We are upgrading Epicentre from a Neutral to a BUY with a TP of S$0.41, pegged to 12x FY13F earnings. This represents an upside of 32% in addition to a yield of 10-13% based on last closing. Earnings improvement in the coming results should be a catalyst to stock price. We expect the current Apple mania fad in Asia to spur Apple branded sales. APRs like Epicentre will continue to see sales grow despite the Apple Online Store as Epicentre is able to offer customers better bundle deals in terms of extended warranty, discounts on associated hardware like speakers, keyboards and accessories. FY12 earnings were affected by at least S$1m one-off costs associated with:- 1) Expansion in China, 2) New M-commerce platform,  3) New CRM programme, and 4) Forex costs. Excluding the one-offs, net margins would have come in at 1.1%. We believe our FY13/14F net margin forecast of 1.6%/1.9% is conservative (FY12: 0.3%, FY11: 2.9%, FY10: 3.8%). The Group has historically offered a dividend payout of 90% and with costs set coming off and earnings starting to kick in, we are confident management will continue to maintain this generous payout.
 
No where to go but up. Epicentre was barely profitable in FY12 with net margin hovering at 0.3%. This is a far cry from a high of 3.8% in FY10 and 2.9% in FY11. Going forward, we have remained cautious and forecasted a slight improvement in net margins to 1.6% and 1.9% for FY13/14F respectively. Earnings are expected to be driven by new Apple branded products and ramp up in sales of new stores. We also note that the Group has decided to put the brakes on its expansion into China with its current three stores. As at June 2012, the Group has 10 stores in Singapore, five in Malaysia and three in China. Going forward, we expect 1-2 new stores in Singapore and Malaysia respectively.

Brick and mortar wins online stores. While some investors are concerned over the threat of Apple Online Store eating into Epicentre sales, we do not see a large impact. Customers generally prefer to purchase from Epicentre as they get to touch and feel the actual product, enjoy bundle discounts which include extended warranty and accessories deals which are not offered by Apple.

Gross margins impacted by forex. We note that the Group suffered about S$3m loss on their GP margins from the appreciation of the USD against the SGD. Going forward, Apple has agreed to allow Epicentre make purchases in SGD hence this should iron out the forex issue but Epicentre Malaysia will still continue to make purchases in USD. Malaysia accounts for a smaller proportion of Group sales at 18% in FY12 vs 80% for Singapore.

Retail network now at 19 stores. As at June 2012, the Group has a retail network 18 stores. This includes five in Malaysia, eight in Singapore and three in China. Out of the three in China, two are located in Shanghai and one in Beijing.

The Group opened a new store in Malaysia in July 2012 at the hip and trendy Bangsar Village hence it now has six stores in Malaysia. Epicentre has also already gotten Apple's approval for a new store at the upcoming new mall at Jurong Point in Singapore. The mall is slated to open its doors in 1Q 2013. Finally, we note that management has decided to put the brakes on its China expansion plans, leaving it at three stores.

Why was Singapore down? We note that while revenue for Singapore rose 6% YoY, earnings fell by 79% YoY to S$1.1m. This is due to rising rents and headcount costs as new stores were opened last year which has yet to see sales ramp up to normal levels. Approximately 10% of labour is foreign.

Singapore is also the Group's headquarters hence all the admin costs which includes engaging external consultants to implement customer centric initiatives, implementing a new customer retention management (CRM) programme and conducting training programmes for customers have all been booked as costs to Singapore.

Source: OSK