Sheng Siong Group (SSG SP) - Maybank Kim Eng 2018-04-02: At The Heartland Of The Matter

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SHENG SIONG GROUP LTD OV8.SI

Sheng Siong Group (SSG SP) - At The Heartland Of The Matter

Not just resilient, winning market share; BUY 

• Excessive concerns about e-commerce disruptions led to Sheng Siong Group (SSG)’s 12-month underperformance of 10% against the STI, despite its results resilience.
• Sheng Siong Group (SSG) continues to offer grocery-shopping convenience, focusing on fresh foods in densely-populated HDB estates, where more than 80% of Singapore’s residents reside. We resume coverage with a BUY rating, expecting catalysts from:
  1. further improvements in consumer spending; 
  2. SSG’s further market-share wins from convenience stores and traditional market grocers;
  3. a potential surge in new stores in 2018; and 
  4. continued good sets of results, supporting high ROEs and dividends. 
• Our DCF Target Price is SGD1.20 (7.7% WACC, 1.5% LTG). 
• Key risks include landlords taking back their rental space and fiercer-than-expected competition.

INVESTMENT SUMMARY

• A name that stands for low overheads and great value in grocery shopping, Sheng Siong Group (SSG) is the third-largest and only listed pure supermarket operator in Singapore. At our latest count, it operated 48 stores for a 19% market share by sales. 
• A steady consumer-staple stock, we believe Sheng Siong Group should be a long-term core holding in any consumer portfolio. Near-term, we see catalysts from faster-than-expected new-store opening, which could lead to earnings surprises.

Turnaround in consumer spending 

• Singapore’s supermarkets continue to claw market share from convenience stores and traditional market grocers. This is being led by their good accessibility and wider variety of cheaper goods, especially after many outlets started 24 hours operations in densely-populated estates. Along with improved consumer sentiment as the economy chugs along, supermarket sales grew 3% in 2017, up from 2% in 2016. 
• The supermarket & hypermarket retail sales index improved to +3.7% in 2017 from -0.1% in 2016. Sheng Siong Group was not left out, with its SSSG (same store sales growth) rising to 2.1% in 2017 from 0.2% in 2016. We see GDP, employment and wage growth supporting further consumer spending this year and next.

Ample new sites for new stores 

• Crucial to Sheng Siong Group’s revenue and earnings growth is the opening of new stores. There were fewer than 10 sites available for bidding p.a. in the last three years as many HDB new projects were still under construction. Come this year, available HDB sites for bidding are expected to more than double to 20, as the construction of the new projects approaches completion. We expect Sheng Siong Group to be successful in bidding for three sites of 5k sf each.
• Although it closed two of its largest stores in FY17, it managed to secure more space ahead of their closures. As of 1Q18, it had rolled out 32.1k sf of new space. This forms 68% of our target of 47.1k sf for 2018E. For 2019- 2020, it aims to open five new stores p.a., with combined floor space of 25k sf. We model 4-6% revenue growth for FY18-20E, on par with FY15- 17’s 4-5%, mainly led by new stores.

China’s contributions not priced in 

• Sheng Siong Group trades at 19x FY18E P/E and 13x FY18E EV/EBITDA. We believe the market has not priced in potential contributions from its new store in China, which started operations in 4Q17. 
• Relative to ASEAN supermarket operators and food retailers that trade at 32x/28x FY18E/19E P/E averages, Sheng Siong Group does not appear overvalued. While these peers operate in bigger consumer countries such as Thailand, Indonesia and the Philippines, it offers higher net margins and dividend yield of 3.6%. We believe it should be a long-term core holding of consumer portfolios. 
• Our DCF Target Price of SG1.20 implies 25x FY18E P/E and 17x EV/EBITDA.

Turnaround In Consumer Spending 

• Singapore’s supermarkets continue to gain market share from convenience stores and traditional grocers. This is aided by their convenient access in many localities and wider variety of cheaper goods. Many outlets in densely-populated estates have also started 24 hours operations. Smaller supermarket operators, however, have been losing out, due to a lack of scale and centralised warehouses. Their exit has eased competition for new shop space since early 2017. 
• Supermarket sales increased 1ppt to 3% YoY in 2017, up from 2% y-o-y in 2016. SingStat’s retail sales index, excluding motor vehicles, grew 1.8% in 2017, a reversal from -2.6% in 2016. The index’s sub-component, supermarket & hypermarket sales, performed even better. It was up 3.7% in 2017, from -0.1% in 2018. Sheng Siong Group was not left out, with SSSG of 2.1% in 2017 vs 0.2% in 2016.
• This year, our house is expecting GDP growth of 2.8% y-o-y. Strong growth in wage and job are also expected to be lift retail sales.

Supermarkets gained market share, so did Sheng Siong Group 

• Euromonitor’s recent grocery-industry analysis suggests that supermarkets in Singapore will continue to gain market share from:
  1. convenience stores such as 7-11;
  2. minimarts and traditional grocers found in wet markets;
  3. food, drink or tobacco specialists; and
  4. other retailers.
• Convenience stores have been losing out as supermarkets keep expanding their variety of goods, at lower prices. More supermarkets have also started to operate 24 hours, especially in heavily-populated estates. Traditional grocers have been downsizing or exiting due to rising rentals, a lack of successors and price competition from the big boys. The chaotic setting of wet markets also contrasts unfavourably with supermarkets’ air-conditioned comfort and wide selection of products.
• Among the supermarkets, Sheng Siong Group and FairPrice, a cooperative run by the National Trades Union Congress (NTUC), the apex of trade unions in Singapore, have been gaining market share from Dairy Farm International (DFI SP; Not Rated) and the smaller supermarket players. 
• Dairy Farm’s sales have been declining for two of its four supermarket formats: Cold Storage and Giant Super. We attribute Cold Storage’s poor performance to increasing price consciousness among Singapore’s consumers on one hand and more premium food options being rolled out by online retailers on the other. Giant Super’s huge supermarket outlets could also be facing more disruptions from online retailers, as non-fresh and non-FMCG products such as apparel and electrical appliances tend to be more convenient and cheaper to buy online, with more choices to boot. Dairy Farm attributed its FY17 results weakness to fierce price competition and the growth of discount retailers & e-commerce.
• From 2014 to 2017, Sheng Siong Group’s market share increased 1.2ppts to 18.9%. Although it was still only the third-largest supermarket brand in Singapore in 2017, after FairPrice and Dairy Farm, it has closed its gap quite dramatically with Dairy Farm since 2013.

End of aggressive bidding by smaller players 

• Sheng Siong Group’s management observed that irrational site bidding by the smaller supermarket players, which started at end-2016, has ended. 
• Reflecting their gradual loss of market share, the smaller players have not fared well in recent site bidding. While they won five out of five sites tendered in Dec 2016–Jan 2017 with winning bids of SGD15-21 psf, they have only won one out of six since Mar 2017, with lower winning bids of SGD9-16. 
• Their cautious stance should provide a more conducive environment for Sheng Siong Group to open more new stores.

Online grocery not hindering industry growth 

• Despite the increasing popularity of online grocery shopping, supermarkets in Singapore continue to book sales growth. In Jan 2018, a Euromonitor study concluded that online grocery has not been hindering the growth of physical supermarkets. This could be due to:
  1. growing demand for hand-picked fresh food. Singaporeans are increasingly conscious of the quality of food they consume. They generally perceive hand-picked fruits to be fresher. Sheng Siong Group has been growing its fresh-food contributions, from 35% of its revenue in 2011 to 44% in 2017;
  2. rising restaurant prices have compelled many to eat at home more often. In general, the cost of operating restaurants has increased with rents and wages, while supermarket product prices have not surged as much;
  3. most mass-market shoppers are price-sensitive and would rather shop and carry than pay for delivery; and
  4. supermarkets themselves have responded to the online threat by experimenting with new retailing formats and online platforms. Click-&-collect or click-&-deliver services have been launched by almost every major supermarket brand, though contributions are miniscule at 1% of their revenue.
• We also believe FairPrice’s first-mover advantage and market dominance have limited the room for disruptions by new entrants for the incumbents. From what we can detect, the impact of online retailing is probably felt the most in bulk purchases, as bulk purchases can be heavy to lug home from physical stores. Examples are packaged drinks and personal-care & home-care products.
• A comparison of the selling prices of several online players also suggests that price differences are not prominent. The biggest difference appears to be the minimum orders required for free delivery. FairPrice has the lowest requirement while Redmart, an up-and-coming online grocery purveyor, offers a membership programme which charges annual fees of SGD28.80. This entitles its members to lower order requirements for free delivery and 5% rebates on all orders. Dairy Farm’s Giant does not provide free delivery while Sheng Siong Group provides free delivery for minimum orders of SGD100.
• But as the bill size of Sheng Siong Group’s customers is typically small, at SGD15-30, most of its customers do not meet its minimum order requirement of SGD100. As such, Sheng Siong Group’s online services are small, making up just around 1% of total sales.

Bigger Pipeline of New Stores 

• Historically, Sheng Siong Group’s SSSG is heavily dependent on the opening of new stores, as the older stores reach steady state in 2-3 years. This, in turn, is contingent on the availability of HDB sites for bidding, as Sheng Siong Group locates its stores in HDB heartlands with population density. Management highlighted that sites for bidding will more than double to 20 this year from the levels three years ago, as HDB new projects, which started three years ago, approach completion. 
• YTD, Sheng Siong Group has already opened 32.1k sf of new space. This forms 68% of our forecast of 47.1k sf for 2018E. Beyond that, it intends to open five new stores each year, yielding combined floor space of 25k sf. These should more than make up for the closure of two of its largest stores in FY17 due to land redevelopment by their landlords.
• New stores lift sales more than older ones as the growth of mature stores tracks that of their mature catchment populations. Large stores also generate lower revenue psf due to space wastage or product offerings that compete with online retailers’. The latter include electrical appliances and apparel. 
• Given Sheng Siong Group’s heartland positioning, the availability of new HDB sites for tendering will be critical for its revenue visibility, as in the past. From HDB’s annual reports, we gather that the number of supermarkets under construction in HDB heartlands jumped from eight in 2011-2012 to 37 in 2016 and 34 by Mar 2017. But the number of sites awarded was limited in Mar 2016 and Mar 2017, as most were still under construction. In HDB’s schedule of new commercial units estimated for completion by 4Q18, 15 are sizeable supermarket sites of more than 5,000 sf each. This is a big jump from the 4-5 sites awarded in 2016-2017. 
• In addition to sites opened for bidding, HDB occasionally invites supermarkets to tender privately for existing space. Management estimates there could be around five of such sites available in 2018. In total, there could be 20 up for grabs in 2018.

Taking its name into China 

• Sheng Siong Group opened its first overseas store in Kunming, Yunnan province in 4Q17. It aims to replicate its Singapore business there and expand into densely-populated residential districts which dangle low rentals to provide modern grocery shopping convenience. 
• Management highlighted that the Chinese grocery industry is still dominated by traditional wet markets and neighbourhood convenience stores. As cities go, Kunming is special. Not only does its population of 6.6m dwarf that of Singapore, it is slated to benefit from China’s One Belt One Road initiative. It is destined to be the terminus of a 3,000 km high-speed rail link to Singapore. 
• Sheng Siong Group’s local partner for its 54,000 sf store is the unlisted Kunming Lǜchén Group, which owns 30%. Sheng Siong Group owns 60% and Singapore-listed printing company, A-Smart Holdings (previously known as Xpress Holdings), the remaining 10%. Kunming Lǜchén has interests in property, hotels, micro-financing, supermarkets, condiment manufacturing and retailing.
• In a Jan 2018 industry report on “Supermarkets in China”, Euromonitor estimated that China’s supermarket sales grew 3.2% y-o-y in 2017, up from 1.7% in 2016. Supermarkets suffered less from the online threat than hypermarkets, as their smaller sales areas and smaller inventories apparently enabled them to adapt quicker to changing consumer tastes.
• Community supermarkets have been gaining ground. Located in residential areas, these offer products which many local consumers need, usually daily necessities and local fresh foods. To improve convenience, more community supermarkets have also been providing home-delivery services.
• Leading supermarkets in China are gradually adopting smaller formats to reduce their operating costs from space rental and labour and to increase their flexibility in meeting consumer needs. Compact supermarkets have become popular, as they maximise the use of small sales areas.
• The development of premium outlets is another way to differentiate brands. For instance, Sun Art Retail Group (6808 HK; Not Rated) introduced its premium supermarket brands, RH Lavia and Hi Auchan, in 2017.

FINANCIAL ANALYSIS

P&L 

• We expect revenue to grow 4-5% in FY18-20E, largely from new stores. We assume SSSG of 2.0%. Although Sheng Siong Group closed a major 41.5k sf store at Woodlands Block 6A in 4Q17, it secured four new stores in the same period, with a combined floor space of 32.1k sf. This makes up 68% of our estimate of 47.1k sf new space for FY18E.
• We expect net margins to climb only 0.1ppt pa, from marginal savings in administrative expenses, cost savings from bulk purchases and IT improvements.
• Sheng Siong Group’s net margins improved from 6.6% in FY14 to 8.4% in FY17 on the back of:
  1. growing fresh-food contributions, from 40% of its revenue in 2015 to 44% in 2017. Fruits, vegetables, meat, fish, dairy and baked goods carry gross margins of more than 30% vs mid-teens for non-fresh-food groceries; and
  2. big productivity drives since its IPO, particularly the opening of its purpose-built distribution centre at Mandai Link in 2011. This is now its HQ.
• Since 2012, gross margins have improved from 23% to 26%. In almost every quarter, more competitive direct and bulk purchasing made possible by Mandai Link has been cited as a reason.

Cash flow 

• Sheng Siong Group generates SGD80m p.a. of operating cashflow. 
• Supermarkets are mainly cash-and-credit businesses. With their skew towards fresh produce, inventory days are usually less than a month. But as its suppliers give Sheng Siong Group 50 days of credit, its business is essentially financed by its suppliers. 
• FCF turned positive in FY17 to SGD61.2m from -SGD10.6m in FY16. This reflected the end of capex for its new warehouse and acquisition of two properties. We expect FCF to improve further in FY18-20E, as there should be no large capex after paying the remaining SGD16m for its warehouse and in the absence of property acquisitions.
• Operating cash flow is typically more than enough to cover capex and 90% payouts. In a year with no property acquisitions but just new-store renovation, capex should not exceed SGD7-8m pa. Maintenance capex is typically only SGD4m pa. FY16 was an exception when it acquired two properties in Bedok Central 209 and Yishun Junction 9. 
• Sheng Siong Group prefers to rent sites but will buy over existing properties if it sees risks of lease termination or if a store’s revenue is large enough to justify its acquisition. In the case of a new mall such as Yishun Junction 9, it bought its shop space there as it appreciated the potential of the Yishun estate, which is part of the HDB’s estate-rejuvenation programme.

VALUATION & TARGET PRICE

• Sheng Siong Group trades at 19x FY18E and 13x FY19E earnings vs 32x / 28x for ASEAN supermarket operators and food retailers. While its peers operate in bigger consumer countries such as Thailand, Indonesia and the Philippines, Sheng Siong Group offers higher net margins, ROEs and dividend yield of 3.6%.
• FY18E core EPS growth is estimated at 7.5%. If more new stores can be set up, there could be upside to our FY18-20E forecasts. Sheng Siong Group is interested in bidding for 20 store sites in FY18, which could potentially increase its GFA by 23%, assuming each is 5k sf.
• Our SGD1.20 Target Price is based on DCF valuation, to capture the full value of its long-term potential. This is a steady business run by a cost-conscious management, with substantial influence over the national food supply.
• Our DCF utilises a 2-stage model. The first incorporates 5-year forecasts for FY19-23E; the second assumes steady-state expansion of 3% for the next five or FY24-28E. Our Target Price implies 25x FY18E P/E and 17x FY18E EV/EBITDA. We believe this is reasonable, given its high ROEs, steady execution and earnings delivery.

RISKS

Landlords’ redevelopment / sale decisions 

• In 2011, revenue was set back by the closure of two of its biggest supermarkets, in Ten Mile Junction and along Tanjong Katong Road. Their closure was necessitated by their landlords’ decisions to sell or redevelop their buildings. 
• In 2017, its two largest stores at The Verge and Woodlands 6A were closed, in 2Q17 and 4Q17. Their closures were due to landlord disposals and HDB redevelopment, respectively. In the case of Woodlands 6A, Sheng Siong Group was given advance notice by HDB. In the case of The Verge, it had more than a year to prepare for its landlord’s disposal. 
• As all these changes were flagged ahead of time, Sheng Siong Group and the market had time to prepare for them. Sheng Siong Group’s revenue continued to grow by 4.2% in FY17, despite the closure of The Verge, as it managed to prepare four new stores elsewhere with 25k sf of floor space from 1Q16 to 2Q17. It added another 8 stores with total floor space of 51k sf from 3Q17 to 1Q18. On top of that, it refurbished and expanded existing stores, adding 15k sf of floor space at Tampines 506 in 2Q17. It also found replacement space of 11.8k sf in Woodlands Str 12 in 4Q17.

Competition 

• The only time in the past 10 years when a supermarket price war erupted was in 3Q11, shortly after Sheng Siong Group’s listing. This was a tug-of-war between Sheng Siong Group and FairPrice for market share. Fortunately, it ended as quickly as it started, in 4Q11.
• The seasonally strongest 1Q and 3Q tend to be quarters of heightened competition. Rival supermarkets capitalise on festive demand to grab market share.
• Perhaps the biggest threats that cannot be effectively quantified are firstly, new entrants. Aggressive site bidding by smaller new players at end-2016 led to a bidding war for rental sites. But this ground to a halt in less than a year, after a severe margin squeeze for the smaller players.
• The other threat is from online grocery players such as Redmart and Amazon. They could precipitate price wars for market penetration. However, given that most of Sheng Siong Group’s stores sell about 45% of fresh foods in HDB residential estates, we believe they should be fairly insulated from online competition, which largely has lower average bill size.

China’s wild card 

• Management has positioned its Kunming venture as a trial. If it succeeds, it may expand further. If not, attributable sunk-in cost should be limited to USD6m, excluding management’s time and resources.
• We are satisfied that Sheng Siong Group has more than a fair chance of success, based on the following: 
  1. Location. The supermarket is located in a new shopping mall built by Hong Kong-listed Greenland Hong Kong Holdings (337 HK, Not Rated). This is ultimately owned by a Chinese SOE, Greenland Holdings (600606 SH). The mall is smack in the middle of a large residential enclave in the suburbs of Kunming. This is important as Chinese shoppers prefer to find their big supermarkets in malls.
  2. Limited big-boy competition. Sheng Siong Group’s competition in the vicinity is confined to wet markets and local supermarket chains. The only Western supermarkets - Carrefour, Tesco and Walmart - are located in Kunming’s financial district, far from Sheng Siong Group’s outlet.
  3. Differentiation. Sheng Siong Group intends to use its established supply chain in Singapore to bring into China more brands from the West, Japan and Korea. It will also emphasise the fresh produce it is known for.
• Management says that getting food supply is not a problem as China is a buyers’ market and sellers are tripping over themselves to find buyers.
• We have not factored in any revenue contributions for China. While Chinese supermarkets are a cut-throat business, we see the potential for success if locations and propositions - more fresh produce, more goods not found elsewhere - are good. Sheng Siong Group’s CEO is personally leading the charge and he is an industry veteran.

FX 

• Only 10% of Sheng Siong Group’s material purchases is denominated in foreign currencies. The rest is in SGD. 
• Sheng Siong Group buys from the local offices of its suppliers, such as Nestle and Procter & Gamble. Historically, exporters also prefer to sell to Singapore importers in SGD due to SGD’s stability

John Cheong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2018-04-02

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