Potential catalysts

• We believe that Sheng Siong with its decent store network and logistics chain could be a takeover target for online players eventually. Online players such as Alibaba’s Hema (盒马鲜生) and Amazon (Wholefoods) are taking the online-to-offline route and are operating physical stores. We see scope for higher dividend payout if there is excess cash on its books.

WHAT’S NEW - New stores driving growth

Earnings in line

• Sheng Siong's 2Q19 revenue of S$238m (+11.8% y-o-y), operating profit of S$20.4m (+7.3% y-o-y), and earnings of S$18.4m (+7.4% y-o-y) were in line with our expectations. Revenue growth was driven by new stores as same store sales (SSSG) was -0.3% and annual sales per square foot was dipped 1.7% to S$1,921.
• China operations are now profitable, despite opening of a second store in Kunming in June.
• An interim dividend of 1.75 Scts was declared, equivalent to 70% payout rate.

Gross margins stable

• Gross margins remained stable at 27.4% (+0.1 ppt y-o-y). This was sequentially higher than 1Q19’s 26.1% due to the Chinese New Year sales period, where discounting and promotions lowered selling prices and margins. Sales mix of fresh products was higher, which led to the slightly higher margins.

Operating margins lower

• Sheng Siong's operating expenses increased by 14.6% y-o-y to S$44.8m, with operating margins falling by 0.3ppt to 8.6%. Distribution expense increased by 2.8% y-o-y to S$1.5m on higher headcount and fleet cost from higher sales volume.
• Admin expenses increased by 14.6% y-o-y to S$42.6m as staff costs and bonus provisions increased on a higher store count.
• Other expenses increased to S$0.7m (+50% y-o-y) due to higher finance charges relating to credit cards and other non-cash payments.

Outlook continues to be positive driven by new stores

• Earnings are tracking our estimates despite a slightly negative SSSG and decline in annual sales psf, with new stores continuing to drive revenue growth. Three new stores that were opened in May 2019 (Bukit Batok, Anchorvale and Sumang Lane) will add to 2H19 revenue, while there will be a full 12 months of contribution from a total of 10 stores that were opened in 2018.
• Post adoption of SFRS (I) 16 in 2019, the accounting impact on 1H19 earnings was -S$1m. Net profit would have been 9.6% y-o-y higher in 1H19 at S$38.8m if the accounting impact was excluded. We estimate that net margin would have remained stable at about 8% as well.

Maintain BUY, Target Price S$1.32

• We leave our forecast largely unchanged as 2Q19 results are in line. We maintain BUY but raise our Target Price higher to S$1.32 Target Price, based on 25x FY20F PE, rolling over from FY19F earnings previously.
• We continue to like the stock for its defensive qualities including stable earnings, net cash balance sheet, cash generating abilities, decent dividend yield.
• Maintain BUY for 19% upside.