Consumer & retail. abc. Consumer & retail team

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1 Latin America Equity Research

Consumer & retail July 2012

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Consumer & retail

Consumer & retail team

Francisco J Chevez Analyst

HSBC Securities (USA) Inc.

+1 212 525 5350 [email protected] Manisha Chaudhry

Analyst

HSBC Securities (USA) Inc.

+1 212 525 3035 [email protected] Stewart H Ragar

Analyst

HSBC Bank Brasil SA

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Latin Ame rica Eq uity Resea rch C onsumer & re ta il July 20 12 2

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Sector structure

Hypermarcas Genomma Lab Natura Cosmeticos MercadoLibre Lojas Americanas B2W Internet Retailers Lojas Renner Lojas Marisa Companhia Hering Guararapes Confeccoes Arezzo Alpargatas Le Lis Blanc Liverpool Wal-mart de Mexico

Grupo Pao de Acucar Soriana

Chedraui Comerci Mexicana Exito

Cencosud

Home & Personal Care Staples retailing

Beverages xxxxxxxxxx

See sector section for further details

Apparel Retailers xxxxxxxxxx

Consumer & Retail – LATAM

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Food

See sector section for further details Hypermarcas Genomma Lab Natura Cosmeticos MercadoLibre Lojas Americanas B2W Internet Retailers Lojas Renner Lojas Marisa Companhia Hering Guararapes Confeccoes Arezzo Alpargatas Le Lis Blanc Liverpool Wal-mart de Mexico

Cencosud

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Food

See sector section for further details MercadoLibre Lojas Americanas B2W Internet Retailers Lojas Renner Lojas Marisa Companhia Hering Guararapes Confeccoes Arezzo Alpargatas Le Lis Blanc Liverpool Wal-mart de Mexico

Cencosud

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Food

See sector section for further details Lojas Renner Lojas Marisa Companhia Hering Guararapes Confeccoes Arezzo Alpargatas Le Lis Blanc Liverpool Wal-mart de Mexico

Cencosud

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Food

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Sector price history

0 500 1000 1500 2000 2500

Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12

Consumer Staples Consumer Discretionary Source: Thomson Reuters Datastream, HSBC

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EBIT margin – asset turnover chart (2011)

Soriana

Genomma Lab Internacional

B2W-Cia Global do Varejo Lojas Americanas S.A

CBD Chedraui

MercadoLibre Inc

Cia Hering

Lojas Renner S.A

Wal-Mart de Mex ico

Arezzo & Co Guararapes Confecµêes

Marisa Lojas 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 0.0x 0.2x 0.4x 0.6x 0.8x 1.0x 1.2x 1.4x Asset Turnover EB IT m arg in

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Sector description

Consumer products and retailing

Retailing in emerging markets like Latin America is supported by structural growth, favourable macroeconomic conditions including decreasing unemployment, increased inclusion of women in the workforce, positive consumer sentiment, shopping mall growth, and easier availability of consumer credit. The retail industry in Latin America’s key retail economies, Mexico and Brazil, is driven by a large and growing middle class. Chile is another important emerging player in the industry, with ownership stakes in other countries throughout the region. Ownership structures for Latin American companies in the industry are varied, with a strong representation of family ownership. While many of the retailers in the region are family owned, such as Marisa and Arezzo, with more than 60% ownership, others such are Lojas Renner are 100% public. Other are subsidiaries owned by larger global firms, such as Walmart de Mexico, which is owned by Walmart, and CBD in Brazil is owned by French food retailer, Casino. Industry players as well as new entrants seek to capture market share by targeting this fast-growing consumer base. The IPO market in both Brazil and Mexico countries saw a wave of activity in the early to mid-1990s, when a majority of the Mexican and Brazilian food and apparel retailers went public.

Recent IPOs in Brazil have included more premium, fashion focused, apparel brands such as Les Lis Blanc and Arezzo & Co in 2008 and 2010, respectively. This trend responds to rising incomes and female labor force participation, which has been a critical driver to both food and apparel retail in the region. Female labor force participation increased by 75.2% in Brazil and 18.7% in Mexico between 1980-2008. Growing access to credit has also been an important driver of consumption in both Mexico and Brazil. In 2011, Brazil had 22% growth in personal credit. In Mexico, consumer credit grew 24% in 2011.

Mexico’s retail sector remains attractive due to its growing middle class, supporting a retail sector that is expected to expand by 12% by 2014. Domestic demand has been a strong driving force, reaching record highs since 2008, as the purchasing power outlook also reached record levels in 2012 since 2008. Given the relative saturation in food retailing in Mexico, industry growth has shifted toward speciality retailing. A number of US and European retailers are entering through joint ventures and franchises.

The retail sector in Brazil has been boosted by shopping mall growth, which accounts for around 20% of retail sales. The acceleration in Brazil’s mall development with a recorded 408 malls at 2010-end, is critical to the country’s retail growth. HSBC estimates acceleration in mall growth with the addition of 21 malls in 2011 and 43 in 2012. Mall developments have been mostly concentrated in the southeast region of Brazil, suggesting opportunity for regional expansion.

While Brazil’s middle class represents a majority of the population, upward trends into higher income segments has given rise to consumer spending and Brazil’s luxury market. Brazil’s middle class

constituted 54% of the population as of 2011. A total of 22% of Brazilians in 2011 were in the highest A and B in income segments, compared to 15% in 2005. Rising incomes and women’s labor force

participation in recent years are favorable trends for Brazil’s apparel and accessories market, the second-fastest growing consumption category registering growth of 17% in 2010.

In terms of competition, Brazil's economy is protected from international competition to some extent due to tariffs on imported goods. Mexico is at the other end of the spectrum, with a very open economy and a

Francisco J Chevez, CFA Analyst

HSBC Securities (USA) Inc +1 212 525 5350

[email protected]

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Latin America Equity Research Consumer & retail

July 2012

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large external sector. These structures have resulted in relatively high prices for Brazilian consumers and lower prices for their Mexican counterparts.

The sector is divided into consumer products and retailing companies. The retail segment is further divided into staples retail, soft-line retail, and e-commerce. The consumer segment is divided into food, beverages and HPC (home & personal care). The food and beverages sectors are described in other parts of this report.

Staples retailers

Companies in the staples retailing segment are mostly food retailers in the region. Food retailing in emerging markets like Latin America is supported by structural growth, favorable macroeconomic conditions including growing disposable income, declining unemployment, and consumer credit expansion. We believe that presently, c45% and c50% of retail trade in Brazil and Mexico, respectively, is through modern retail format, thus creating a high growth industry in these countries. Food retailing is highly fragmented in Brazil but there are just a few dominant players in Mexico. Thus consolidation opportunities in Brazil represent another industry growth driver. Discretionary spending growth encourages food retailers to diversify their merchandise by offering to other non-food items.

The industry in Latin America is under-penetrated and highly fragmented which offers both organic and inorganic growth opportunities to companies, particularly in Brazil. Retailers such as Walmart and Casino have established operations in the region seeking the next wave of growth. Wal-mart de Mexico is one of fastest growing subsidiaries, and through Walmex, the company is expanding into other Central American countries. Walmart also believes that Brazil will be one of the key growth markets in its international operations. Casino is present in Brazil through its stake in CBD and in Colombia through its stake in Exito. Exito further has a majority stake in Disco and Devoto stores in Uruguay.

The industry operates different store formats: hypermarkets, supermarkets, discounters, convenience stores, cash and carry, and department stores.

 Hypermarkets are large stores (above 8,000 square meters per store) that focus on volume and compete on price. They usually sell groceries and general merchandise offering up to 50,000 stock-keeping units (SKUs), a common measure of each unique product or item for sale in the retail industry

 Supermarkets are medium sized stores (about 2,000 square meters per store) which also focus on groceries but have a limited collection of non-food items as well. These stores primarily compete on price and have around 13,000 SKUs in grocery

 Convenience stores offer a variety of food and non-food items and are located very near to the target customer population. As the name suggests, these stores provide convenience of location to

customers in return for higher prices

 Discount stores are no frills stores with low prices targeting lower income customers

 Department stores have many different categories functioning as different business units beneath one roof. They have the largest number of SKUs.

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Soft line retailers

Soft-line is a retailing term relating to a product line primarily consisting of merchandise like clothing, foot-wear, jewellery and other linens. The soft-line retailers in Latin America have performed well despite negative economic conditions recently on the back of increasing discretionary spending in the region.

E-commerce

E-commerce in Latin America is the fastest growing in the world not only due to low penetration rates but also thanks to improving macro economic conditions in the region as well as growing availability of broadband services. The internet penetration in the region is comparatively low at 40%, with Brazil having 39% and Mexico having 37% penetration when compared to US with 78% and Europe with 61% penetration. Brazil experienced a 20% annual growth in broadband subscribers over the last two years. The industry should continue to see faster growth as the supporting distribution network improves. There are a few pure e-commerce companies in Latin America such as B2W and MercadoLibre. In addition, many brick and mortar retailers are building an online presence as well.

Key themes and sector drivers

Staples retailers

Consumer confidence

This is measured through regular surveys of consumers who reveal their assessment of the state of the economy and their own personal financial situation. The survey acts as an indicator for the direction of the economy and consumer propensity to spend on products. When consumer confidence grows, consumers trade up as has been the case in recent years.

Selling space growth

The staples retailing companies experienced close to 10% growth in 2011which should allow increased economies of scale which lead to expanding margins. As penetration rates improve, retailers in Latin America are moving to small-store formats. However, we expect retailers in Latin America will continue to build large format stores as the most effective way to penetrate the market.

Same store sales growth

As retailers bring new products to stores they tend to generate more sales from the space they already operate. Such growth represents the attractive appeal of the store which can be enhanced using better branding, diversifying merchandise, pricing and loyalty offerings.

Soft line retailers

Imports

Imported merchandise contributes to higher gross margins from a combination of higher prices and lower costs to the retailers. We estimate the mark-up on Latin America-made apparel is 2.5x while it reaches 3.0x for imported items. The price-value proposition of Asian manufacturers is difficult to replicate by the Latin American textile industry, especially when it comes to synthetic fibers. Imported merchandise contributes to higher gross margins from a combination of higher prices and lower costs to the retailers.

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Designer collaborations

Designer collaborations with retailers, a concept spearheaded by European retailers such H&M, have been picked up by a range of retailers including Walmart and Target, and recently by apparel retailers in Brazil including Guararapes, Lojas Renner, and Arezzo. While these collections sellout quickly and break-even at best they generate millions of dollars of free advertising and buzz value, which is invaluable for brand image. We emphasize fashion content as an important driver of sales in apparel retailers.

Outlet mall

Outlet stores are beginning to emerge in Brazil as the retailing industry modernizes and apparel

manufacturers and retailers find new ways to distribute and sell their merchandise. Outlet stores typically sell returned, discontinued, or irregular merchandise at heavily reduced prices. This American invention has been spreading around the world and it has now reached Brazil. Initially, manufacturers opened individual outlet stores in different locations, including airports. Now, outlet malls are getting a boost in Brazil with the announced JV formed by Simon Properties and BR Malls.

E-commerce

E-commerce growth in Latin America should continue to be driven by broadband penetration in the region’s competition between cable and telephone companies intensifies, the supply of services is increasing and pricing is becoming more accessible. In addition, technology improvements and wider acceptance of electronic payments is boosting e-commerce growth in Latin America.

Valuation

The consumer and retail companies trade on traditional earnings metrics, namely forward-looking PE multiples and EV/EBTIDA.

The staples retailing companies currently trade on c20x our 2012 earnings estimates. The apparel retailers are around c18x our 2012 earnings estimates, while the internet retailers trade around c28x our earnings estimates. Compared to these valuations three years ago, staples were trading at 18x, apparel at 17x and internet retailers were trading at 31x.

Consumer & retail

2008 2009 2010 2011 2012e Growth Sales 15.9% 15.4% 24.9% 17.0% 15.1% EBITDA 23.7% 20.0% 28.7% 13.1% 22.8% EBIT 27.8% 24.2% 31.3% 11.7% 26.8% Net profits 9.1% 53.9% 23.9% 4.8% 8.7% Margins EBITDA 11.7% 12.4% 13.3% 12.6% 13.5% EBIT 9.5% 10.4% 11.3% 10.5% 11.5% Net profit 5.7% 7.2% 7.4% 6.6% 7.6% Productivity Capex/sales -7.0% -4.6% -5.4% -5.3% -4.8% Asset turnover (x) 0.7x 0.7x 0.8x 0.8x 0.8x Net debt/Eq 25.4% 32.1% 21.8% 13.8% 2.2% ROE 18.3% 24.1% 25.6% 20.8% 20.7%

Note: based on all HSBC coverage of Consumer & Retail Source: HSBC estimates, company data

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We derive our target PE multiples by applying the following formula: PE = (ROE-g)/(ROE * (k-g))

Where g = long term growth rate of earnings and ROE = HSBC’s projection for 2011 for each company Ke = cost of equity

Given these two inputs, we calculate different growth rate assumptions to arrive at a “fair” multiple for each company. We compare the implied growth rate derived from our target multiple against our perception of potential EPS growth. We also compare it against the growth implied by the current market PE.

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Sector snapshot

Key sector stats

Consumer discretionary 4.39% of MSCI EM Latam

Trading data

ADTV (5 Year) (USD mn) 242.26

Free float market cap (USD bn) 33.78

Performance since 1 Jul 2002*

Absolute 215.95%

Relative to MSCI EM Latam -54.69%

3 largest stocks TV.N, FALABELLA, LREN3.SA

Correlations (5-year) with

MSCI EM Latam 0.88

*Performance includes dividends

Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S, At June 30, 2012

Top 10 stocks

Stock rank Stocks Index weight

1 TELEVISA CPO 1.47% 2 FALABELLA 0.60% 3 LOJAS RENNER ON 0.46% 4 LOJAS AMERIC PN 0.36% 5 CIA HERING ON 0.36% 6 CYRELA REALT ON 0.30% 7 PDG REALT 0.26% 8 ANHANGUERA ON 0.21% 9 MRV ON 0.21% 10 LIVEPOL 'C-1' 0.20%

Country breakdown Country Weights (%) Mexico 7.51% Chile 6.73% Brazil 3.58% Colombia 0.00% Peru 0.00%

Core industry driver: Consumer Confidence Index

0 50 100 150 200

Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12

Brazil Mex ico

Source: Thomson Reuters Datastream, HSBC

PE band chart 12x 15x 18x 20x 24x 28x 0.0 10.0 20.0 30.0 40.0 50.0 60.0 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11

Source: Thomson Reuters Datastream, HSBC, MSCI

PB vs. ROE 1.0 1.5 2.0 2.5 3.0 3.5 4.0

May -11 Jul-11 Sep-11 Nov -11 Jan-12 Mar-12 May -12 0 2 4 6 8 10 Fw d PB (LHS) Fw d ROE % (RHS)