Sheng Siong(OV8) DCF Analysis

Introduction:

Sheng Siong has always prided itself as a supermarket for the people offering the cheapest possible price because it wants to be a place for the people ran by the people. However, in recent times it has lost that edge. 


Taking at look at LINK & LINK , out of 23 essential products, Sheng Siong only offered 4 products the cheapest.
But Sheng Siong's problems go far beyond just losing its competitive edge. With an unrealistic growth plan, strong refusal to step out of its comfort zone and poor corporate governance may mean curtain call for the Sheng Siong show.

Investment Thesis 1:

EROSION OF COMPETITIVE ADVANTAGE

Due to a lack of competitive advantage over competitors, the inability to differentiate itself will lead to its market share slowly depleting as consumers are willing to swap over to another brand easily. And given that other brands are beginning to develop their unique selling point(USP) such as Redmart being the subsidiary of an online shopping platform and NTUC having a large presence in other aspects of our life such as NTUC income developing even stronger loyalty in its customers.

Investment Thesis 2:

UNSUSTAINABLE GROWTH PLANS

Sheng Siong's main growth plan as laid out by management is to open up new stores in both Singapore and China. I'd argue that given the larger players in China having such a strong presence and having so much more time than Sheng Siong to develop their business without a USP, the China growth plan is unlikely to succeed. There are also legitimate concerns on their Singapore growth plan. Firstly, given the land scarcity in Singapore to constantly grow by opening new stores till perpetuity is unrealistic. Secondly, eventually opening stores will actually destroy value rather than create value. Sheng Siong may be forced to be located nearer to competitors due to lack of “Good” spaces and lesser land, affecting Operating Profits. Higher demand for these lands which pushes the price up to open stores so the Required Rate of Return (RROR) may far exceed the Expected Rate of Return (EROR) in the near future.

Investment Thesis 3:

LACK OF INNOVATION & REFUSUAL TO ACCEPT INNOVATION

Sheng Siong refuses to embrace new technology, their margins may remain stagnant in the best case scenario or drop in the worst case scenario. An example of this is in the online Grocery Delivery space, I can foresee there being a "stickiness" to the online Grocery Delivery space as the convenience it offers is unparalleled. The power of convenience is demonstrated when Grab & Uber first came along, they had mass adoption due to the convenience they offered to consumers which led to Grab eventually cementing its place in our everyday life. As a proxy for how well firms adopted online Grocery Delivery we take a look at the minimum basket size in order to qualify for free delivery. The lower it is, the better as it means that the company has higher economies of scale from investing heavily into the space that it can maintain similar or higher margins whilst still offering free delivery at a cheaper basket size.

 52% of consumers say they purchase online because of the convenience offered. (SOURCE)

Wacc:

COST OF DEBT

RFR is 2.8425%, based on the average 10Y Singapore Treasury Bond for the last 3 months. As Sheng Siong does not have a credit rating, I've decided to use a synthetic rating when trying to find the risk spread. This methodology was developed by Aswath Damodaran. Risk spread is 6.5%, Sheng Siong as of 2022 had an interest coverage ratio of 1.5 giving it a bond rating of B.
Cost of Debt is 9.3425%

COST OF EQUITY
ERP was taking US markets. Since both US and SG are stable markets. 
Using last 3 months data, treating the stock market as a bond, coupon payments being the earnings yield from the US market.

4105.02 = [4.58% x 4105.02] x (1+5%) / (1+R) + ([4.58% x 4105.02] x (1+5%)) x (1+3.417%) / R - 3.417% / (1+R) ^2
R = 8.635%
RFR (US) = 3.417% 
ERP = 5.218% Beta is 0.48 taken from (SOURCE) and using the Hamada equation. Cost of Equity is 5.4410%

WEIGHTAGE

Debt is 322.695M based on 2022 10-K
Average share price is $1.67 based on last 6 months average
Shares outstanding is 1500M based on 2022 10-K
Equity Value is 2505M Equity is 87.1% of capital structure
Debt is 12.9% of capital structure.
WACC is 5.944%

Revenue forecast:

The main value driver of Revenue comes from the stores and how well they perform. We have to take a look at Square feet(SQ FT) of the stores, Revenue/SQ FT and total number of stores opened.

When forecasting revenue, I opted to not take into consideration revenue generated in China. Going for more granularity rather than ineffective forecasts. Due to the volatility of potential growth, there’s high growth potential in China which may show up at a date far beyond my forecast period.

I took the average SQ FT/Store for the last three years (2020 - 2022) as Singapore is a small country so Sheng Siong is unlikely to be able to continue adding stores with very large SQ FT like it previously did in 2018 (9729.41) so, to further account for land scarcity in Singapore, I took the average SQ FT/Store to decline to 9000


Average REV/SQ FT has 2 factors affecting it. Consumers' spending habits and the efficiency of usage of store space. So I took the average of 2017 - 2019, where consumers spending habits were more normalized and 2022 where due to space constraints stores were smaller and more efficient. As stores get smaller, they get more efficient at using each SQ FT to generate revenue. I assume that % Revenue/SQ FT grows 1:1 with % SQ FT Decline.

Sheng Siong management has stated it has a “Target of opening 3 new stores per year”. That 3 stores need not necessarily come from stores being opened up in Singapore. So I forecast that it will open 2 stores in Singapore before tending to open up 1 store in Singapore by 2027.

Margins forecast:

Management has stated that because of recent changes in interest rate environment it has caused imports to be more expensive due to unfavorable FX rates. However, I don't think this contributes much to margins even when FX rates normalize, in 2022 Sheng Siong has a margin of 10.58% versus in 2017 8.62%. Sheng Siong has very high fixed costs as well 84% goes to Transport and purchasing the product. So the impact on margins when adding more stores is likely to be low. I forecast that margins are likely to slightly eek upwards to 11%, assuming that the general interest rate environment normalizes over time.

Assumptions:

1) Change in NWC hovers about 1% - 1.2% as Sheng Siong likely has to take up more inventory to furnish new stores.

2) TGR is 1% as Sheng Siong will lose market share and is unable to minimally grow at inflation rate till perpetuity.

Conclusion:

Sheng Siong is priced at $1.38/share, Sheng Siong is a setting sun.

The only upside about Sheng Siong is that it currently has positive free cash flow and is the second largest supermarket in Singapore so it's descent will be slower. But unless management changes its methodology of growth to better put the free cash flows to good use its unlikely to be able to win its competitors.

But even then, it seems unlikely as the majority stakeholder in Sheng Siong is management. Picture of my Excel: LINK


COST OF EQUIT








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