China Food Retailing:Hypermarket operators try to stay relevant with new format

Supermarkets/CVS to continue to gain market share .

    The FMCG volume growth slowdown in the hypermarket segment might be one of the reasons why hypermarket operators are testing new formats like supermarkets and convenience stores (CVS). The challenges of smaller formats are in product selection, back-end logistics, and DC support of the chain. Based on public data, only Family Mart’s convenience store chain is profitable in China. Channel fragmentation continues to evolve and modern trade as a whole continues to take share from the traditional. Within the hypermarket space, we prefer Yonghui given its resilient position with more fresh offerings and its geographical positioning with the least impact from e-commerce.

    Hypermarkets slowing down; supermarkets/CVS outperformed .

    Further to our note Key takeaways from Bain’s presentation on FMCG published on 27 July 2015, which focuses on FMCG trends, we extend our discussion to the food retailing channel. The key findings: 1) supermarkets and hypermarkets still dominate the urban FMCG retail market, with a total sales mix of 62.8% in 2014; 2) hypermarket growth has slowed down, mainly due to traffic erosion; 3) supermarkets/CVS have outperformed in terms of traffic and growth, mainly driven by ASP improvement and larger package size; and 4) online channels have surged on an increasing penetration rate, greater shopping frequency and larger order size. With hypermarket growth slowing down, leading local retailers have performed better than foreign retailers.

    Hypermarket players are testing supermarket/CVS formats .

    Hypermarket operators (Carrefour, Metro, Lotus, and RT Mart) have started testing different store formats, i.e., convenience stores. We believe this is an encouraging trial, as 1) CVS is still in the developing stage (shopping frequency of nine times/year is much lower than hypermarkets’ 24 times/year); and 2) CVS have maintained stable traffic in a challenging environment.

    Leading CVS start to bear the fruit .

    Most of the CVS chains are loss making. We believe underdeveloped logistics facilities have hindered the development of CVS in China. CVS have limited store space and require more logistics capabilities, especially in warehousing, stock replenishment, and cold chain transportation, in our view. Family Mart is one of the best CVS operators; it started to make a profit in 2014.

    Valuation and risks .

    Our primary valuation methodology is DCF, which captures the future cash flow of consumer companies. We also use trading multiples in the China/HK consumer sector. Downside risks: low CPI, rising operating costs, intensified competition from foreign players and online channel, and slower-than-expected expansion plans.