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Isetan needs more than a store refresh

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Net loss at Isetan's retail segment widened to S$21.2 million last year. Sales are falling at the flagship Isetan Scotts store at Shaw House, despite the popularity of its basement supermarket.

COMPETITION is stiff on the retail battlefield, and Japanese department store operator Isetan Singapore is just one of the many casualties on the Orchard Road front-line.

Sales are falling at its flagship Isetan Scotts store at Shaw House, despite the popularity of its basement supermarket where small families gladly pay a premium for clean and well-packed Japanese fare.

But retail headwinds can only partly explain why Isetan's stock has traded deep below its theoretical liquidation value for years.

A lack of confidence in how the company's assets are being managed could have something to do with it.

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This much was clear at Isetan's annual meeting on April 26, where minority shareholders voiced worry that the retail business is headed for more losses, while the group's net income from property leasing can't even beat the returns on a Singapore Savings Bond.

Isetan's retail segment posted a net loss of S$21.2 million last year, widening from a net loss of S$9.4 million in 2017. The losses in 2018 include a S$11.9 million impairment for two underperforming heartland stores and a S$2.4 million provision for onerous rental contracts.

To bring back the crowds, the board outlined a three-pronged plan: It will launch a new mobile platform this year for customers to redeem store vouchers, slowly monitor underperforming stores, and spend S$12 million to transform Isetan Scotts at Shaw House into a lifestyle destination, with renovations to be completed in 2020. The Isetan Scotts premises are owned by Shaw House, not Isetan.

Shareholders were not entirely convinced. One of them asked the board why it prefers to use Isetan's excess cash to buy bonds of other companies, instead of buying back its own undervalued shares.

Independent director and lawyer Victor Yeo Chuan Seng, who chaired the meeting, replied: "It's a valid point and something we continuously look at."

Isetan Singapore has a market cap of S$128 million, and sits on bond investments worth around S$68.5 million, as well as S$50.7 million in cash.

Shareholders also disagreed with the board's investment property strategy. When Isetan ceased its own retail activities at Isetan Wisma Atria in 2015, it converted the store into an investment property to earn rental income.

The Wisma Atria property was valued at S$290.7 million at the end of 2018, but generated a net profit of only S$4.45 million last year, as rental income fell 13.6 per cent from 2017.

In other words, the annual return of 1.5 per cent that Isetan earns from renting out Wisma Atria is even lower than what you get from buying Singapore Savings Bonds, said shareholder Phua Puey Joy. He asked the board: "Is this a correct decision?"

Mr Phua was an executive director of Isetan until 2016. He resigned because he believed he had failed as a board member, he told the meeting: "We cannot continue this way."

Wisma Atria has 42 years left on its lease. If the property's value is going to drop faster than what management can generate from it in the same period, then it should be sold or put to an alternative use, Mr Phua argued. Isetan owns 25.77 per cent of the total share value of strata lots in Wisma Atria. The rest is owned by Starhill Global Reit.

Mr Yeo did not answer Mr Phua's question directly, explaining instead that "major transactions" are unable to proceed without shareholders' approval.

Mr Yeo's answer is revealing. Japanese holding company Isetan Mitsukoshi owns 52.73 per cent of Isetan Singapore, and could easily get a transaction done if it wanted to. Mr Yeo added later that it is not up to the board to decide if Isetan Singapore should be closed down, even if it "might be a good idea".

The meeting concluded with most shareholders surmising that the board of Isetan Singapore has very little autonomy over most aspects of its business here, apart from how to manage its retail business.

If this is true, then board members are indeed in a tight spot. But independent directors still have a responsibility to minority shareholders of Isetan Singapore.

At various points during the meeting, Mr Yeo, the independent director, sought to assure small investors that "there is and has been active engagement with all shareholders concerned to come to a result that is in the best interests of the company."

Effective corporate governance is not measured by engagement alone, but the delivery of results that create value for all parties engaged. This includes resolving shareholder deadlock and getting controlling shareholders to undertake a strategic review if needed.

Mr Phua, the former director, put it this way: "If the board and management of Isetan Singapore are not able to present the (big) picture to Isetan Mitsukoshi, then this is a very serious matter."

Meanwhile, the gap between Isetan Singapore's share price (last traded at S$3.10) and its revalued net asset value (RNAV) per share is unlikely to close.

Isetan Singapore has a reported NAV of S$3.81 per share, but its RNAV is closer to S$11 if adjustments are made to account for certain properties at fair value. Isetan does not adopt a fair valuation policy for its properties.

Its Wisma Atria stake is held in its books at S$28.8 million (based on cost minus accumulated depreciation and impairments), but has a fair value of S$290.7 million. Likewise, Isetan owns a freehold office and freehold warehouse which are held on its books at S$23.8 million. These have a fair value of S$53.8 million.

When a stock trades deep below its theoretical liquidation value, it's worth asking why the market thinks this company is worth less as a going concern than it would be if it were wound up and the proceeds returned to investors.

Whether Isetan Singapore is a value stock or a value trap is a choice that the board can make.