A Relook at Sheng Siong's Valuation

Introduction

    Hello everyone! It's been quite a while since I updated my blog given the fact that I was busy with my work, but I'd like to think that I've learned a lot about Fundamental Analysis during this period. It has been a rather tumultuous period for the Singapore stock market as of late, so it is only appropriate that I review a stock that I've recently taken a small position in (although I've previously reviewed it here); Sheng Siong!

Sheng Siong's Logo (Source: BrandsoftheWorld)

    To start off, let's conduct a quick recap with regards to what exactly Sheng Siong's core business is; In essence, Sheng Siong owns and operates a chain of supermarket retail stores (70 in Singapore and 6 in China) primarily residing in neighbourhood heartlands or local malls focused on providing a great value proposition for the day-to-day Singaporean. Its outlets are particularly known for delivering fresh live-seafood options ranging from clams, and crabs to fish, allowing the typical Singaporean access to more attainable "luxuries". 

Porter's Five Forces Analysis 

   To begin with our Porter's Five Forces Analysis, it is imperative that we can accurately ascertain the industry in which Sheng Siong operates. In the context of Singapore, we will establish that Sheng Siong is operating solely in the retail supermarket industry, which means that its main competitors would be NTUC Fairprice and Cold Storage/Giant which provide a product mix diverse enough to accommodate the bulk of Singaporean's daily grocery necessities. This would mean that we've excluded small individual players such as Mamak Shops and convenience store chains such as 711 due to the relatively small operating size while also excluding niche players such as Scarlett Supermarket due to the limited product variety/accessibility.

    In Singapore, the three major players in the supermarket industry would be operated by Sheng Siong, National Trades Union Congress (NTUC), and Dairy Farm International Retail Group (DFIRG) with each organisation controlling a vast network of stores. There are only three major players for a reason.

Threat of New Entrants: LOW 

    According to Sheng Siong's FY2023 AGM, the estimated CAPEX for each new store is around SGD $1 - $1.2 Million, making the establishment of new competition prohibitively costly. Not to mention the fact should any potential competitor wish to directly compete with Sheng Siong for neighbourhood store space, they will have to go through the arduous and uncertain process of placing winning bids with the Housing Development Board (HDB) for leases in the heartlands. 

    Another headwind for potential competitors would be the fact that given the nature of the industry, leveraging supply-side economics of scale is essential for survival, which is next-to-impossible for new entrants. The supermarket industry is a volume game due to the high fixed costs associated (and consequently high operating leverage), with incumbents setting prices of rather undifferentiated products competitively low by leveraging their capacity to handle bulk volumes resulting in razor-thin margins in hopes of high inventory turnover resulting in high net profit. Up-and-coming adversaries, unless backed by a sponsor with significant resources, will simply not be able to compete. 

    Lastly, for the approval of sales/preparation of raw food (which would be integral for features of a supermarket such as a butchery), a Supermarket License must be granted by the Singapore Food Authority (SFA), subject to regulatory compliance by the business. Review of establishment layout and inspections to ensure compliance with SFA standards are done which pose another roadblock to new companies looking to enter the supermarket fray.

Bargaining Power of Suppliers: MEDIUM

    It is no secret that Singaporeans are rather brand-conscious. In fact, according to a study conducted by the Singapore Business Review in 2022, approximately 65% of Singaporeans stick to brands they like/are familiar with. This means that to retain their market share, major supermarket players like Sheng Siong typically have no choice but to stick to household classics like Coca-Cola, Nabisco, and Magiclean. 

    That being said, it doesn't mean supermarket stores are entirely beholden to these popular suppliers. According to Sheng Siong's website, they "select our supplier partners based on reputation, sales, and alignment with Sheng Siong’s values." and want the product/service that is "the most innovative, best quality and at the most competitive price". It stands to reason that Sheng Siong is constantly on the lookout for potentially new or backup suppliers should any of their partnerships go awry. 

    Lastly, it is notable that Sheng Siong has started developing its range of house brand offerings (e.g. Tasty Bites, Heritage Farm, and Happy Family) to consumers which not only yield higher profit margins but also grant a greater degree of control over its supply chain. These products encompass several categories from frozen goods to typical groceries like fruits and vegetables. 

Bargaining Power of Buyers: HIGH

    Unsurprisingly, Singaporeans are generally extremely price sensitive, no thanks to the High cost of living the tiny red dot is renowned for. Additionally, Supermarkets, offering a wide array of different products, are not able to employ product differentiation strategies with consumer experience being largely undifferentiated as well. A corollary of these various factors at play is the fact that consumers can easily switch to competing players offering better value propositions. 

    Although the location of individual outlets may sometimes be a contributing factor to one's patronage, Singapore is a small country with well-developed infrastructure and high population density, meaning there's always a competing supermarket outlet just next door. Not to mention the now-not-so-nascent concept of online grocery shopping resulting in consumers having better access to price comparison information alongside the wonders of free doorstep delivery. 

Threat of Substitute Products/Services: LOW

    The threat of Substitute Products / Services is generally irrelevant to the supermarket industry as most key players in Singapore have migrated to an omni-channel retailing experience. 

Competitive Rivalry: MEDIUM

    Any rivalry between the large organisations in the Singapore Supermarket industry will necessitate price competition, which is unlikely due to the already-razor thin profit margins associated with the very nature of the saturated industry.

    However, in times of high-cost inflation, NTUC, a government-associated entity, may opt to lower prices below the norm, requiring the other two competitors (Sheng Siong and DFIRG) to follow in tandem. 

    Nevertheless, each major player in the industry has the sufficient resources and expertise necessary to encroach on incumbents' market share. 

Strengths, Weaknesses, Opportunities & Threats (SWOT) Analysis

Strengths

    Sheng Siong as a major Singapore supermarket player, is able to reap significant internal economies of scale by buying products in bulk and distributing them to its various outlets via its Singapore Distribution Centre at Mandai. The company's brand reputation is also well-regarded amongst Singapore residents, typically viewed as a reliable grocery retailer with an emphasis on value-for-money products. The inclusion of fresh seafood produce allows for a high-margin product mix as well as fulfilling consumers' needs which may not be met by other competitors. 

    With regards to company governance, the company is known for taking care of its employees as well, boasting a 3.9-star rating on Glassdoor (Rather high for a Singapore organisation) which would bode well for manpower acquisition efforts for future expansion/turnover, alongside other cost-savings associated with the administrative nature of employee sourcing and onboarding. 

    On a financial level, Sheng Siong boasts a robust balance sheet with a Cash Position of SGD 352 Million versus zero in interest-bearing debt and hence is insulated from any interest rate risks. 

Weaknesses

   I believe it is safe to say that one of Sheng Siong's main weaknesses is the lack of awareness surrounding its online delivery platform. Perhaps this may simply be anecdotal, but I regularly see or hear about NTUC Fairprice's delivery as opposed to Sheng Siong, which leaves me rather puzzled. Upon review of their respective websites, it's apparent why; To be eligible for free delivery, Sheng Siong requires a Minimum Order Value (MOV) of $100 as opposed to NTUC Fairprice's $59, and no one wants to pay for delivery. 

    My guess is that Sheng Siong does not have sufficient market share in the online delivery space to develop a sufficiently efficient delivery network (such as quality delivery routes) to enable them to compete at the same level as Fairprice. Interestingly, I've found out that deliveries are made via picking up goods from individual stores over a centralised distribution system.  This results in a sort of "Chicken or Egg" problem. Sheng Siong lacks competitive MOV rates which result in fewer patrons of their delivery platform, preventing the development of an operationally efficient delivery network, and hence preventing MOV rates from becoming more competitive. 

Opportunities

    With Sheng Siong's significant net cash position, they have the war chest necessary to engage in high capital expenditures or Mergers & Acquisitions (M&A) activities, so the possibilities are truly endless. 

Firstly, I'd like to bring up the fact that out of the three major supermarket players, Sheng Siong is the only one without a "luxury" business arm to appeal to the more discerning Singapore consumer. NTUC Fairprice has Fairprice Finest, DFIRG has Cold Storage, but Sheng Siong has nothing. I acknowledge that as someone without direct industry knowledge, considerations have been made, but with Singapore's rising affluence, perhaps it's time to launch a new concept store to see how things pan out. 

    Moving on, Sheng Siong needs to somehow increase its online delivery utilisation rates. Consumers should either be made aware of the option via more aggressive marketing campaigns, or the company may use its sizeable war chest to make the upfront investment needed to bring MOV rates down. Perhaps additional effort can be made to optimise the website/app's UIUX as well as to match the user-friendliness of NTUC Fairprice's app. Perhaps it's the naivety of my youth, but Sheng Siong could potentially capitalise on its reputation for fresh live seafood by offering it on its delivery platform to compete with the likes of Evergreen Seafood, Tankfully Fresh and The Ocean Mart (although this does come with its own set of logistic constraints). 

    Lastly, although this is outside the context of Singapore, Sheng Siong can and has expanded beyond the borders of our country, with its foray into China via the aforementioned 6 stores. Interestingly, according to the 2023 Sheng Siong AGM, management has indicated that their main focus will on be China with there being no plans for other expansion plans, given the large size of the country. It is good to see that the management has acknowledged the potential saturation of the Singapore market. There can only be so many HDBs. 

Threats

    There is a possibility of Sheng Siong's market share being slowly eroded by online delivery platforms such as Amazon Fresh or NTUC's and DFIRG's solutions. Given the amount of products and services supermarkets carry and provide, a lot of coordination work is involved. Any lapse in the supply chain may result in devastating ramifications, as evident from the 2022 Singapore Chicken Shortage (Anyone remember that folks?). We also shouldn't pin too much hope on Sheng Siong's China expansion plans. Out of Sheng Siong's financial reports, the only information I could glean from them is that the China outlets are profitable with not much further information available. The scene in China is completely different from Singapore, with the prominence of wet markets, larger competitors such as Costco, and weak brand reputation with the locals there posing significant challenges. Even if Sheng Siong can successfully establish a sizeable presence in China, comparing the country's whopping 1.4 billion population as opposed to Singapore's 6.3 million, logic would dictate that the business would become heavily weighted in China in the long-term, which would result in significant forex fluctuation risk for what is supposed to be a defensive Singapore company. 

    In terms of the macroeconomic environment, Sheng Siong's debt-free balance sheet renders it immune to interest-rate risk, although it may cause issues for certain suppliers that carry large amounts of debt such as Del Monte Pacific. Given the cycle-agnostic nature of the business, an economic downturn shouldn't affect the company too much as well, with its top-line even potentially benefitting. However, it is to be acknowledged that gross margin would probably take a hit due to live/fresh produce being seen as a consumer discretionary luxury, reducing the product segment's contributions to the bottom line. 

    

Balance Sheet Health

I am not particularly concerned with Sheng Siong's Balance Sheet health, but I've included the quick and current ratio of the company (as of FY2024 Q1) to ensure that it is able to meet its financial obligations. 

The current and quick ratio being 1.88 and 1.53 respectively lends credence to the expectation that Sheng Siong's business operations continue to be a going concern.

    Sheng Siong benefitted greatly from the COVID-19 pandemic as evident by the huge jump in Revenue, Gross Profit, and Net Profit respectively, though it did start to plateau from FY2021 onwards. However, business has been rather stable in terms of financial performance. I have added sparklines to the data visualisation as well in case you deem it useful to visualise the performance. 

Valuation

    To derive an intrinsic valuation of Sheng Siong, I have mainly used a Discounted Cash Flow method by projecting a discrete forecast of the next 5 years (ignoring FY2024 Q1's information) Unlevered Free Cash Flows. I have also taken into consideration the average of the company's 52-week Highs & Lows + the company's historic 10-year median PE ratio. A compilation of the exact revenue drivers and assumptions I used for the DCF can be found in the APPENDIX below. 

    

    The derived intrinsic value via DCF was approximately $1.58 per share, I did not add debt as Sheng Siong has negligible amounts of interest-bearing debt. I have included a sensitivity table with Capital Asset Pricing Model (CAPM) / Cost of Equity (As opposed to WACC due to the assumption of zero interest-bearing debt) and Terminal Growth Rate as variables. 

    Taking into consideration the median of the other two valuation methodologies, the implied share price calculated was $1.70 per share, which carries an approximate upside of 13.5% compared to the current share price of $1.70 at the time of writing. 

Key Catalysts & Growth Strategy

    Key share-price catalysts of Sheng Siong would include a higher-than-expected success rate in securing new leases for stores (above the projected 2-3 average per year), an economic recession triggering a flight to safety in defensive value stocks, and more substantial evidence of China store operations being a success which would instil confidence in shareholders with regards to Sheng Siong's overseas expansion growth trajectory. 

    According to Worldometer, Singapore is expected to reach a population of 6.5 - 6.9 million by 2030 as opposed to the current population of 6.3 million. This has warranted additional efforts from the government to keep up with the demand for affordable public housing, as evident from the development of land such as Sungei Tengah as BTO projects, though delays of residents moving in due to certain defects and complexities left by the contractors have been observed. As more estates open up, the availability of space tenders will allow for Sheng Siong's continued growth. 

    Although Singapore narrowly avoided a technical economic recession previously, which is defined by experiencing two subsequent quarters of contractual economic growth in GDP, by recording 0.1% QoQ growth in 2023 Q2 after a 0.3% QoQ contraction in 2023 Q1, I believe there is a common consensus on the ground-level that at the very minimum, we are seeing an economic slowdown. Horror stories of citizens facing prolonged periods of unemployment have filled online forums, possibly attributed to the interest rate hikes in 2023 finally kicking in, which may reflect via further contractions in GDP moving forward once the lagging effect has diminished. 

    Lastly, it is rather intriguing to note that in China, fresh produce supplied by wet markets is perceived to be of greater quality, freshness, and variety according to this paper on AnthroSource by Shuru Zhong and Cynthia Werner. Additionally, the paper mentions that wet markets have become a place for socialising, further aided by widespread accessibility due to close proximity to residents. Although the paper goes on to detail how wet markets are not losing their foothold in China, they did cite the fact that in Tier 1 cities like Beijing, wet markets' dominance has faltered. Perhaps we will be able to see Sheng Siong compete against supermarket competitors like CostCo by leveraging on its fresh seafood forte, once the tougher competition has been driven out (Kunming City is a Tier 2 city, which has been the focus of Sheng Siong's China expansion efforts).

    In terms of growth strategy, the management has stated that in terms of capital allocation priorities, the main focus would be on the acquisition of new stores, warehouse spaces, and investments in technology to further increase operation efficiency. To be very honest, I am not exactly sure how Sheng Siong intends to fully capitalise on emerging technologies, although I am aware of the fact that they have started to implement self-checkout lanes as opposed to cashier lanes in stores to reduce labour costs. Beyond that, I frankly have little insight into their plans for technology. Perhaps use the latest trend in Artificial Intelligence to optimise product layouts in their stores? Just throwing in some of my thoughts! 

Appendix 

  In the appendix, I will be elaborating on certain assumptions I've made during the valuation. Of course, this list will not be fully exhaustive, but I hope I am able to elaborate on most of it. 

    Firstly, I will be starting with the drivers and schedules I've made. For the revenue schedule, I've made the main drivers the total number of stores and projected Singapore inflation. I assumed any newly opened stores to be located in Singapore, alternating between 2 and 3 new stores opening per year as per the management's growth strategy.  

    Using this formula, I increase the revenue per store previously obtained by averaging from FY2023's data by the projected inflation rate (1+F6) then obtaining total revenue by the total number of stores, but reducing the store effect by using (E9+1)/F9 which is the (Previous Year's No. of Stores + 1 / Current Year's No. of Stores) to account for slight cannibalisation of sales. The constant of 1 is simply an arbitrary number I found apt to model the revenue. 

 After calculating the implied revenue model,  I felt it was reasonable since it trended towards my intended Terminal Growth Rate (TGR) of 2.0% given that Singapore's long-term nominal GDP growth was between 1.0% - 3.0% (which is why I used this as the range for the TGR in the earlier sensitivity table as well)

 For Gross Margin, I used the average of the average and median of FY2021 - FY2023's gross margins and incrementally increased it by 0.2% per year over the next 5 years to reflect higher gross margin arising from improved sales mix and prevalence of house brands. Given that FY2023's gross margin percentage was 30.0%, I believe the used values are on the more conservative and realistic side. SG&A and Others were increased based on projected inflation. 

 In terms of the Working Capital Schedule, I took the average of the average and median of FY2021 - FY2023's working capital days which I found to be rather stable, and simply used them throughout the entire model. 

 For the Depreciation schedule, I took the average of the average and median D&A expressed as a percentage of the total Right-Of-Use (ROU) Assets and PP&E from FY2021 - FY2023. Subsequently, CAPEX was determined by equalling to depreciation of current assets + CAPEX of $1.2 million per newly opened store which is the highest range given by management estimates.

 

    I did not differentiate between current and deferred taxes due to the fact that:

    1. I did not know the exact details of Sheng Siong's accelerated depreciation & hence taxable depreciation.

    2. Sheng Siong's payable taxes were more or less always consistent with Singapore's corporate tax rate of 17%. 

    Interest expense was set to 0 which is actually on the more conservative side since Sheng Siong is extremely cash-rich with negligible debt obligations, hence this reduced interest income if anything.   

    

     CAPM was calculated via Sheng Siong's levered beta of 0.51 with the Risk-Free Rate being Singapore's 10-year SSB rate, resulting in a CAPM of 7.76%. 

    A disclaimer I would like to put out is that I did not create a 3-statement model for my valuation of Sheng Siong (Admittedly, due to my unfamiliarity with certain BS and CFS items), I only modelled the relevant cash-flow items alongside certain assumptions such as no changes in equity such as common stock issued, etc and no changes in interest-bearing debt items. Hence, I must admit the DCF is not exactly foolproof but I believe it is sufficient to gain a general sense of Sheng Siong's appropriate valuation. 

Conclusion

    Overall, Sheng Siong is well-positioned to benefit due to the confluence of the aforementioned factors, with a calculated intrinsic value ($1.58) and average implied value ($1.70) above the current share price. However, due to the relatively low margin of safety, I will not eagerly add further to my stakes lest it drops substantially, although I am highly confident in its defensive ability. In fact, it truly shows how efficient the market is actually, given that the margin of difference between calculated IV and actual share price is not too far off. 

Author's Note: Thank you for reading this post, it has been a great experience to use what I've learnt as of late to improve my analysis of companies, and I hope my work has reflected that. Sadly, it is most likely I will continue to not be too active due to having to juggle many external commitments, but do let me know your thoughts of your article down in the comments section below! Do read the below appendix as well if you would like more detail with regards to how the valuation was done!

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I have no plans to initiate any additional positions in the stocks I have mentioned within the next 72 hours. All content published by me should not be construed as any sort of financial or investment advice and is simply for informational purposes. Although all research and figures are accurate and calculated to the best of my ability, I am not liable for any decisions made based on inaccurate information.