• FY2016 Revenue/PATMI are in line with our expectations of S$817.9mn/S$63.4mn
• 85 cent final dividend proposed, higher than preceding year’s 1.75 cent
• Target to bring FY17F Revenue per sqf to c.S$2,000 from S$1,827 despite closure of two big stores, at Woodlands Blk 6A and The Verge
• Expect new stores to drive FY17F top line growth, while FY17F gross margin steady at c.26%

Sheng Siong Group (“SSG”) bucked the general Singapore supermarket retail trend by growing 4.2% year-on-year (“yoy”) in turnover as compared to a 1.4% yoy contraction in Singapore’s supermarket retail sales. We remain confident of the management’s prudent expansion and cost management strategies, as demonstrated by the opening of 19 new stores and the 1.7 percentage points improvement in EBIT margin since IPO.

• Yishun Junction 9 and Blk 506 Tampines Central to lift FY17F sales. Yishun Junction 9’s new concept (in terms of layout and customer-friendliness) has proven to be a successful strategy. Its maiden quarterly contribution set new stores growth at higher rate of 8% in 4Q16 compared to 6.2% in FY2016. The new Blk 506 Tampines Central will be adopting the same concept as Yishun Junction 9, and is expected to have a similar positive impact on FY17F new stores growth.

• Gross margin to steady at c.26% as favourable margin drivers extend into FY17F. FY2016 margins are at all-time high, driven by higher rebates from suppliers and we think that the Group would continue to benefit from lower input prices in a lacklustre retail outlook. On the other hand, room for margin improvement derived from bulk handling diminishes as SSG is reaching its theoretical capacity for bulk handling of 80%. Therefore, catalyst for higher margin will be an improvement of product mix, i.e. more fresh products compared to groceries. The ratio has improved to 42:58 from the previous ratio of 41:59.

• Prudent expansion strategy amid intensified competition for retail space. Management’s key consideration for bidding price is the store’s potential revenue per sqf. SSG refrained from engaging in a bidding war when some smaller supermarket operators have been aggressively bidding up the rent of new HDB shops in the last six months. While a slower expansion could weigh against its growth, we view its effort to maintain its long term margin positively.

Maintained ‘Accumulate’ rating with a lower TP of S$1.06, based on unchanged 23x PE multiple. We lowered our FY2017 growth forecast due to a subdued retail landscape and increased competition for new stores. These translate to a lower estimated FY17 EPS at 4.61 cents. We expect the five new stores opened in 2016, alongside the two newly renovated and bigger stores at Loyang Point and Blk 506 Tampines Central, to drive FY17F top line growth; while comparable same store sales growth to remain flattish. The enhanced margin and its ability to pass on partial, if not full, increases in input cost to customers will cushion the adverse impact from food inflation.

• Sustainable dividend despite net cash position halved on heavy CapEx in FY2016. Cash position remains healthy at S$63.5mn as at 31 December 2016 with zero debt. One big ticket capital expenditure (CapEx) for FY17F would be the construction costs for central warehouse extension (estimated at c.S$20mn which would be spread over 18 months until end-FY2018). In view of its net cash position and strong operating cash flow (FY2016 net operating cash flow was S$21.8mn), we expect SSG to be able to (i) fund the construction project internally and remain free cash flow positive, and (ii) to sustain its dividend payout ratio at 90%.

• Closure of two underperforming stores could lift FY17F Revenue per sqf to above S$2,000 from S$1,827. Although the two stores at Woodlands Blk 6A and the Verge contributed c.10% of SSG’s revenue, their revenue per square foot (“sqf”) is lower than the Group’s level. Management is looking to establish new stores at locations with better yields. According to data on HDB HBiz, there are three new supermarket units pending completion by Aug 2017. Opening of new stores would be a catalyst for re-rating.

Figure 1: Revenue per square foot (sqf) expected to increase above S$2,000 in FY17F

Table 1: Changes in Retail Space/ Business Area