Where we are now from the prior analysis:
Price turns lower as expected from a theory that sentiment, as measured by expected EVA growth that is implied by the share price, goes from optimistic to pessimistic. In the previous analysis, I have concluded that investor expectation at that time was ‘pretty fair'. It was not pessimistic yet. Hence, I anticipated that investors would soon turn to be pessimistic. So, here we are now, in some 3000s level compared to the 5000s level when I wrote the first analysis on LPPF.
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I am pleased to say that LPPF has continued to be a strong value creator company since the last analysis. The thing is, EVA has continued its decline. By the looks of the Q2 result, it seems LPPF EVA contraction is the largest this year. EVA momentum is -1.7% from the beginning of this year. That's a lot of contraction. Take a look at the chart below.
So, here is the break down of what really matters in the big picture: The biggest concern in my view is the persistent, huge decline in productivity. What do I mean by productivity? EVA margin. Growth, on the other hand, adds nothing to value (a.k.a growth in EVA) as it currently stands because sales growth is pathetic.
First of all, I need to remind you that LPPF EVA Margin is stupidly high. 15% EVA margin is HUGE. Let's think about this in ROIC terms: currently, LPPF ROIC is about 113%, while its cost of capital (WACC) is about 13% (!!).
No matter what other people say, I believe, based on this data, that LPPF is a strong value creator.
As you can see, EVA margin has been declining since 2017 which is why productivity gain in the second chart turned negative. Why is that? I believe the same answer applies to the current situation.
So, what makes NOPAT margin sways? The answer lies largely in its operating expenses (SG&A).
The biggest cog in LPPF's EVA Margin Wheel, and hence, value, is operating expenses.
Now we know, the critical factor that drives EVA margin for LPPF is operating expenses. Here is the story: In 2017, the closing of stores added IDR 32 Billion losses to operating expenses. The media then became useless after that. There was no comment on the news regarding operating expenses after 2017. I must assume the reason is the same thereafter, closing of the stores.
If you read the news regarding LPPF issues of closing stores, you would find that it is full of scandals. Contracts were breached, which led to higher expenses, and there have to be severance packages which add up nicely.
EVA says it all: The closing of the stores is a bad move from the management. It is true that growth is next to nothing, but the costs incurred are not worth the value. Usually, when a store is closed down, it soon is sold to others which lightens up capital. This light capital is the major reason why closing down stores often could boost EVA. That is not the case here for LPPF. What is more, fixed assets are not key components to EVA margin in LPPF business model. It's true that closing down stores could decrease operating expenses down the line, but it has been almost 3 years now, and I have not seen this evidence in numbers.
Let's not blame the business environment first. I believe strongly that the major reason why LPPF is in this situation (EVA contraction in 3 years in a row – not specifically the share price), is because the management makes bad moves by closing down stores with bad deals. This bad move is motivated by a false belief that growth is good and less growth is bad, which led to closing down stores where the growth is bad...and the media and analysts community shared that belief which adds the pressure to make a bad decision. And, Presto! Shops closed down, but EVA tumbles.
OK, Now What?
Do we see LPPF stops closing down stores? Do we see signs that LPPF could outrun competitors' specialty stores? I do not know the answers to those questions, but I suspect the answer is NO. All I know for certain is that EVA has continued going down. Even if some could argue that LPPF is now in a better position to outrun competitors, I have not seen the impact at EVA, which is to say it has not materialized yet.
It is a high probability that EVA is worse by the end of this year compared to 2018. As a general rule, I do not wish to own stocks where I see EVA contracts in the current year.
The chart below is instructive to point out the main culprit why LPPF share price fell so hard: unrealistic expectation.
It just took a bit of a nudge in EVA to topple this expectation tower. With the prospect of continued EVA contraction this year, I'd say we have not seen the bottom yet (read prior analysis for more explanation regarding past unrealistic MIM).
Remember this. As of now, shareholders have not priced in LPPF as a wealth destroyer. Its MVA has always been positive despite the major fall in share prices. It is unlikely that shareholders would view it as a wealth destroyer, but I think the chances are high that they would price it lower – not to the point as a wealth destroyer – but close enough as a wealth neutral. I'm keeping my balance to invest here when that time comes.
Despite everything, shareholders still see LPPF as a wealth creator. It IS after all, a wealth creator.
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