I do not think is as tight as the ones imposed onto banks.

Of course, CAR is not as straight forward as that and there are weightings given for different kinds of loans or risks. It is actually quite complex (quite a fair bit of people make a living out of it) and based on the BASEL Accord (google it, the place where Roger Federer was born) continues to come out with new guidelines on this. Nevertheless, the above CAR for AEON Credit seems sufficient even despite the CAR drops to below 20% for this year due to the high receivables growth.

So it's confirmed AEON buying Carrefour Malaysia

News today, AEON (don't know which yet, but the news is saying AEON Ltd, Japan) is buying Carrefour's Malaysian operations for Euro250 million (almost RM1 billion) lock stock and barrel (which includes the debt). I do not see Carrefour Malaysia having much debt though.

Contrary to some of the analysts reports, I doubt AEON will be operating a hypermart but rather supermart and mall. That's my speculation as AEON is better off operating malls and supermarts being its expertise.

On another note, whether it is AEON Japan buying or it using AEON Malaysia's balance sheet to buy, I see the purchase to be merged up with AEON Malaysia's operations. No sane management would be managing and having a structure which is separate from one another in terms of holding structure.

In fact, AEON Malaysia's balance sheet is strong enough to absorb the operations almost immediately. This is premature, but I am even confident of it not needing to raise additional cash from rights issuance or private placements. But any of these options may be possible as well so as not to burden the balance sheet too much.

If anyone is interested, in the longer term or even shorter term, AEON Credit would benefit from this immediately as compared to AEON Malaysia itself.

I nevertheless sees it as positive for both AEON Malaysia and AEON Credit despite reports that there are overlapping in locations.

AEON Credit would be able to immediately increase its reach while AEON Malaysia (the supermart and mall) tasks would be trickier - i.e. turning around a hypermart. Nevertheless, the move is good for an immediate increase in outlets as well as doubling its reach. The business of supermarket is about reach, size, logistics and strong balance sheet.

My other articles on AEON:

AEON Credit: Perhaps this other AEON is even better

AEON: Using other people's money

AEON buying Carrefour would be positive for AEON Malaysia

AEON Credit: Perhaps this other AEON is even better

I can tell you that I perhaps was looking at the wrong AEON or rather overlooked it. While I like AEON, the supermarket and mall business, what I missed out is its credit business. I have always treated it as a supporting business to its mall operations than a business that can stand alone by itself. Perhaps it is still very dependent on the mall, but its credit business is making waves.

Let me tell you why I took it for granted the business of credit for AEON:

• I took the cue from Courts. While at first it was doing pretty well, later on it did suffer from its receivables problem as well as other competitors;
• AEON Credit is non-deposit taking financial organization. When your costs are higher than the banks, it will take a bigger effort to compete. Already most banks are credit card issuers, what is another card issuer from AEON?;
• the RM50 yearly tax on credit cards by the government. Need I say more, the total cards in circulation will surely drop;
• receivables - I could not really understand how good or how bad this can go.

Well, then let's look at its 5 years performance.

Its growth is fantastic over the last 5 years, but starting from small base

At its current price of RM11.92, while may have had a run quite a bit recently, it is still trading at below 15x PE. Worth looking, if it's business is to grow at this pace and the concerns that I have mentioned are addressed. Let's look at these concerns then.

Competition

Plenty, if you take the banks into account. What differentiates AEON from the banks is that it is a very much shoppers based credit card. If you noticed, Tesco ties up with RHB Bank, Giant ties up with Citibank for the cards. AEON whereas, has its own card. I hold an AEON card but not its credit card (which may be a mistake). AEON does provide better benefits to its credit card holders. Hence, over here if you feel that AEON, the supermarket's business is growing, then the card business will continue to grow, for sure. Competition is there but AEON Credit has its own space that it is slowly building on.

Costs of doing business

Banks are able to have costs of funds as low as 2% to 3%. By issuing cards, banks are enjoying chargeable rates of 18% to 24%. Fantastic. What about AEON Credit? I would have thought its costs of credit would be much higher. If you look at the red box below, its longer term rates are below 5%. Wow! for a non-deposit taking organization. If we read further, it sources for USD financing which it hedges against fluctuations. Well, if the financing is in USD then possibly the rates can be that low.

What about receivables?

My biggest fear in the cards business is bad receivables. From below, its past due receivables are less than 10% of its total. Past due receivables does not mean it is not collectible and the below 10% threshold is very manageable, I should think.

As for the RM50 charge from the government, it is something no credit card company can do about it. If any, the measure by the government has stabilized the credit card base, which means that it is much more difficult to do new customers acquisition than before.

My take

If any measure is to be used, AEON Credit's business has yet to reach its full potential. Riding on its supermarket and mall operations business alone, the credit business itself has the potential to grow further. If you notice, AEON is concentrating on building mid-sized malls in new and some old townships than just operating a supermarket business. Its cards business is working on promotions with the tenants that AEON has. Now, with the growth of the mall business alone, it should be able to ride on the momentum. However, over the last few years, what we managed to see was that AEON Credit in fact grew faster than AEON.

If it continues to be able to manage the bad debts and costs of credit well, then this stock is one attractive company.


What does AEON Credit do?

Rather than trying to explain at length, let me just cut this out from its annual report and show from here. :)