Supermarket stocks may lose some shine in Covid endemic phase

Singapore

SUPERMARKETS had been among the biggest Covid-19 pandemic beneficiaries as shoppers rushed to stock up on groceries and cooked at home more often than before. But as Covid-related restrictions are lifted, the exuberance over supermarket stocks could recede.

Last year, shares of Singapore-listed Sheng Siong Group and Dairy Farm International Holdings gained 50.5 per cent and 12.7 per cent respectively, from the Mar 23, 2020 market low. But this year, Sheng Siong has fallen 3.2 per cent while Dairy Farm is down 18.9 per cent.

Statista's Singapore retail sales index of supermarkets and hypermarkets rose to 126.4 in 2020 - up from 97.1 in 2019 and the average of 95.8 over the last 9 years. Statista indices for supermarket sales in other geographies have shown similar trends.

The penchant for grocery stocks in some other markets has continued this year. In the United States, the Dow Jones US Food Retailers & Wholesalers Total Stock Market Index has gained 31.1 per cent this year. Meanwhile the FTSE 350 Food & Drug Retailers Index - which includes the likes of J Sainsbury, Morrison Supermarkets, Ocado and Tesco - is up 1.3 per cent.

Investors have likely been attracted to these sectors on the back of strong consumer demand. Restrictions to curb the spread of Covid-19 have forced consumers to spend more time dining at home, leading to higher spending on groceries. In the UK, improving prospects combined with low valuations created an optimum environment for private equity groups to shop for supermarket stocks.

Shareholders of UK supermarket chain Morrisons in mid-October approved a £7 billion (S$12.7 billion) takeover by American private equity company Clayton, Dubilier & Rice (CD&R) - a deal that many market watchers say is a bargain.

And last year, billionaire entrepreneurs Mohsin and Zuber Issa, along with private equity firm TDR Capital, acquired a majority stake in Asda, valuing it at £6.8 billion.

Fortress eyeing Sainsbury

Investors are now anticipating Fortress, which narrowly missed out in the bid for Morissons, to eye Sainsbury's. Shares of Sainsbury's hit a 7-year high in August following reports that it could be the next takeover target.

Supermarkets in the UK have been undervalued for some time due to poor shareholder returns amid a depressed economy since the Brexit referendum in 2016, said Ethan Hsu, head of retail at Knight Frank Singapore. "Coupled with a weak sterling and low interest rates, supermarket assets in the UK, especially those with strong fundamentals, would represent good value to foreign investors based on their affordable prices," said Hsu.

Stephen Springham, head of retail research at Knight Frank UK, added: "They are perceived to be a strong source of income, with much more limited risk than other retail assets. The UK grocers all have strong covenants, leases are long and the likelihood of the tenant walking away or closing stores is very limited."

Also, some of the UK supermarket chains own a substantial number of their stores, production facilities and distribution centres - versus leasing them.

"The value of their real estate portfolio could be more than the company's market value, which can also lead to easier financing for the investors," said Hsu. Morrisons, for instance, owns about 85 per cent of its close to 500 stores, as well as manufacturing sites, making it attractive to private equity bidders.

Springham estimated Morrisons' property portfolio alone to be worth about £10 billion compared with its market cap of under £7 billion prior to the takeover.

Post-acquisition, private equity funds can tap supermarkets' loyal customer base and expand into new verticals, said Oliver Wilkinson, deals strategy leader at PwC Singapore.

They could also divest attractive assets owned by the supermarket players to free up cash, he added.

Even as traditional retailers struggle to compete with e-commerce, supermarkets remain resilient.

The penetration of online grocery is much lower as it is harder to make e-commerce work with fresh produce, said Wilkinson.

Some e-commerce players have therefore seen value in investing in brick-and-mortar grocery retail.

"To e-commerce players, supermarket chains provide additional touch points in the 'omni-channel' strategy, as well as strong supply chain and logistical backing that comes with it," said CGS-CIMB analyst Ong Khang Chuen.

Physical grocery space

In 2017, Alibaba purchased a 36 per cent stake in Sun Art, one of its early investments in the brick-and-mortar grocery space, as part of its "new retail" strategy of integrating online technology into traditional retail. That same year, Amazon.com spent some US$13 billion to acquire US supermarket chain Whole Foods.

But most industry observers do not see bidding wars emerging for local or even regional supermarket plays, due to slight differences between markets.

They also noted that not all supermarket operators are attractive as takeover targets. The supermarket business still has slim margins, and faces the challenges of intense competition and a demanding customer base.

Unlike the US and UK markets, which commonly have what the industry calls "big-box retail", Singapore tends to have smaller supermarket operations, said DBS analysts Yong Woon Bing and Derek Tan.

They reckoned that a better proxy for supermarket spending here could be the suburban retail asset class, whose malls are well located and serve the needs of a captive population staying in the vicinity.

Furthermore, supermarket operators here do not directly own stores. Most of the stores under Sheng Siong and Dairy Farm International are leased. On the other hand, the UK's supermarket chain Morrisons is arguably more attractive given its property portfolio, said the DBS analysts.

The size of Singapore's population also may not be compelling enough to investors seeking acquisition opportunities that can meet yield expectations for their shareholders, said Hsu of Knight Frank.

Phillip Securities' research head Paul Chew said Sheng Siong remains attractive given that it has been gaining market share in groceries spend in Singapore over the past several years.

"But any (prospective) buyer will need to adapt and maintain Sheng Siong's intensive business model of low cost and management. An alternative purpose for purchase is to remove a competitor," said Chew.

The appeal of the grocery business will depend on the motivations of investors, according to Springham of Knight Frank.

"Food stores are a mature asset class, so they are never going to be a 'quick win' and deliver spectacular returns over a short time frame as other sectors might," he said.

"But they are low risk, a safe haven for investment, and offer strong income returns over a longer time frame. In this regard, they are definitely the safest of the retail use classes," he added.

Ong of CGS-CIMB said there will always be interest in supermarket assets from a strategic point of view: "To property developers, supermarkets can be good anchor tenants for commercial assets. To private equity funds, it also provides stable cash generation amid other possibilities."