Understanding Sheng Siong Group's (SGX:OV8) Financial Statements

I have mainly been writing about reits as real estate is an asset class which I understand well. For a change, I would be analysing the financial statements of Sheng Siong Group, a supermarket operator based in Singapore. Sheng Siong has evidently been one of the few companies to benefit from the Covid-19 outbreak, as supermarkets are classified as essential services and remain open during this period of lockdown. 

From a financial standpoint, Sheng Siong has posted strong results for their first quarter of FY20, with revenue and net profit rising 30.7% and 49.9% respectively from a year earlier. These strong operating results meant that Sheng Siong was able to provide employees with an additional month of bonus – very appropriate, in my opinion, given the risk that frontline workers put themselves in.

I looked at Sheng Siong’s past 5 years of financial statements, from FY2015 to FY2019 to get a better understanding of the company’s business model, and how it earns its profits. Although we are probably familiar with Sheng Siong from a consumer’s perspective, looking at the individual line items in the income statements provides us with a better understanding of the factors that affects its profitability, and an idea of how Sheng Siong can continue to grow its business going forward.

Gross Profit Margins

Firstly, Sheng Siong’s gross profit margins have increased from 24.7% in 2015 to 26.9% during the past 5 years. This means that in FY2019, for every dollar of sales Sheng Siong makes, the items cost them around 73 cents. This steady improvement in gross profit margins may indicate that Sheng Siong is has increasing bargaining power when purchasing from its suppliers. This could be due to increase economies of scale, as Sheng Siong may be able to negotiate for better prices if they are purchasing larger volumes.

While gross profit margin of 27% is on the low side, given Sheng Siong operates in the consumer staples sector with little product differentiation, it is understandable that Sheng Siong would not have much pricing power when selling to customers.

Increasing its gross profit margins would be one way for Sheng Siong to increase its profitability. This could come in the form of higher mark-ups on their products, or lowering the purchase price from suppliers. The first option may be tough for Sheng Siong, as it operates in a highly competitive industry where consumers are price sensitive. If Sheng Siong were to increase the price of its goods by too much, consumers would simply purchase their groceries from other supermarkets for a cheaper price. Hence, the second option would be more practical, and further increases in gross profit margins may instead have to come from its purchasing strategies, to be able to negotiate for more favourable prices from its suppliers.

Operating expenses

As selling and distribution expenses and other expenses only constitute 0.8% and 0.3% of revenue respectively, there isn’t much to elaborate on these as their impact on profitability is minimal.

Sheng Siong’s Administrative expenses form the bulk of the operating expenses, at around 17.4% of revenue for FY2019. Looking at the 5 year trend for administrative expenses, it has been creeping up gradually from 16.4% in FY2015 to 17.4% in FY2019. This can be attributed to an increases in depreciation and manpower costs which make up the bulk of administrative expenses.

Drivers of Revenue Growth

Basically, Sheng Siong can grow its revenue in three main ways.

1. Same store sales growth

2. New store sales growth

3. Overseas Expansion

In the table above, I have compiled the growth rates for each of the revenue drivers from Sheng Siong’s annual reports from 2015 to 2019. In 2019, Sheng Siong did not provide a breakdown, except for noting that growth was mainly from the new stores opened in 2018 and 2019.

Sheng Siong’s growth has mainly been driven by new store sales growth. This may be more unpredictable, as it depends on Sheng Siong being able to consistently identify locations to open new stores. There is also the competition from other supermarket operators when bidding for new retail space from the HDB. Conversely, same store sales growth would be a more stable source of growth. Regarding overseas expansions, Sheng Siong has two stores in Kunming, China. These stores contribute to less than 2% of Sheng Siong’s revenue.

Free cash flows

The table above shows Sheng Siong’s free cash flows for the past 5 years. Free cash flows are calculated by deducting capital expenditures from operating cash flows. This indicates that Sheng Siong is able to consistently generate strong free cash flows for shareholders.

Capital Expenditures

I have complied Sheng Siong’s capital expenditures incurred from 2015 to 2019, and included the breakdown of each of the categories. In 2017, Sheng Siong did not provide a breakdown of their capex.

Capex had fluctuated from year to year, but if we were to focus on the capex on old and new stores, we get a clearer picture of the capex incurred to maintain and grow the business. Going forward, we can also estimate the capex required per new store opened, to get better visibility of Sheng Siong’s future capex, hence estimating Sheng Siong’s future FCF.

The main uses of cash are to purchase retail space for its stores, however, these are harder to forecast, as Sheng Siong can choose to either lease or purchase the retail space. Hence, the cash outlay of 30 to 50 million incurred for the purchase of three locations over the past 5 years should not be viewed as a recurring capex.

In summary, here are the positives and negatives of Sheng Siong:

Positives

Resilient to economic cycles: Operating in the consumer staples industry, Sheng Siong sells necessities which would be in demand regardless of the economic cycles. A good example would be the current recession; while most companies have seen their share prices hammered, Sheng Siong recovered after a brief sell off and has continued to hit all time highs.

Strong free cash flow generating business: As discussed above, Sheng Siong’s business has generated strong free cash flows for shareholders.

Risks

Low margin business: Susceptible to rising manpower costs. Given that Sheng Siong’s business model has low operating margins, Sheng Siong would have to manage its operating costs well.

Threat of e-commerce: A few years back when Amazon first entered the Singapore market, investors were concerned that Sheng Siong may face disruption from online grocery sales. However, a few years later, there seems to be little change in consumer spending habits, as Sheng Siong continued to post strong growth. Hence, the question that investors should ask would be whether consumer preferences for in-person grocery shopping would be likely to change anytime soon – will the Covid-19 lockdowns accelerate the switch towards home deliveries of groceries?  

Increasingly saturated home market: Sheng Siong’s store count in Singapore has increased from 39 in end-2015 to 59 today, there are fewer neighbourhoods where Sheng Siong isn’t present. Hence, with the market becoming increasingly saturated, Sheng Siong would have to expand overseas for new growth areas. Currently, its China operations only contribute 2% of revenue, and could be a potential area of growth. However, overseas expansion brings about execution risks as well.

Conclusion

Sheng Siong’s business has definitely been doing well over the past 5 years, and the current situation has showed the resilience of its business. I hope this write up has provided investors with a clearer understanding of Sheng Siong’s financial performance.

Disclaimer: This article is intended for informational and discussion purposes only, and do not constitute financial advice. When in doubt, please contact a licensed financial adviser.

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