This post is the third in a series on Investing in Asia.
The state of asset plays in Asia was the subject of the previous post in this series on investing in Asia. In it, we mentioned that Forager has uncovered ‘a number of well-managed Asian companies with a clear area of expertise’ and promised to share a story with you.
That story is about the Forager International Shares Fund’s first investment in Asia, supermarket operator Sheng Siong (SGX: OV8).
Sheng Siong is the third largest grocery retailer in Singapore, behind NTUC FairPrice and Dairy Farm-owned Cold Storage (SGX: D01). The company’s stores are a hybrid between old-school Asian wet markets and modern supermarkets. They cater to the lower income segment and are mostly located in the areas surrounding the Lion City.
The first Sheng Siong supermarket was opened by Mr Lim Hock Chee and his brothers in 1985. Business since then has flourished thanks to a reputation for low prices and speedy service. Today the chain has 39 stores generating around S$760m in annual sales.
Sheng Siong is a minnow in an industry where scale matters. But despite its size, the company’s profitability is the envy of larger international chains, as you can see in the accompanying chart.
The Lim brothers have kept costs low by investing in technology and increasingly skipping the middleman when procuring supplies. Home brands, which are priced lower than comparable international ones but carry a higher margin, have also been a winner for Sheng Siong.
But it’s the way Sheng Siong utilises its retail space that makes it a wonderful business. As Mr Lim puts it, ‘ever since Sheng Siong was established, it has always been thinking hard about how to raise sales revenue per square foot’. It’s not by chance that Sheng Siong’s asset turnover ratio (sales/assets), a measure of efficiency, is a lot higher than that of other widely known supermarket operators.
The combination of a high margin and high asset turnover has produced a stunning return on equity of almost 50% over the past five years (adjusting for excess cash on its balance sheet). This is even more astonishing given that the company is debt-free.
At the time Forager invested in early 2013, Sheng Siong’s market capitalisation and net income were S$850m and S$40m respectively, giving it a price to earnings ratio of 21 times. It hardly looked a bargain.
However the business was opening new stores stealing market share from the traditional markets. Revenue was growing strongly and margins were also improving thanks to a new modern distribution center at Mandai Link. Importantly, the business was also paying a 5% dividend yield and didn’t require additional funding to finance its growth.
Three years later, the business is now earning almost S$60m in annual profits and the market capitalisation has risen to S$1.3bn. In other words, the price to earnings ratio is still a high-looking 21 times. Is this multiple still justified?
While the Lim brothers have a great track record of growing the business, the reality is that there can only be so many supermarkets in Singapore and margins are unlikely to improve even further. So if Sheng Siong wants to grow meaningfully from here, it will probably have to look overseas or diversify into adjacent areas.
Both options carry significant risks and we recently decided to sell our shares for a 50% return (including dividends) over a period of a bit less than three years.
While the Fund has enjoyed even better returns in Asia from other stocks, Sheng Siong illustrates the breadth of opportunities available. Asia may carry more than its fair share of cigar butt stocks— most of which are cheap for good reasons— but there are well-managed, focused and shareholder-friendly gems to be uncovered, too.
3 thoughts on “Hunting for Quality in Asia”
Thanks for the article.
Out of curiosity, how have Singaporean long term interest rates moved over those 3 years. More to the point, if there has been a significant lowering of the risk-free rate then how does this affect your view?
Although there is an obvious difference in the size of the growth runway available, an interesting stat that I heard about eighteen months’ ago is that if you paid 1000 times earnings for Wal Mart back in 1974, then your CAGR since then would nevertheless be in the double digits.
SG – your comment on Walmart is interesting, and is basically the foundational philosophy of ‘growth investing’; i.e. that sustained high growth can quickly compensate for a high entry multiple over time. The problem is the hindsight survivorship bias issue. For every spectacular long term success story, there are many companies that initially appeared to have promising prospects which subsequently ran into unexpected difficulties, and if you pay a high multiple, there is a long way down if you’re wrong. Walmart put a lot of other companies that seemed to have bright prospects out of business along the way. Could you have picked the one winner at the time?
At first there appears to be an asymmetry – if I win I make, say, 50x my money, turning a $10k investment into $500k; but if I’m wrong and its a 50-bagger in reverse and lose 98%, its only $9.8k downside. The problem with this is that to take the remaining $200 and turn it back into $10k requires 50x upside. The intuitive asymmetry is therefore illusory and is simply a reflection of the mathematical impact of compounding. This is why value investing work’s quite well – it covers your downside. If you lose 50% you need to make 100% to get back even in dollar terms. Avoiding large losses is therefore key to sustaining high returns long term.
However, I agree with Alvise that paying a reasonable multiple premium for a good quality company is often well worth it. It’s like investing in bonds. Would you rather buy a very-high grade corporate bond – say from Coke – at a 5% yield, or a speculative grade issue – perhaps a high cost shale oil company – at 8%? If the default probability is more than 3% higher, the yield premium is illusory. The same goes for buying a stock at 20x PE (5% earnings yield) vs. 12.5x PE (8% earnings yield). If there is only a 3% higher chance the business’ long term earnings power is structurally impaired, the return premium is also illusory.
Buying stocks on a low PE just because they are on a low PE is like buying junk bonds just because they have a high yield. That’s not real value investing. Real value investing is about finding mispriced situations where the return on offer is attractive relative to the company’s quality and the level of risk involved. I.e. a Coke bond yielding 6.5% when it should be yielding 5%.