Grocery Shopping in China

Grocery Shopping in China

By KOPIN TAN | MORE ARTICLES BY AUTHOR

Big food retailers in China face daunting challenges, not the least of which is the rising cost of labor; but they also serve a vast and growing and hungry market

Emerging Markets

Investors scouring for bargains might want to add Chinese supermarkets to their shopping lists, even if they may not want to load up the carts just yet.

As the recession threat eases, U.S. food retailers' stocks have eked out small gains, while shares of so-called hypermarket operators―the heavyweight class that includes Costco (ticker: COST) and Wal-Mart Stores (WMT)―have jumped 17% over the past year. In contrast, their Chinese counterparts have only slipped into a deeper funk, weighed down by soaring rents and cautious consumers. More problematically for investors, China's minimum wage rose 22% last year, and Beijing hopes to double that wage between 2011 and 2015.

None of this is good news for Lianhua Supermarket (980.Hong Kong), which runs 152 hypermarkets, 2,984 supermarkets and 2,014 convenience stores. About 85% of its stores are in eastern China, including many in Shanghai, that mecca of unabashed consumption. While sales grew 6.2% in 2011 to 27.5 billion yuan (US$4.4 billion), surprisingly stiff operating costs held profit growth to just 0.7%. Same-store sales growth slowed from 8.6% in 2011's first half to the low single digits by the second half, before shrinking to -2% earlier this year. Alarmed investors have sent shares down 54% over the past year, far worse than the 14% pummeling meted out to the Hang Seng Index.

Lianhua faces challenges. It plans to open 350 stores this year, but growth isn't assured. Eastern China is saturated with retailers. Last year, it opened 390 stores but had to shut 412. Changing government rules also limit how customers may use popular prepaid Lianhua cards to pay third parties, and that means dwindling commissions and fees, adding to the pressure to run stores even more efficiently.

But it helps that expectations are falling swiftly and sharply. Analysts have been slashing profit estimates, the bearish case is well articulated, and shares slumping near HK$8.51 fetch just 10.7 times projected 2012 earnings, well below historical averages and multiples commanded by its peers. And, in the long run, rising wages and urbanization improve the demand for supermarkets.

What's more, Lianhua has been lifting its cash stash, ending 2011 with net cash of more than US$1.5 billion―more than its current market cap of $1.26 billion. The last time the undervalued stock traded below its net cash position was in early 2009, noted Selina Sia, Mirae Asset's head of consumer research. Since then, Lianhua has not only raised earnings, "it has also worked on system logistics and procurements in order to grow its business further."

LIANHUA IS HARDLY THE ONLY choice, of course. Sun Art Retail Group (6808.Hong Kong) runs some 230 stores all over China, nearly all of them hypermarkets whose vast volumes give the company great bargaining power with suppliers. But the robust growth and high sales per square meter come with a heftier price tag, with shares fetching 33 times 2012's profit.Wumart Stores (1025.Hong Kong) are all over Beijing and Tianjin, but shares have corrected just 8% over the past year and still fetch 21 times profits. That's hardly a bargain.