Sheng Siong Group - DBS Research 2017-06-20: Margin Expansion Not Over Yet

Sheng Siong Group - DBS Vickers 2017-06-20: Margin Expansion Not Over Yet SHENG SIONG GROUP LTD OV8.SI

Sheng Siong Group - Margin Expansion Not Over Yet

  • We expect margin improvement to continue on upcoming warehouse expansion.
  • Expanded warehouse will realise higher margins from volumes, SKUs and fresh food.
  • Store network expected to grow on more supply of HDB shops available for bidding.
  • Maintain BUY; S$1.20 TP.



Maintain BUY, Target priceP S$1.20, more positive on margins. 

  • We remain positive on Sheng Siong on the back of better visibility for higher margins. We believe expansion of its distribution centre will grow and sustain gross margins going forward. Margins remain on the uptrend supported by the increase in direct sourcing, bulk handling, and fresh mix, contributing to earnings growth.
  • Stock is trading attractively at 20.4x FY18F PE compared to historical average of 23x since listing. Yield remains attractive at 4.4%.


Where we differ. 

  • The market is concerned with competition for shop space, closure of key stores (Verge and Woodlands), online threat, and threat of gross margins being unsustainable.
  • However, we have found that the critical factor driving Sheng Siong’s stock price is margins. We believe margins should continue expanding as its distribution centre is being expanded, driving earnings growth.


Potential catalyst. 

  • We see added warehousing capacity supporting its margins over the next few years from its warehouse expansion. Higher volume rebates, higher fresh mix, economies of scale, more stock keeping units (SKUs), and better leverage to support more stores in the future will likely improve margins from current levels. 
  • With the HDB opening up new estates and putting up more commercial shop spaces for supermarkets, we see more scope for store network expansion going forward, contributing to growth.


Valuation

  • We maintain our BUY recommendation on Sheng Siong. We like Sheng Siong for its steady earnings growth, net cash, growing margins and strong dividend yield. 
  • Our target price for Sheng Siong is S$1.20 based on 25x FY18F PE. 
  • The valuation is pegged at +1SD of its historical mean since listing and below regional peers' average of 30x PE.


Key Risks to Our View

  • Store openings, price competition. Revenue growth will be led by new store openings. Excessive discounts and promotions in the market by competitors will ultimately result in lower margins.



WHAT’S NEW


More margin expansion on the cards 


More catalyst in warehouse expansion 

  • Background of the KTM land. When Sheng Siong constructed its present distribution centre at Mandai in 2009, a part of the land next to which the building sits on belonged to the current rail corridor (former KTM railway land). 
  • The current 2.32 hectares of land which JTC awarded to Sheng Siong as a result, is constructed in a U shape instead of a regular rectangle. This is due to the nature of land ownership when the land was awarded. 
  • Last year, the JTC resolved the rights to the former KTM railway land and Sheng Siong can now utilise the former KTM land. This means that the current U-shaped layout can be flushed into a regular rectangular-shaped building, essentially expanding the distribution centre’s capacity.

Sheng Siong to expand Mandai Link warehouse by another 10%. 

  • The current distribution centre’s capacity is 500,000 sqft. Flushing the building into a regular rectangle from a Ushaped layout will add another 50,000 sqft to the warehouse capacity. With all systems clear and heavy equipment already on site, construction is due to start in June 2017 and is expected to complete in 2018. 
  • Sheng Siong will incur S$19m in construction cost with the bulk amounting to c.S$13m to be incurred in 2018, all internally funded. The warehouse will have storage capacity for both chilled and regular storage products.


What does this mean for Sheng Siong? 


Beneficial to margins and better economies of scale. 

  • A bigger distribution centre will increase warehouse throughput and support volumes for new stores in the future. Besides, margin expansion will be supported by higher fresh food mix, volume discounts from suppliers and scope for higher-margin SKUs (stock keeping units). More cold storage capacity built into the expanded area will support higher mix of fresh food. 
  • We do not see any significant increase in manpower and delivery costs for now as its current human resources have scope to increase productivity further.

Higher margins through fresh mix. 

  • Sheng Siong is increasing its proportion of fresh offering in stores. Its fresh food mix is currently higher than that of key competitors Dairy Farm and NTUC Fairprice. The higher-margin nature of fresh food over non-fresh grocery items will lead to higher gross margins.

Better margins from higher volume discount and higher-margin SKUs. 

  • The existing warehouse space is running at close to full capacity that supports 43 stores currently. Following the expansion, Sheng Siong’s warehouse space will increase by another 10%. 
  • Higher volume orders from suppliers and increase in higher-margin SKUs will support margin expansion. These will come from better discounts from bulk orders, essentially creating better economies of scale.

Capacity to support more stores in the future. 

  • Higher throughput in the future will support a larger store network as well. HDB is constantly putting out commercial shop spaces for supermarkets in various areas. We believe Sheng Siong will eventually increase its store count from the 43 stores currently. 
  • A higher warehousing capacity, throughput and higher store count in the future would ultimately help to defray fixed operating costs and support margins.


Consensus is mixed on Sheng Siong, but we are positive on margin expansion 


What is the market concerned with? 

  • Consensus is generally concerned about competition and Sheng Siong’s ability to open new stores. Store opening has been a function of HDB’s available supply for shop space and the competition in bidding for them. 
  • Competition for shop space has been keen over the past few months, with smaller players winning shop space at aggressive bids. This has fuelled concerns on Sheng Siong’s inability to grow store network and open new stores. 
  • Besides, there also concerns that two of its stores are due to close in Woodlands (41,500 sqft) in August 2017 and the Verge (45,000 sqft) in June 2017.




Our critical factor for the stock is margin, not top line. 

  • We believe consensus has placed too much emphasis on Sheng Siong’s top-line growth. This is where we differ and offer our differentiated view from the market in our analysis process. We have found that the correlation for Sheng Siong’s stock price to margin is strong (very close to 1) at a reading of 0.9. Hence, earnings growth and margins are driving Sheng Siong’s stock price rather than top-line growth. 
  • Singapore’s grocery retail growth is typically unexciting at 0-5% for top line, yet the stock price has risen in tandem with margin expansion and earnings growth. We are positive on continued margin expansion backed by the higher warehouse capacity we have aforementioned.

Cost management is a critical factor in preserving margins which Sheng Siong is always mindful of. 

  • Sheng Siong has > 40 stores islandwide with more than 400,000 sqft of selling space. In our opinion, being the third largest supermarket player in Singapore with a Mandai distribution centre, Sheng Siong has both critical mass and economies of scale. 
  • We believe focus has been on cost management rather than driving sales. If Sheng Siong’s focus was to drive sales, it would be bidding aggressively against the smaller players regardless of price. However, it emerged as the winning bidder in only one out of six supermarket bids this year, at a reasonable S$15 psf, lower than c.S$20 psf bids in 4Q16.

Market is concerned that top line is slowing, but we believe it is short term and see store network increasing eventually.

  • We refute the argument that outlook is unexciting because Sheng Siong has not been winning new shop space. Instead, we believe the market should focus on the rental levels that Sheng Siong is securing new stores, rather than short-term headwinds of two store closures and not winning new stores. Sheng Siong also recently won one 11,000-sqft new store in Woodlands St 12. 




  • Meanwhile, the Tampines Central store expansion will add 15,000 sqft to its store network space. These will mitigate the impact of store closures. Also, we believe that footfall for the Verge and Woodlands has been tapering and well accounted for in recent quarters results due to news of their imminent closure. Negative short-term impact should therefore be minimal. 
  • With HDB continuing to put up shops earmarked for supermarkets for tender in existing and new estates, there are ample opportunities to secure more stores going forward.

Growing through operating efficiencies. 

  • Store count is not the only factor that drives growth. Higher store efficiencies can supplement growth as well along with greater focus on cost. These include running more promotions, quicker checkout process, store layout, new SKUs, higher-margin products to generate greater stock turnover, sales volumes and better profitability.

Online is not a real threat for now. 

  • We do not see online business as a significant threat for now. There are supermarkets located across Singapore, making it convenient to pick up groceries. HDB has put up properties earmarked for supermarket over the years and as such, supermarkets are now conveniently located across Singapore. 
  • Online businesses although gaining traction, remain in an unprofitable state. Pureplay online grocery retailer Redmart’s business remains in core operating losses and negative free cash flow. It has less than S$100m of revenue in a S$6bn Singapore grocery retail market after four years of operation. 
  • HDB will release six supermarket and two minimart properties in the next six months, not forgetting future supermarket properties in new estates such as Biddadari. Scope for growing store network abound over the long term. We believe this will give online a run for its money as it remains convenient for consumers to pick up groceries. 
  • About 80% of people living in Singapore live in HDB estates (which have planned amenities including grocery shops) and do not live “off the beaten path” to really warrant grocery delivery in our view.






Financial impact 


Internally funded. 

  • Sheng Siong will internally fund the warehouse expansion to the tune to S$19m comprising construction and fit out. As of 1Q17, Sheng Siong had S$68.3m cash on its balance sheet with no debt. 
  • Sheng Siong generates c.S$70-80m in operating cashflow each year, more than sufficient to fund the expansion. There is no further cashflow burden on past property purchases as previous cashflow strain on the purchases of Tampines property (2014, S$65m), Bedok property (2016, S$55m) and Junction 9 (2013, S$55m) have all already been expensed.






Alfie YEO DBS Vickers | Andy SIM CFA DBS Vickers | http://www.dbsvickers.com/ 2017-06-20
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.20 Up 1.140



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