Sheng Siong Group - DBS Research 2017-07-28: Continues Delivering

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SHENG SIONG GROUP LTD OV8.SI

Sheng Siong Group - CONTINUES DELIVERING

• 2Q17 earnings in line, gross margin expansion continues.
• DPS of 1.55 Scts declared.
• Amazon’s entry not a serious threat for now.
• Maintain BUY, TP S$1.20.

Maintain BUY TP S$ 1.20, margin expansion to drive earnings growth. 

• We remain positive on Sheng Siong as we see growth led by improving margins. We believe expansion of its distribution centre will continue and the company will 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 19.8x FY18F PE, compared to its historical average of 23x since listing. 
• Yield is attractive at 4.5%.

WHAT’S NEW

2Q17 results 2Q17 in line: 

• Earnings of S$$16m (+6% y-o-y) were in line with our expectations. Revenue of S$202m (+7% y-o-y) was driven by 0.9% SSSG and 5.2% from new stores. 
• Better consumer sentiment was offset by footfall decline at stores affected by the slowdown in the oil and gas industry, Woodlands store, as well as Tampines renovation. 
• An interim DPS of 1.55 Scts was declared, amounting to 70% payout in 1H17.

Gross margins all-time high: 

• Gross margins hit an all-time high of 26.6% due to lower input costs, better supplier rebates, and better fresh food mix.
• Record high operating profit margin at 8.9%. Operating profit was S$17.9m (+11.8% y-o-y), and flat Q-o-Q.
• Operating expenses increased by (+6.8% y-o-y), led by admin expenses which grew 6% to S$33.6m. Operating profit margin was at a record high as gross margins expanded while operating expenses were kept at 17.7% of sales.

Other income fell. 

• Other income dropped to S$1.8m and this was due to 
  1. lower rental income as the property floor area of its Tampines site was increased to 25,000 sqft; and 
  2. a decline in government grants on lower wage credits as well as temporary and special employment schemes.

Expect gross margins to improve further. 

• As expected, Sheng Siong continued in its margin improvement with record gross and operating margins. We have held the view that margin expansion will continue on the back of better input prices as it expands its distribution centre going forward. 
• Completion of new warehouse space going forward will drive the growth of gross margins further with bulk and volume discounts.

Amazon opens this week, not a real threat for now. 

• Amazon has started operations in Singapore with Amazon Prime Now, sending jitters through Sheng Siong’s stock investors. The entry of Amazon should not affect Sheng Siong for now as 
  1. Singapore’s online grocery retail market remains small at < 2% (S$96m) of modern grocery retail sales of S$6b; 
  2. Amazon’s scale is relatively small; its 100,000-sqft warehouse is comparable to Redmart’s but far smaller than DFI’s 260,000-sqft, SSG’s 500,000-sqft and NTUC Fairprice’s 730,000-sqft warehouses; 
  3. Amazon would pose a direct threat to Redmart as they both target the same customers in the online grocery space; 
  4. we do not see the market size swelling just because Amazon is coming in, as the growth of the grocery market is still largely based on population size and inflation, which requires a real shift from store to online for Sheng Siong to be affected; 
  5. our initial price comparison showed that Amazon’s pricing is not exactly cheap at the moment, making it difficult to take share off the physical stores at current prices; 
  6. Sheng Siong’s target customers are largely not the techsavvy millennials who are open to buying from online channels.

Maintain BUY, S$1.20 TP. 

• Our forecasts remain largely unchanged. We maintain BUY with S$1.20 TP, 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.
• Even though we do not see fundamentals playing out immediately on Amazon’s entry, we are mindful that the market may be cautious on long-term implications to Sheng Siong and hence would like to highlight that negativity could weigh on the stock over the short term, based on market sentiment. 

Where we differ. 

• We do not think Amazon’s entry will pose a serious threat to Sheng Siong for now for six reasons. The online pie remains small; Sheng Siong’s target customers are not the millennials who are open to online grocery shopping; Amazon’s warehouse is relatively small; Amazon will pose a more direct threat to Redmart; its pricing is not exactly cheap to attract offline buyers online; and the online market will take time to gain share from brick-and-mortar stores rather than ramp up rapidly. 

Potential catalyst. 

• We believe that Sheng Siong, with its decent store network and logistics chain, could possibly be a takeover target by online players eventually. Online players such as Alibaba’s 盒马鲜生 and Amazon (Wholefoods) are taking the online-to-offline route, operating physical stores.

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. 

Alfie YEO DBS Vickers | Andy SIM CFA DBS Vickers | http://www.dbsvickers.com/ 2017-07-28

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.200 Same 1.200