Asiamoney Top 10: retail (includes profiles of Big C, Sa Sa and Golden Eagle)

Asiamoney, March 2008

There is, says HSBC analyst Matt Marsden, “a consumption revolution happening in China.” It’s a key component of the country’s broader economic and social development, and its pace is accelerating. “It’s all part of the process of China becoming a market economy, and the consumer plays a very important part in this,” he says. “There’s a very interesting fundamental story and the equity market is there and ready to finance it.”

Take, for example, the shoe sector. Even if we look only at Chinese companies listed in Hong Kong, there was one listed shoe company in early 2007; now there are five. “There is a whole sub-sector of footwear stocks that didn’t exist a year ago,” says Marsden. “If you look at the evolution of the department store sector you’ve got a similar story.”

Indeed, the growth of China’s department store sector is the area that has had the biggest impact on our monthly Top 10 chart of the Asian companies with the highest return on equity, which this month looks at the retail sector. Golden Eagle, Parkson and Lifestyle International all make our top 10.

They’re all growing dramatically. Golden Eagle, profiled below, logged a 64.1% year-on-year increase in profits attributable to shareholders in the first half of 2007, to EMB 195.8 million. Parkson, the China arm of the Malaysian Lion Group’s retail business, is growing almost as fast: its profit went up 54.7% over the same period, to RM303.5 million. It manages 39 stores in 26 Chinese cities today and in the first half of 2007 alone executed new lease agreements to add 40,000 square metres of retailing space to its portfolio.

 And Lifestyle International, best known in Hong Kong for the Sogo stores in Causeway Bay and Kowloon, has launched the same model in China through its Jiuguang Department Store which opened in September 2004. Flush with the success of that approach, in October it bought 59.4% of the equity in a sino-foreign joint venture which owns the Xian Tian Xia Square retail shopping complex in Shijizhuang, in Hebei Province, for RMB 538 million. It is also building and redeveloping properties elsewhere in China: new complexes should open this year in Suzhou, Dalian and Tianjin, with others to follow in Shengyang, Qingdao and Harbin.

 It’s a sector that is attracting more and more attention. ABN Amro analyst Katherine Chan spent part of October visiting 20 department stores in China and seeing the management of groups including Golden Eagle, Parkson, Intime, Peace Mark and Seagull Watch. “We walked away with more confidence in the Chinese department store sector,” she says. The wealth effect of strong stock markets pushed national retail sales up by 17.1% year on year on the first half, she says; “Historical data suggests that people tend to spend less on food and other necessities as disposable income grows. We believe department stores will benefit most in this environment since they do not sell daily necessities, apart from a tiny proportion of sales from supermarket food items.”

 Whether that remains the case given the more recent turmoil in stock markets remains to be seen. But even if that dampens the top end department stores, there is also a growing supermarket sub-sector in China, with listed companies including Wumart, Times Supermarkets and Jiahua. “Supermarkets are a robust business,” says Marsden. “They don’t fall off a cliff. People need food, they will always shop for consumer staples; a more modern supermarket format offers then more choice, sometimes at lower prices, in a clean, modern, air conditioned or heated environment for Mr and Mrs average consumer China.”

 And if the good times do continue to roll in China, then the presence of luxury retail names will be maintained. Our top 10 list includes two groups in this category: Ports Design, a fashion and luxury goods company, and Xinyu Hengdeli, which represents 50 international watch brands in China. Peace Mark, also in the watch industry, is just outside our list, in 11^th place.

 There are other interesting retail stories in Asia – the pace of expansion in India keeps retail names like Pantaloon off our return on equity list, but it’s a fascinating period of intensive change – but China is the one that is combining great opportunity with tangible results. It’s the story of over a billion people growing in wealth and learning to love spending.

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1. Esprit Holdings, Hong Kong/Germany : 48.9%

Apparel and accessories brand, headquartered in Germany but listed in Hong Kong. Now sells in 44 countries through over 600 stores and over 11,000 wholesale point-of-sales, designing 20,000 products every year. Profit attributable to shareholders was HK$5.18 billion in 2007, compared to HK$3.73 billion in 2006.

2. Golden Eagle, China (listed Hong Kong): 35.1%

Mainland Chinese department store operator with nine stores in Jiangsu, Shanxi and Yunnan provinces. Positions itself as a mid to high end chain. Listed in Hong Kong in 2006. Profits attributable to shareholders grew 64.1% year on year, to RMB195.8 million, in the first half of 2007.

3. Ports Design, Hong Kong/China, 30.4%

Fashion and luxury goods company combining design, manufacturing, marketing, distribution and retail. Focuses on China and Hong Kong and runs the brands Ports International, Ports 1961 and BMW Lifestyle. First half turnover at RMB 577.6 million was up 38.49% year on year, and first half net profit up 41.62% at RMB142.8 million.

4. President Chain, Taiwan, 24.5%

Holds the Taiwan franchise for 7-11 and has opened over 4000 stores nationwide since 1980. Also active in department stores, supermarkets, distribution, restaurants and drug stores, and increasingly active overseas, including Vietnam, Canada, the Philippines and the PRC. Net income was NT$3.26 billion in the first nine months of 2007, compared to NT$2.7 billion in the same period the previous year.

5. Sa Sa, Hong Kong: 23.8%

Cosmetics retailing and beauty services group based in Hong Kong and active across Asia. Represents 100 international beauty brands through stores and an e-commerce arm. In the half year to September 30 turnover was up 13.1% to HK$1.52 billion, and profit attributable to shareholders up 20.4% to HK$90.7 million.

6. Parkson, Hong Kong/China: 23%

Chinese department store chain, focusing on the mid to mid-upper end of the retail market. Started out with one store in Beijing in 1994 and now covers 26 cities in 18 Chinese provinces. Gross sales shot up 61% year on year in the first half, to RMB4.3 billion; profit attributable to the group was RMB303.5 million, up 54.7%.

7. Lifestyle International, Hong Kong/China: 20.6%

Runs department store and retail outlets focusing on the high end customer. Operates the Sogo brand name, including the famous store in Hong Kong’s Causeway Bay, and Jiuguang, in Shanghai. In October it and its subsidiaries bought 59.4% of a sino-foreign joint venture which owns the largest retail shopping complex in Shijizahuang, in Hebei province. Has also acquired sites for development of retail complexes in Suzhou and Shengyang; stores in Dalian, Tianjin, Harbin and Qingdao are also under development.

8. Home Product Center, Thailand, 18.9%

Thai retail business built on the HomePro home improvement brand. Runs 29 stores in Thailand selling 60,000 items. Net profit at Bt469.7 million for the first nine months of 2007 was well up on Bt417.6 million over the same period of 2006; sales boast a compound annual growth rate of 40.9% since 1999.

9. Xinyu Hengdeli, Hong Kong/China, 18.4%

Sells watches of international brands in China through retail (around 100 shops selling 50 brands) and wholesale. Brands include TAG Heuer, Zenith, Christian Dior and Fendi. In recent years has acquired Elegant International Holdings, which owns retail watch outlets in Hong Kong; Henan Fuhao Watch; and Artdeco Decorating & Packaging.

10. Shinsegae, Korea, 18.1%

Korean department store operators whose first store opened in 1930. By 2009 it plans to have nine department stores, 130 discount stores, and a further 25 discount stores in China, with targeted sales revenue of W33 trillion (it was W14 trillion in 2006). It aims, in fact, to be one of the top 10 distribution retail companies in the world. Holds joint ventures with Starbucks, Shinsegae Chelsea, Shanghai E-Mart and TianJin Taedal E-Mart.

 Ones to Watch

In 1994, on Bangkok’s Chaengwattana Road, Big C Supercenter took its first step to bringing a localised version of the Wal-Mart model to Thailand when it opened its first outlet. “At that time, we had a lot of mom and pop stores and wholesalers, but not big shopping malls,” says CFO Rumpa Kumhomreun. Big C decided that by building malls focused on medium to low income people – 90% of Thailand’s population – and installing anchor tenants in the fast food industry like KFC and McDonald’s, they would have a winning formula.

It’s certainly demonstrated impressive growth. Big C had five stores in 1995 and now has 54. You won’t see them everywhere – Big C finds its catchment area in Bangkok’s suburbs, not the CBD, and half of its stores are in that area now – but they are well-placed for a cost-conscious market and will open eight more stores this year.

In keeping with the low-cost approach, over 90% of the goods sold in Big C stores are Thai produce. “It’s cheaper to have Thai products,” Rumpa says. “Even when we import items, we buy them from distributors in Thailand.”

Big C started out as a subsidiary of Central Group, then formed a business alliance with the France-based Casino Group in 1999; Casino then bought 530 million shares in a Big C capital increase and remains the company’s biggest shareholder. In the past it has been responsible for selling off a garment business in order to concentrate on retail. Big C’s chief executive, Yves Braibant, is French, and the shareholder roster has an international feel to it too: AIA, AIG, Apollo and Aberdeen Asset Management all appear. “Our price is not up and down according to any situation in the Thai market,” says Rumpa. “Most of them [international shareholders] I have met are happy because they can sleep well.” Analysts like it too: Macquarie Research has an outperform on the stock. “We believe BIG offers a defensive quality with half of its cashflow driven from dependable rents,” wrote analyst Kitti Nathisuwan in August, before departing Macquarie. “At the same time it is well positioned to tap the overall macro recovery in 2008.”

Golden Eagle

Golden Eagle is one of three Chinese department store operators to make our return on equity top 10, reflecting the sector’s buoyancy on the back of China’s domestic consumption growth.

Golden Eagle differs from the others mainly in its geographical spread. It started out in 1996 with a flagship store in Nanjing, and remains heavily concentrated in Jiangsu province, where eight of its 10 stores (including the most recent one, which is also in Nanjing) are based. It has expanded a little over the years, opening in Xi’an and Kunming, but is still mainly a home-province company.

That’s about to change, though, with the coming opening of a store in Shanghai. That will expose Golden Eagle to a different type and intensity of competition, and bring it into more direct comparison with peers. “We’re going to be competing with the big boys like Plaza 66 and City Centre [both prominent Shanghai retail malls] in this very competitive area,” says chairman Roger Wang. “Shanghai is an area where you need to take a much longer time to prepare before you can compete.” For one thing, unlike Jiangsu, in Shanghai Golden Eagle will be up against foreign players, from Sachs Fifth Avenue to Galeries Lafayette.

So far, staying local has served the company well. In its most recent interim results, for the six months to June 30, the company logged gross sales of RMB2.2 billion, a 31.7% year on year increase, with profit attributable to shareholders up 64.1% to RMB 195.7 million. Earnings per share were up 36.3%. “We do have more knowledge and more network in the Jiangsu area,” Wang says. “In Jiangsu we can build stores at lower costs, and then we have a kind of pipeline arrangement for the gradual opening of other stores.” Kunming and Xi’an, as provincial capitals, boast strong markets and are not yet flooded with competition, so stores there have performed well too. And even after Shanghai opens, the next stores are going to be back home. “We would like to do two to four stores a year in our area,” says Wang, who expects 15 to 18% growth in consumer spending in the Chinese retail sector in 2008, despite the problems caused by stock market wobbles and the Lunar New Year weather conditions.

Wang is optimistic because of a particular segment of Chinese society, who he calls China’s baby boomers, now entering their 30s. “They look for high-end [retail], they look for name brands, and they have pretty strong confidence that they are going to make more money,” Wang says; 80% of his stores’ customers are aged between 18 and 35 and the newest store in Nanjing has been carefully targeted at this young generation.

Golden Eagle was listed in Hong Kong in 2006, an experience Wang says has been positive, from the additional capital for expansion to the increased transparency and exposure to international investors. “It’s helping the whole company to grow from a local company to an international level,” he says. The fact that over 250 staff are involved in a company stock option plan is proving a useful motivation, he says.

An important point of difference between Golden Eagle and some other operators is that the company owns 85% of its own floor space. “We always regard the increase of rent as the biggest threat for retail operations,” he says. “There’s a lot of operators that have shrunk their involvement in China and Hong Kong and most of the time the rent forced them out. That alarms us. If we want to make this business work in the long term we have to watch out for real estate increases, so we like to own as much of our property as possible.” Some analysts consider this a sign of a lazy balance sheet, but Wang disagrees. “People think it’s defensive, but I regard it as positioning ourselves in a way where we can be very aggressive when the time is right.”

One broker that likes the stock is ABN Amro, with a buy recommendation. Analyst Katherine Chan highlights the company’s strong local brand awareness and customer loyalty; the fact that Jiangsu’s GDP and retail growth outpaced the national averages in 2006; and the good mix of branded fashions and apparel that Golden Eagle stocks, which brings higher commission rates than other categories of merchandise. “Great timing in a good sector,” she says.

Sa Sa International

When you buy cosmetics, there are two extremes to your shopping options. There’s the counters in the department stores, each of them representing an individual brand, with a sales team employed by that brand and remunerated by how much of it they sell. At the other end there’s the open shelves of the supermarkets or pharmacies, where customers help themselves without dedicated service or advice. The Sa Sa International Holdings model falls between the two.

Sa Sa stores – of which there are 100 in Asia, the majority in Hong Kong – sell 400 brands of skin care, fragrance, make-up and hair care products. They sell their own brands, and over 100 international beauty brands; consultants don’t mind particularly which brand the customer buys, and can give advice across the full range of available product. “While we have the advantage of multi-brand direct access, and direct testing of products, we also offer a similar level of service to the department stores,” explains Guy Look, Sa Sa’s chief financial officer. “We train our consultants well so they can advise customers on product usage, and unlike the department stores they can do so across a range of brands.”

Lately, it’s a model that has been working very well. When Sa Sa announced its interim results in November, for the six months to September 30, consolidated profit attributable to equity holders was up 20.4% year on year, to HK$90.7 million. Turnover was also up, by 13.1% to HK$1.34 billion. It runs a 43.2% gross profit margin on its core Hong Kong and Macau retail businesses.

But can it stay that way? If darker economic times are coming, then aren’t disposable items like cosmetics firmly in the firing line? Answering that requires a distinction between the way cosmetics are viewed in Asia and elsewhere in the world. While the fragrance and make-up products that tend to dominate sales in Europe and the US are clearly not recession-proof, in Asia skincare products are more important, and behave differently in a downturn. “Skincare products in Asia are now being seen as necessities, because ladies believe they need to make the investment so that they can maintain their youthful look and, as they age, slow down the process and make themselves look better,” says Look. “There’s a belief among many ladies that if they have good skin they don’t need make-up. Given that it’s increasingly being seen as a necessity, in terms of recession it tends to be more resistant to cuts in spending. Ladies generally will cut lunch before they cut skincare spending.”

Look is positive about the company’s positioning. “The outlook is still pretty good. We all know there have been pretty big fluctuations in the stock market but we have not really seen much of that negative effect filtering through to spending in our stores.” One of the reasons the Hong Kong stores have done so well is because of the huge pass-through traffic the city attracts, including growing numbers of people from China.

That has given it a bigger brand name in Asia than its heavily Hong Kong-skewed presence would suggest, and Sa Sa hopes this name recognition will help it as it seeks to expand in Asia. Sa Sa does have outlets in China, Malaysia and Taiwan, but it’s really China where attention will be focused for expansion. “People there know us, they use similar products to those in Hong Kong, and have a similar skin type; also it’s very big and growing very fast. It has all the combinations that we want,” says Look.  But it presents very different challenges. “We cannot just copy the business model for China. In Hong Kong we have only one kind of store and everyone who comes in can afford something in it, partly because of the range and partly because wealth patterns are quite uniform. But China has a much bigger range in terms of spending power.”

Consequently, Sa Sa will take a range of different approaches to China. It will use its multi-brand stores, but also offer single-brand beauty counters under exclusive brands in department stores. More and more is being invested in improving product development, and getting registration through for sales on the mainland. The traditional Sa Sa stores will expand into a bigger network through franchising, which in turn reduces the need for heavy capital expenditure; despite the ambitions, Look says there is no need for additional capital raising.

Look attributes the group’s high return on equity to the productivity of its stores. “Many factors are in play when we look at increasing the productivity of our stores,” says Look. “One is the products we sell, another would be the service we deliver, another would be queuing time, and the investment in the decorations for each store. Also optimising the right store size would improve return on equity. All of these have a part to play.”