Given the dismal economic outlook, Sheng Siong Group (SSG) represents a good defensive play and we like its strong fundamentals and healthy balance sheet. Its plan to increase the contribution from the higher margin fresh produce segment and deepen its penetration into Singapore’s hinterlands is positive. However, the closure of two key stores will temporarily affect SSG’s revenue, especially in FY11. The stock has outperformed with a strong 35% appreciation since listing, largely due to its defensive business and proxy play into Singapore’s domestic consumption demand. We initiate coverage on SSG with a HOLD rating at a fair value estimate of S$0.43 based on a discounted free cash-flow-to-equity model (cost of equity: 7.6% terminal growth rate: 2%), and this translates to a dividend yield of 4.6% based on FY11F earnings. We will turn buyers of SSG at S$0.40 or lower.

Synonymous with value. Sheng Siong Group Ltd (SSG), with its highly recognizable brand name, is one of the top three supermarket chains in Singapore in terms of revenue, and has a current size of 23 supermarket stores with three wet market stalls.

Fresh produce – a lucrative segment. Fresh produce contributes about 30% to its revenue, with strong gross profit margins ranging from 21% to as high as 30%. Naturally, management hopes to achieve higher contribution from this segment going forward. Coupled with their expertise in handling fresh produce and the new distribution centre where it can handle larger quantities of fresh produce, we expect to see increased revenue contribution (> 50%) from this segment within the next few years.

Store expansion to drive future growth. An expansion of its store network is essential to drive future growth and we believe that the local market is able to support additional stores without over-saturation. There are several highly populated areas in Singapore (approximately 45% of the total number of Singapore residents) where SSG lacks a formal store presence, and management has identified Sengkang, Hougang and Toa Payoh as key growth areas in the interim. Although NTUC Fairprice has between four to five stores in these locations, most of these are located in the central areas, which frees up the hinterlands for SSG to enter.

Temporary revenue dip in FY11. Due to the closures of two key outlets, lower revenues are forecasted (-10% YoY) in FY11 although we expect profitability margins to at least maintain at its current adjusted FY10 levels. However, the fall in revenue is expected to be temporary as the two new outlets opened in FY11– in areas with comparable residency levels as the two closed stores – will contribute fully in FY12. We estimate FY12 revenue growth to pick up by at least 12% YoY.

Initiate with HOLD after spectacular share price run-up. Its shares have appreciated almost 35% since its listing. We like SSG for its strong fundamentals and healthy balance sheet, but are also mindful of the temporary revenue decline expected in FY11. Overall, given the dismal economic outlook, SSG still represents a defensive play into domestic consumption demand. We initiate coverage on SSG with a HOLD rating and a fair value estimate of S$0.43 based on a discounted free cash-flow-to-equity model (cost of equity: 7.6% terminal growth rate: 2%), and this translates to a dividend yield of 4.6% based on FY11F earnings. We will turn buyers of SSG at S$0.40 or lower.