1 Reason Why I’m Staying Away From Sheng Siong Group Ltd Shares, For Now

Sheng Siong Group Ltd (SGX: OV8) is a homegrown supermarket chain with 54 outlets in Singapore. The company’s outlets are primarily located in the heartlands of our country, providing customers with both “wet” and “dry” shopping options. Sheng Siong recently expanded into China as well.

Sheng Siong’s strengths

The company is well-known for selling fresh produce and goods at competitive prices; this trait gives it quick brand-name-recall among local consumers. Furthermore, Sheng Siong has managed to increase its gross profit margin and net profit margin over the years, which could point to a durable competitive advantage. The following chart shows Sheng Siong’s gross profit margins from 2013 to 2017:

Source: Sheng Siong 2017 annual report

Sheng Siong’s gross profit margin has grown from 23.0% in 2013 to 26.2% in 2017. Likewise, its net profit margin has climbed from 5.7% to 8.4% during the same time frame.

The company could also have growth potential in China with its new supermarket in the country. During 2018’s third-quarter, the China supermarket contributed to 1.2% of Sheng Siong’s total revenue growth of 8%. The company’s growth strategy in the Middle Kingdom is to nurture the growth of its new supermarket and build the Sheng Siong brand in the country.

Expensive goods

Despite Sheng Siong’s merits, I’m staying away from its shares for now due to its high valuation.

as of 14 November Sheng Siong’s share price stands at S$1.06 , they had a trailing price-to-earnings (PE) ratio of 23 and a dividend yield of 3.2%. Its EV/EBITDA (enterprise value to earnings before interest, tax, depreciation and amortisation) ratio was 15.

In my opinion, the PE and EV/EBITDA ratios are too high.

For perspective, the SPDR STI ETF (SGX: ES3) had a PE ratio of 10.8 on the same day with a higher dividend yield of 3.7%. The SPDR STI ETF is an exchange-traded fund (ETF) which tracks the fundamentals of Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI).

I think the high valuation for Sheng Siong stock will be warranted only if it has phenomenal growth in its core market in Singapore. However, that is not the case, in my view. There is keen competition in the supermarket space, especially with online supermarkets such as RedMart and HonestBee. I also think that there will be a saturation point in terms of store-growth in Singapore for Sheng Siong, due to our city-state’s limited size.

The supermarket in China just started operations in November 2017. It remains to be seen if Sheng Siong can gain a competitive advantage in China. As such, I would be watching to see if the new supermarket can sustainably grow its revenue and earnings in the coming years.

The Foolish takeaway

I’m staying away from Sheng Siong’s shares due to its high valuation, even though the company’s underlying business is strong. If the valuation comes down to a more palatable level for me, I might consider the company for my portfolio. But for now, I’m sitting on the sidelines.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of Sheng Siong Group Ltd. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.