Why Singapore’s Grocery Retailers Are A Buy

The rise of the Internet has disrupted businesses worldwide, and the grocery retailing landscape in Singapore has not been spared. Amazon made its first foray into Singapore a few months back with the launch of its Prime Now mobile app, a service that offers consumers lightning-fast delivery of household goods and grocery items straight to their doorsteps within two hours, and it did so with much fanfare. Prime Now was so well-received that the e-commerce giant was quickly overwhelmed with a deluge of orders, some of which had to be fulfilled through a hastily-assembled fleet of taxis and private hire cars. As Internet grocers Redmart and Amazon throw down the gauntlet on local supermarket chain operators, the question beckons: are brick-and-mortar grocery stores still relevant in the age of digital disruption? We believe they are, and here's why.

1. In-Store Experience Remains Relevant!

Here's how technology has been influencing consumer buying habits: more than 93% of global respondents in Nielsen's online Connect Commerce Survey said they have ever shopped online before – not surprising given the pervasiveness of online shopping in our everyday lives. Since its advent, online shopping has provided consumers with a convenient way to purchase virtually all types of goods, an absolute life saviour for the time-starved and the couch potatoes.

When it comes to groceries, however, it seems that the in-store experience matters too. For many shoppers, online images simply can't replace the physical look, feel and smell of fresh grocery products. Based on the survey results, online grocery shopping has been slow to gain traction among consumers, with only about one in five respondents indicating that they have ever shopped online for fresh groceries (Chart 1). The inability to hand-pick fresh groceries is understandably a clear barrier to online adoption.

Chart 1: Groceries Slow To Gain Traction Among Online Shoppers

The weekly trudge to the supermarket is also an enjoyable activity that is ingrained in the lifestyles of many Singaporeans, with more than six in ten Singaporeans (in a separate survey conducted by Nielsen last year) indicating that they enjoy shopping for groceries in brick-and-mortar retail stores – one of the reasons why supermarket aisles are still thronged with busy shoppers, especially on weekends. Evidently, the in-store experience remains relevant, both on a psychological and functional level. Not only is grocery shopping at brick-and-mortar supermarkets enjoyable, it also allows consumers to touch and inspect the products beforehand, and these are experiences that the online grocer cannot replicate.

2. Grocery Shopping Is Reasonably Convenient In Singapore

Grocery shopping in Singapore is a fairly convenient affair. Unlike countries (such as the US) where food deserts – referring to areas where access to grocery stores is extremely limited – are a real problem, and consumers usually have to travel long distances to get to the nearest grocery store, the concept of a food desert is largely unheard of in Singapore. With a total of 932 supermarket outlets and convenience stores spread out across various parts of the country, including shopping malls and HDB flats, the nearest store for most Singaporeans to stock up on their groceries is usually just a stone's throw away. Even for households that are living off the beaten path, Singapore's efficient transport system also ensures that grocery stores are within convenient access.

While having groceries delivered right to your doorstep is certainly convenient, it is not free, and some consumers may understandably be unwilling to pay delivery charges when they can easily purchase groceries from a nearby supermarket. The delivery charges also do not come cheap unless a minimum purchase amount is fulfilled (Table 1). As fresh foods tend to turn bad easily, some consumers may choose to do their grocery shopping a few times a week to reduce food wastage. This results in smaller baskets sizes that may not be entitled to free delivery. As such, shopping at brick-and-mortar supermarkets would make more sense for these small-basket shoppers.

Table 1: Delivery Charges Of Singapore's Online Grocery Retailers

3. Brick-And-Mortar Grocers Still Have Competitive Advantage

Make no mistake, online grocery shopping is here to stay. While still at the early stages of its development, Singapore's online grocery sales has been growing exponentially over the past few years and is likely to gain further traction as consumers become increasingly acquainted with the digital shopping landscape. However, that does not mean all consumers will trade in bricks for clicks. Amazon's acquisition of Whole Foods and Alibaba's investment in physical supermarket outlets are reminders of brick-and-mortar's relevance in modern grocery retailing.

As such, brick-and-mortar grocery retailers will be well-served to adopt an omni-channel strategy – a blend of both online and offline approaches that provides consumers with an integrated shopping experience – that caters to diverse shopping habits, empowering consumers to decide how they want to purchase their groceries, how they want them delivered, and when they want to do it. In fact, physical stores, which are supposedly the Achilles' heel of brick-and-mortar grocery retailers, can give the offline players a competitive edge over their online counterparts as the synchronisation of the physical and the digital worlds to provide shoppers with an integrated multi-channel experience is something that pure-play online grocers cannot match.

Despite all that chatter about how e-commerce will put brick-and-mortar stores to the sword, Singapore's pure-play online grocers are still struggling to get their businesses going. RedMart, for instance, saw its operating losses widened from SGD -2.0 million in 2013 to SGD -50.2 million in 2016. Moreover, RedMart and Amazon's Prime Now currently do not have sufficient scale to compete effectively with NTUC, Sheng Siong and Dairy Farm (Table 2). Given that the grocery industry is characterised by its razor-thin margins, having strong economies of scale and bargaining power with suppliers to drive down costs is another source of competitive advantage for the brick-and-mortar grocery retailers.

Table 2: Online Pure-Plays Currently Lack Scale

Our Top Grocery Retail Stock Picks

Singapore is a highly urbanised country with a well-developed grocery retail landscape. While traditional grocery retailers (wet markets and independent small grocers) still retain a sizable 28% market share (Chart 2), they are likely to cede market share to the modern grocery retailers (supermarkets, hypermarkets and convenience stores) due to the latter group's accessibility, wider product range, and ability to accept different payment methods. Grocery shopping at modern retail channels accounted for about 72% of the total USD 6.0 billion grocery retail spending in Singapore last year, and is expected to grow by a compounded annual growth rate (CAGR) of 2.5% over the next five years, based on Euromonitor estimates. Given the market's low single-digit growth, companies with strong economies of scale to drive down costs, a sizable store network and the ability to generate consistent cash flows, will be well-positioned for future growth.

Chart 2: Singapore's Grocery Market Dominated By Modern Retail Channels

We like Sheng Siong (SGX.OV8) for its resilient business model, courtesy of its mass-market positioning and healthy margins that are comparable to market leader NTUC Fairprice. Its warehouse expansion, due to be completed in 2018, is expected to add another 10% capacity that will help enhance the company's margins through greater economies of scale and increased fresh food offerings (Chart 3). While Sheng Siong's share of Singapore's grocery retail market is only about 9%, we believe the company has room to further expand its network of 43 stores (most of which are located in the heartlands), especially in housing estates where it currently does not have a big presence in, such as Serangoon, Hougang and Sengkang.

Chart 3: Sheng Siong's Margin Expansion Over The Years

With about 10 supermarket units to be put up for tender by HDB over the next six months, Sheng Siong's SGD 69.6 million net cash (with zero debt) on its balance sheet allows it to engage in store acquisitions. Its first supermarket in Kunming is also expected to commence operations this year, and the successful executive of its China expansion strategy could help drive growth in the future. While Sheng Siong reduced its dividend pay-out ratio recently to pursue growth, we believe its fundamentals remain intact. Its estimated dividend yield of 3.80% in 2018 also remains attractive, and certainly warrants a place in any dividend-oriented stock portfolio.

We have also included Dairy Farm (SGX.D01) in our Value Focus List as we are positive over the company's future outlook and believe its share price has further upside potential. A member of the Jardine group, Dairy Farm's diversified portfolio of stores across various retail formats and geographical markets is a plus point for investors given that its fortunes do not depend on any one single revenue source (Chart 4). In fact, diversification has been key to its resiliency in 1H 2017, with the poor performance in its supermarket and hypermarket segment more than offset by its other businesses, such as its convenience store and health & beauty segments.

Chart 4: Diversified Portfolio Of Businesses

Moreover, its focus on strengthening operational efficiencies and increasing its fresh food offerings are likely to drive margin expansion over the next few years. Its exposure to fast-growing Southeast Asian markets such as Indonesia, Vietnam and the Philippines, where increasing urbanisation and favourable demographics have been supporting the retail landscape in these countries, also underpin Dairy Farm's long-term growth. The company's investment in China's Yonghui Superstores is also bearing fruit, and represents a long-term growth driver for Dairy Farm.

We note that the valuations of both Dairy Farm and Sheng Siong are attractive relative to their regional peers. Their PE ratios of 19.2X and 20.0X based on 2018 estimated earnings compare favourably to the peer average of 22.3X despite having much higher profitability, as measured by returns on invested capital (Table 3). Their defensive attributes, strong cash flow generation and good growth prospects are also further reasons why investors should consider these two stocks for their portfolios!

Table 3: Valuations Of Regional Grocery Retailers

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.