• 1Q18 Revenue/PATMI met 26.6%/25.3% of our full year estimations
• Earnings growth driven by new stores contribution, tailwinds from favourable macro backdrop and improving gross margin
• Reaching its 50 stores target by 1H18 from current 48 stores; Will continue to expand its outlet network to grab market share
• Downgraded to ACCUMULATE on recent stock price run-up; TP unchanged at S$1.13

The Positives

• A strong set of results driven by new stores contribution and sentiment uplift. Sales from Singapore operations were up 4.3% YoY, despite being the first quarter to receive the full impact from closure of the Verge and Woodlands Block 6A stores. We expected a flattish to low single digit top line growth for 1Q18. Notwithstanding the boost from the 7 new stores (4 opened in 1Q18 and 3 stores in 2H17), defying expectation was the 5.6% YoY comparable same store sales growth (SSSG). Management attributed the 5.6% SSSG it to higher sales volume, expanded store space in Tampines Blk 506, and customers’ loyalty. Customers shifting from the closed Verge and Woodlands Blk 6A stores to neighbouring Jalan Berseh and WL301 stores also contributed to the SSSG.
• Gross margin yet to plateau, continued to gain ground at c.26%. Thanks to favourable input prices and higher Fresh products penetration rate, 1Q18 gross margin of 26.2% marks the highest 1Q gross margin since listed. Recall that margin for 1Q is seasonally lower as the industry tends to push for volume during the Chinese New Year. 1Q18 sales mix also contrast to the norm of higher groceries purchase during this festive season. This could lead to a higher than expected FY18e gross margin. Our forecasted FY18e gross margin was at 26.2%.

The Negatives

• Higher staff costs on absence of new stores in 1Q17. Administrative expenses for its SG operations went up to 16.7% of its revenue, as compared to 15.8% a year ago. Total headcount increased in conjunction with the addition of 7 stores in 2H17 and 1Q18. There was no new store opened in 1Q17. However, the Group has a solid track record of cost management. We believe that the administrative costs can be contained at below 17% of revenue.
• Kunming China store posts maiden quarterly revenue of S$1.75mn but loss of S$0.1mn. Only 5 months since its first flagship store in China began operations, the Group sees growth potential in the city and intends to add another 1-2 stores.

Outlook

Outlook remains positive. Tailwinds from favourable macro backdrop and contributions from the 9 new stores (see Figure 1) should mitigate lost revenue from the two large stores and to underpin FY18e growth. In addition, we believe there are further upsides from potential new stores in coming quarters. There are 9 new supermarkets units pending completion by 2018, according to data on HDB HBiz website. However, management shared its concern on the proximity of these locations with existing stores, which include those under Sheng Siong’s brand.   

Downgrade to Accumulate with unchanged TP at S$1.13. Our TP is based on an estimated 4.92 cents FY18e EPS and 23x PE multiple. It has strong financial position with zero debt and cash position of S$78.6mn as at end-1Q18. We believe that the Group’s free cash flow should improve further from FY19 with no huge ticket capital expenditures in plan. Growing free cash flows could be a prelude to a higher dividend payout in future.

Re-rating catalysts: (i) Successful bidding of new stores; and (ii) Improvement of product mix.

Operation Updates

• Expanded its store network to 50 stores by 1H18 from 44 stores by end-FY17, reaching its targeted number of stores, and doubling its store count in 2011 (listing year).
• Management shared that it has further room to grab market share (current market share at c.14% vs c.12% in 2011) by expanding its store network. Opportunities prevail in new residential area or redevelopment sites.

Figure 1: 9 new stores to underpin FY18e growth