SECTOR BRIEFING number DBS Asian Insights DBS Group34 Research • January 2017 China Consumer Sector Online Groceries: The Fast Lane DBS Asian Insights SECTOR BRIEFING 34 02
China Consumer Sector Online Groceries: The Fast Lane
Mavis HUI Research Director DBS Vickers (Hong Kong) [email protected]
Eric Yee, CFA Senior Research Analyst DBS Vickers (Hong Kong) [email protected]
Produced by: Asian Insights Office • DBS Group Research
go.dbs.com/research @dbsinsights [email protected]
Chien Yen Goh Editor-in-Chief Jean Chua Managing Editor Geraldine Tan Editor Martin Tacchi Art Director DBS Asian Insights SECTOR BRIEFING 34 03
04 Investment Summary E-Grocery Driving Growth 06 Case Study: The United Kingdom Case Study: South Korea 25 What Does This Mean for China? Rapid Development of Cold-Chain Logistics E-Grocery Could Double in Two Years Who Could Tap Faster Growth? Industry Consolidation on the Cards DBS Asian Insights SECTOR BRIEFING 34 04
Investment Summary
ccording to e-Marketer, global online sales are well set to grow at a 21% five- year compound annual growth rate (CAGR) to reach US$3.5 trillion by 2019, equivalent to a high penetration rate of 12.4%. Compared to sales CAGR of 6% for the brick-and-mortar segment over the same period, retailers around the world Aincreasingly seek to tap growth from e-commerce. Some players form partnerships through mergers and acquisitions (M&A), joint ventures or strategic alliances, while others develop their own e-platforms.
E-grocery sales to Non-food segments have already seen robust online sales growth in China over recent years. double These include home appliances, clothing, footwear, and cosmetics, etc. However, e-grocery has lagged and has a much lower online penetration rate compared to other consumer segments. We expect this to change thanks to advancements in cold-chain logistics, reasonable internet penetration, and an already strong e-commerce culture. We believe China’s e-grocery sales could nearly double from a low base to reach about 240 billion Chinese yuan in two years, attaining around 5% penetration rate by 2017 (2015: 2.8%).
Learning from Korea At present, South Korea and the United Kingdom (UK) are among developed countries with and the UK the highest e-grocery penetration rates of 8% and 5%, respectively. We studied these two markets to deduce what is in store for the Chinese grocery industry. In particular, we focused on (1) the overall rate of growth in e-grocery; (2) potential criteria to achieve a break-even point for online operations; and (3) other components that could drive success in overall grocery retailing. There are certain similarities in the UK and South Korea, which could be applied to help forecast development trends in China.
Best practices In the UK, e-grocery has gained good traction as seen from the profitable operations of Ocado, a pure online grocery retailer. Its winning factors could be replicated in China to a good extent in the medium-term. Aside from e-commerce, convenience stores could also offer scalable, multi-channel expansion for grocery retailers to better adapt to changing shopping habits, such as the rising demand for fresh foods, instant foods, and made-to-order products (e.g. salad, sandwiches). Another emerging format includes the very popular Aldi and Lidl discount stores that focus on just 2,000-odd stock keeping units (SKUs) and aim to provide more private labels. Premiumisation to offer higher-end product quality & services could also help in differentiation as seen from Waitrose. As for South Korea, key growth drivers in the grocery market include e-grocery and convenience stores. A rising focus on private labels has also become a trend to enhance performance. DBS Asian Insights SECTOR BRIEFING 34 05
Keys to success As we apply what we have learnt to China, we believe the key to succeed in grocery retailing over the medium-term include (1) better operating scale and market share; (2) strong business- to-business (B2B) / business-to-consumer (B2C) online capabilities with the right talents/ technicians; (3) higher scalability (e.g. via convenience stores, specialised discount stores); (4) better offering of more niche products (e.g. private labels, exclusively available fresh products); and (5) potential premiumisation for further differentiation.
Creative collaboration Besides the above, any impending opportunities from collaboration among various food & beverage (F&B) brands and retail companies along the value chain could also bode well for the sector. These operators could span from local/overseas suppliers to online/offline retailers, as well as logistics partners. As such, we see ample room for more M&As, partnerships or alliances in China’s grocery market going forward.
Ample room for more M&As, partnerships or alliances in China’s grocery market going forward DBS Asian Insights SECTOR BRIEFING 34 06
E-Grocery Driving Growth
Online retail propelling tatistics show the e-commerce channel has continued to propel global retail growth spending, in tandem with the expanding online payment infrastructure and logistics capabilities, especially in last-mile deliveries. According to e-Marketer, global online retail sales could grow at a 21% CAGR to reach US$3.5 trillion by S2019, as compared with a 6% CAGR for offline retail sales. With this, the e-commerce penetration rate of global retail spending will jump to 12.4% in 2019 from 7.3% in 2015.
Diagram 1. Global online retail spending
Source: eMarketer (E-commerce penetration rate = online sales as a % of total retail sales)
E-commerce penetration rates in South Korea, China, and the UK topped the world ranking, at 16.4%, 12.8%, and 12.5%, respectively in 2015 due to several key factors:
1. In South Korea, high internet penetration (92.1%1), affordable and fast internet speed (4x the world’s average), and the rising demand for convenience amidst busy lifestyles have collectively propelled e-commerce sales. DBS Asian Insights SECTOR BRIEFING 34 07
Diagram 2. Cost of internet usage (2013)
Source: valme.io
Rise of domestic giants 2. China has experienced an e-commerce boom in the past few years, seeing the rise of big domestic players such as T-mall.com, Taobao.com, and JD.com, that have all ploughed in huge investments in internet, logistics, and delivery services to expedite e-commerce development. Aside from a fairly high rate of mobile commerce penetration (around 50%), limited product offerings in the lower-tier cities and their less developed transportation networks have all reinforced strong online progress.
Diagram 3. Mobile commerce penetration
Source: E-marketer, ecommercenews.eu, internetretailer.com, outerboxdesign.com, DBS Vickers DBS Asian Insights SECTOR BRIEFING 34 08
Global shoppers 3. As for the UK, its low-cost internet service and high internet penetration (91.6%2), well-developed online wallets, as well as the popularity of its websites among shoppers of other English-speaking countries such as the US, Singapore, and Australia, have all supported e-commerce expansion. Favourable policies (e.g. Distance Selling Regulations) and a more compact country size versus the US, for instance, also allows better domestic logistical efficiency.
Diagram 4. Top three countries with the highest e-commerce penetration rates worldwide (2015)
Source: China Bureau of Statistics, Office for National Statistics UK, KOSIS
E-grocery – catching up 4. We have already witnessed huge e-commerce sales expansion for non-food categories, including home appliances, apparel, footwear, cosmetics, but e-grocery is a laggard as it involves additional issues of storage and cold-chain deliveries. Hence it only become a target growth area in recent years as most other e-categories are already well developed. E-grocery could also help increase online traffic to benefit overall e-commerce growth. In the following sections, we will explore the more advanced British and South Korean e-grocery retail industry to seek clues for the upcoming progress in China.
Diagram 5. China’s e-grocery penetration is the “last leg”
E-grocery could help increase online traffic to benefit overall e-commerce growth Source: Euromonitor DBS Asian Insights SECTOR BRIEFING 34 09
Case Study: The United Kingdom
Traditional grocers Sainsbury’s, the second largest grocery player in the UK, has released its internal market losing market share projection up to 2020, suggesting that online marts, discount retailers, and convenience stores would continue to grab market share from conventional supermarkets in the coming years. The online grocery model has proven to be feasible as seen from the initial success of Ocado, a pure online supermarket with strong fulfilment capabilities. Sainsbury’s convenience stores have registered consecutive high-teen’s growth in the past three years, which helped to mitigate declining supermarket sales. Discounters, such as Aldi and Lidl from Germany, have also disrupted the UK grocery market with their deeply slashed prices, and are set to grow further.
Separately, some high-end customers continue to stick to premium grocery stores like Waitrose, and such positioning could probably sustain demand from selected shoppers too.
Diagram 6. Grocery market channel share (2007- 22F)
Source: Sainsbury’s 2015 annual report (company estimates) Online Grocers Showcasing potential Major grocers have seen further profitability deterioration as a result of the lingering price war and intensifying competition in the industry, especially given the expansion of aggressive discounters like Aldi and Lidl in past three years. Average earnings before interest and taxes (EBIT) margin of the Big-3*, namely Tesco, Sainsbury’s, and Morrisons, had slumped to 2.3% in 2015 from 5.8% in 2010. On the contrary, online grocery started to showcase its potential, as seen from the rising margin of Ocado since it turned profitable in 2014, driven by better operational efficiency of its centralised fulfilment centres (CFCs) and higher revenues as a result of its partnership with Morrisons.
* Asda, the third-largest grocery player has been omitted, given the lack of publicly available data. DBS Asian Insights SECTOR BRIEFING 34 10
Diagram 7. Core EBIT margin
Diagram 8. Core net margin
Sources: Bloomberg Finance L.P., DBS Vickers Peers = Morrisons + Tesco + Sainsbury’s Ocado: 2015=FY11/15; Tesco and Morrisons: 2015=FY2/16; Sainsbury’s: 2015=FY3/16
Ocado’s innovations Brick-and-mortar retailers initially shunned the online grocery business, given the high capital requirements (for delivery and fulfilment capabilities), high price transparency (less room for arbitrage), and a potentially lower average spending given less impulsive online purchases. However, Ocado’s successful e-grocery format with its proprietary technology and super- efficient CFC economic model, which is of low cost, outweighs the disadvantages mentioned above. In 2013, Ocado’s second CFC at Dordon, UK was completed with a third more capacity at a third less capital expenditure. In the same year, it formed a partnership with Morrisons to run the latter’s online business. Through the partnership, Morrisons bypassed expensive DBS Asian Insights SECTOR BRIEFING 34 11
IT development costs and leveraged on Ocado’s e-commerce and logistics experience; while Ocado created additional revenue streams from the partnership and this led to its first profitable year in 2014. In 2015, a modular, scalable, faster-to-deploy, and cheaper-to-build third CFC was erected in Andover, UK to further strengthen its operations.
Diagram 9. Ocado pioneered numerous innovations
• Critically-acclaimed app for iPhone and iPod touch - “Ocado on the GO” • Order created in seconds using past shopping baskets - “Your Instant Order” • “Life Guarantee” - Ocado is the first and only online grocer to display “use-by” dates for fresh produce • One-hour delivery slots • Groceries delivered right to kitchen table • Satellite navigation as standard • Green delivery slot for customers • Bio-diesel powered vehicles • Colour-coded grocery bags • Handheld computers to speed up doorstep transactions • Closed loop grocery bag recycling • Free text message order reminder on delivery day • Driver boot mitts • Pre-pay delivery pass - “Ocado on Demand” • Comprehensive and accurate back of pack information, including nutritional details
Source: The company
Diagram 10. Criteria for Ocado’s success
• Efficient Business Model - Efficient centralised fulfilment centre (CFC) models • Experience - More than ten years of operational experience • Scale - Company turns profitable when revenues expanded to near £1 billion • Monetising technology - Earns service fee by providing end-to-end online grocery business solutions to clients, such as partnership with Morrisons • Partnership - Founding history with John Lewis Partnership, with long-term sourcing agreement with the latter’s supermarket division, Waitrose • Size of country - Operation in the UK, a relatively smaller country with easier logistical arrangements. The US has 39x as much land, population density is 7x lower. China also has 39x as much land, and a 1.4x lower population density.
Source: DBS Vickers DBS Asian Insights SECTOR BRIEFING 34 12
More O2O Increasingly, traditional grocery retailers are collaborating with online plays. In 2015, collaborations Sainsbury’s began a partnership with T-mall.com and became the first UK grocer to export goods to China through the Tmall Global platform. In February 2016, Morrisons also expanded its external collaboration – linking up with Amazon to supply fresh, chilled, and frozen food to the latter’s Prime Now and Pantry services in the UK. Amazon Prime is a membership scheme offering consumers access to unlimited home delivery at a fixed monthly fee; it is seen as a balanced solution between the less-convenient pick-up point delivery model offered by traditional retailers, and costly grocery delivery services offered by pure online grocers. Following the partnership, the market is also speculating on whether Amazon will strike a deal with Ocado in the future.
While more offline-to-online (O2O) business collaborations are expected ahead, the table below outlines the major economic differences between online grocery retailers (e.g. Ocado) and traditional brick-and-mortar supermarket plays (e.g. Sainsbury’s) to enable a better understanding of a sustainable e-grocery business model.
Diagram 11. Comparing online and offline operations in the UK
Unit: GBP m Online (Ocado) Offline Remarks (Sainsbury’s) Revenue (2015) 1,108 23,506 EBIT (2015) 19 707 Operating profit per GBP 100 basket Revenue 100.0 100.0 Cost Cost of goods 66.0 59.4 Assumes lower sourcing cost (around 10% discount) for Sainsbury’s/Big-3's given larger scale Rental 1.0 2.4 Offline Big-3's have to pay more rental for physical stores Labour 19.2 10.8 Higher wages for IT engineers for Ocado vs. outlet staff for Big-3's. This is fixed cost and is subject to operating leverage Depreciation 4.1 2.4 Higher depreciation for Ocado due to completions of own-built CFCs Other distribution 8.0 22.0 Higher operating/supply chain cost for offline costs retailers (e.g. transportation from regional distribution centre to all outlets + operating cost of all outlets) vs. Ocado's delivery costs from CFC to customers' doorsteps Operating profit 1.7 3.0
Source: Companies, DBS Vickers DBS Asian Insights SECTOR BRIEFING 34 13
A win-win relationship As seen in the table, the (predominantly) offline model of Sainsbury’s*, which had more than 20x bigger revenue base than Ocado in 2015, was more profitable than the online (Ocado’s CFC) model, as the latter has yet to achieve economies of scale. As such, Ocado has the potential to earn a better margin as it scales up. Other major differences include the importance of having strong talents for technology development, as seen from Ocado’s much higher staff cost ratio, and its benefits from lower fixed overheads as compared to Sainsbury’s that runs physical stores. This could suggest that further collaborations between traditional offline players and pure e-grocers might complement each other in terms of scale and fixed cost allocation for a win-win relationship.
Convenience Stores (CVS) Defending declining Margins of the listed Big-3 food retailers have taken a hit, being undercut by intensified margins competition from e-grocers and discounters. It was especially notable for Morrisons and TESCO, which saw their net margins falling from 2.9% to 0.1%, and from 3.4% to 0.5%, respectively in 2015. Interestingly, Sainsbury’s, which had been operating at lower margins than the two, sailed through 2015 with a net margin of over 2%, partially attributable to its diversified multi-channel strategy.
Diagram 12. Big-3 food retailers: Gross and net margins
Collaborations between traditional offline players and pure e-grocers might complement each other in terms of Source: Bloomberg Finance L.P., company reports, DBS Vickers scale and fixed Ocado: 2015=FY11/15; Tesco and Morrisons: 2015=FY2/16; Sainsbury’s: 2015=FY3/16 cost allocation
* Sainsbury’s online sales reached 4.7% of group revenue in 2015. DBS Asian Insights SECTOR BRIEFING 34 14
Offsetting falling Over the past three years, Sainsbury’s has seen rising sales from its convenience stores and revenue online channel that helped offset declining revenue and operating deleverage from its conventional supermarket division. At the same time, convenience stores have increasingly captured customers who value convenience more and are less price-sensitive, with slightly marked up products that helped to sustain profitability for Sainsbury’s. Looking ahead, Sainsbury’s is also expected to generate additional cost savings of about £120 million per annum on the back of synergies from its recent £1.4 billion acquisition of rival, Home Retail Group which owns Argos, through broadening its product range into homeware by putting Argos stores into its supermarkets and acquiring Argo’s online-delivery business.
Diagram 13. Sainsbury’s: Sales growth by channel (% y-o-y)
Source: Sainsbury’s Diagram 14. Market share of UK supermarkets from 2014 to 2016F
Source: Kantar Worldpanel DBS Asian Insights SECTOR BRIEFING 34 15
Discounters Discounters like Aldi and Lidl have grown aggressively and have taken market shares from the Big-4. Over the past two years, both Aldi and Lidl saw their market shares increasing by 1.5 percentage point (ppt) to 5.8%, and by 1.1ppt to 4.2%, respectively. Their strategies are to keep focusing on their niche products, keeping costs low, and to pass on savings to consumers.
Less is more The primary method for discounters to keep costs low is by maintaining a limited number of SKUs that are popular among customers. Both Aldi and Lidl only maintain approximately 2,000 SKUs, representing only 10% of what Sainsbury’s, Morrisons, and Asda have in store, and dwarfed by TESCO’s 80,000-90,000 SKUs. This is supported by their focus on private label products, which are produced by assigned independent manufacturers under close monitoring, at cheaper costs and assured product quality. Discounters could then offer the private label merchandises at much lower prices (as much as 50% discount) than well- known brands. The strategy has proven to be successful, and also helps to avoid the “range overload” issue (i.e. overwhelmed with choices) faced by typical supermarkets.
Diagram 15. No. of SKUs of major supermarkets
Supermarkets No. of SKUs TESCO 80,000 - 90,000 Morrisons 22,000 Asda 20,000 - 25,000 Sainsbury’s 20,000 - 25,000 Aldi 2,000+ Lidl 2,000+
Source: Company reports, European Supermarket Magazines, News
Premiumisation Premium players While the price-sensitive mass-market has flocked to discounters to get better value for maintaining market their money, wealthier consumers are actually sticking with premium grocers like Waitrose. share Waitrose is a chain of supermarkets operated by Britain’s largest employee-owned retailer, the John Lewis Partnership.
Waitrose is renowned for its loyalty card scheme, myWaitrose, which allows card owners to pick up a free cup of coffee when shopping at its stores. Coupled with Waitrose.com, which hosts online ordering including special orders of food and cake services for parties (“Waitrose Entertaining”), the company has enjoyed better-than-industry sales growth for the past three years. Its steadily growing market share (from 3.7% in 2005 to 5.1% in DBS Asian Insights SECTOR BRIEFING 34 16
2015) is a testament that premium quality products and services would always have their own followers. Diagram 16. Waitrose’s market share
Source: www.fooddeserts.org, Kantar, IGD DBS Asian Insights SECTOR BRIEFING 34 17
Case Study: South Korea
Diagram 16. Waitrose’s market share High growth in South Korea’s retail market is categorised into department stores, supermarkets & convenience stores, hypermarkets, convenience stores, e-commerce, and other channels including category- online channel focused specialty stores, wet markets, and TV home-shopping. The convenience stores category stood out with its robust growth, with a five-year CAGR of 15.5% (2011-2016). Online sales also grew strongly at a 10.2% CAGR during the period, as compared to the overall market’s five-year CAGR of 3.6%.
Diagram 17. South Korea retail – Channel breakdown
Others
(Others: e.g. specialty stores, wet markets, TV shopping) Source: KOSIS, DBS Vickers
Convenience Stores Decent sales growth The CVS sector has experienced robust growth, averaging at a mid-teen rate over 2011- 2016 even after excluding the exceptional 29.6% year-on-year (y-o-y) growth in 2015 (inflated mainly by higher cigarette prices as a result of the tobacco tax hike). Aside from the rising need for convenience amidst busy lifestyles, increasing demand for fresh products and instant foods (which has lifted shop traffic), favourable demographic changes (i.e. smaller households), and probably the social initiatives to protect small local businesses, such as government-regulated closures of big stores (e.g. hypermarkets are prohibited from opening stores within the direct vicinity of designated “traditional market zones”), have all led to decent sales performance in the CVS sector. DBS Asian Insights SECTOR BRIEFING 34 18
Diagram 18. South Korea CVS – Industry size and Diagram 19. South Korea Demographics growth
Source: KOSIS, DBS Vickers Source: KOSIS
Diagram 20. CVS: Fresh food and instant food Diagram 21. South Korea retail market and CVS % of monthly y-o-y growth total retail
Source: MOTIE Source: KOSIS, DBS Vickers DBS Asian Insights SECTOR BRIEFING 34 19
Further room to grow There are three major CVS brands in South Korea, namely “CU” (operated by BGF Retail), “GS25” (operated by GS Retail), and “7-Eleven” (operated by LotteGroup). They have dominated the CVS market, at respective shares of 32%, 31%, and 28% as of 20153. Driven by the strong growth trajectory, the CVS sector is seeing its contribution to South Korea’s retail market rising strongly to 5.9% in 2015 from 3.4% in 2010. However, such sales penetration is still deemed low as compared with that of neighbouring countries’, e.g. 9.2% for Taiwan and 7.8% for Japan, indicating that there is further room to grow.
E-Grocery E-grocery’s rising While South Korea has already clinched the position of the country with highest online sales popularity penetration globally, the bulk of sales are still coming from non-food items like clothing, electronics, and accessories, leaving grocery as the last leg for robust growth in recent years. Key growth drivers include:
1. Rising female labour participation rate As South Korea is one of the developed countries battling an ageing population, the government has raised the age of retirement and is encouraging more women to join the workforce, resulting in an increase in female labour participation rate from 50.1% in 2005 to 51.8% in 2015.
Diagram 22. Online sales and penetration in South Diagram 23. South Korea – Female labour Korea participation rate
Source: KOSIS Source: KOSIS DBS Asian Insights SECTOR BRIEFING 34 20
Higher female labour participation implies fewer housewives, and less free time for women to shop for groceries in stores. This has helped to drive traffic and sales of online grocers, especially the mobile platform where big retailers (e.g. E-mart, Homeplus, and Lotte Mart) observed strong y-o-y growth of more than 150% over the past one year.
Innovation by Homeplus was one of the pioneers to push forward South Korea’s e-grocery development, Homeplus by putting up the world’s first virtual store in a Seoul subway station back in 2011. The innovative concept was envisioned to help white-collar workers satisfy their grocery shopping needs while commuting on subway systems. Consumers were able to download a Homeplus app, scan a QR barcode against digital images of their chosen products and have those items delivered straight to their doorsteps. Homeplus offered about 500 items including food, electronics, toiletries, etc. in its virtual store.
Diagram 24. Homeplus’s virtual supermarket
Source: AFP Photo
2. Long working hours, high transportation costs, and busy lifestyles continue to support e-grocery demand In 2015, the Organisation for Economic Co-operation and Development (OECD) statistics ranked South Korea No. 3 in terms of the longest average annual hours worked per person (i.e. 2,113 hours) as it is a general belief that one’s identity comes from his/her title at work, which leads to long working hours. DBS Asian Insights SECTOR BRIEFING 34 21
Being one of the Asian metropolitan cities, Seoul also stands out as one with the highest public transportation costs. The average public bus fare stands at US$1.68, compared with Shanghai’s US$0.39, which is the lowest of all.
Diagram 25. Average annual hours worked in 2015 per employed person
Source: OECD Statistics DBS Asian Insights SECTOR BRIEFING 34 22
Diagram 26. Public bus fares in Asian metropolitan cities
Source: Singapore Land Transport Authority
Market leader goes As the biggest grocery player in South Korea that runs the most store formats including online supermarkets, hypermarkets, convenience stores, and online platforms, E-mart effectively mirrors the country’s retail operating environment. The company has seen a drop in net new openings of hypermarkets over the years, especially after stricter government regulations that sought to protect small businesses since 2011-2012 (see Diagram 27). On the other hand, the company’s online mall posted 27% y-o-y sales growth in 2015, after the opening of its first automated distribution centre in 2014 that was built to enhance operating efficiency and sales volume. Despite running at losses, this has been narrowing as operating margin improved from -8.8% in 2014 to -3.7% in 2015, along with better sales volume and operating leverage. Given such operating trends, e-commerce should sustain a much better growth than big supermarket/hypermarket chains in the medium-term.
Diagram 27. E-mart: Net increase of domestic Diagram 28. E-mart: Online mall gross sales & hypermarkets operating profit margin (OPM) Net increase of stores
Source: E-mart Source: E-mart DBS Asian Insights SECTOR BRIEFING 34 23
Private Labels Rise of house brands In a bid to outsmart its competitors, E-mart has started to move from pure retailing to develop its own private label products. The company launched its own “No Brand” label in April 2015, with product lines ranging from wet tissues to potato chips. The private label launch turned out to be exceptionally successful, urging management to lift sales target 5x, from 20 billion Korean won in 2015 to 100 billion won in 2016. This was also made possible by exporting the brands. For instance, its latest supply agreement was signed with Metro China in August 2016, following export distribution to Vietnam and Mongolia.
Another example is E-mart’s food brand Peacock, which is also exhibiting strong growth,
Diagram 29. Sales of E-mart’s own brand “No Brand” Diagram 30. Sales of E-mart’s food brand “Peacock”
Source: E-mart Source: E-mart
with sales jumping more than two fold to 82 billion won since its launch in 2013. Peacock is positioned as a household brand for home-meal replacement products, which can be instantly cooked with hot water and microwave, tailored for busy singles. The brand carries more than 500 products, including Korean soups, side dishes, and Indian and Vietnamese food.
While hypermarket players like E-mart are investing in private labels to keep prices low Higher margins and sustain sales, CVS players like BGF Retail, which are experiencing growing traffic, have actually managed to record improving margins by offering more high-margin private label products, such as lunch boxes and dessert menus. BGF Retail’s private label sales grew from 20% of total sales in 2013 to 24% in 2015, which in turn lifted operating margin from 3.4% in 2013 to 4.1% in 2015. We continue to see ample room for house brands to beef up grocery retail performance ahead. DBS Asian Insights SECTOR BRIEFING 34 24
Diagram 31. BGF Retail: Private labels (as % of sales ex. tobacco) & operating margin (OPM)
Source: Company, Bloomberg Finance L.P.
Ample room for house brands to beef up grocery retail performance ahead DBS Asian Insights SECTOR BRIEFING 34 25
What Does This Mean for China?
China’s e-grocery is a he development of China’s e-grocery sector lags that of the UK’s and South laggard Korea’s. Although China’s overall e-commerce penetration ranked among the top-three globally in 2015, online grocery penetration only reached 2.8% in T 2015, compared to 5% in the UK and 8% in South Korea. If we look across online sales of non-food products in China, such as home appliances and apparel & footwear, e-commerce penetration of these categories outperformed South Korea’s substantially by 31ppt and 23ppt, respectively. Yet e-grocery penetration in China increased less than 3ppt over the past five years versus 50ppt for home appliance online sales and nearly 35ppt for apparel & footwear online sales during the same period. This could be due to China’s extensive land area (39x bigger than the UK and 95x bigger than South Korea), and the lack of cold-chain logistics facilities to support the growth of e-grocery.
Diagram 32. E-grocery penetration rate (2015) Diagram 33. E-commerce penetration by category: S. Korea vs. China (2015)
Source: KOSIS, IGD.com, BBC, Euromonitor Source: KOSTAT, Euromonitor (based on store-based retailers only)
Diagram 34. China’s e-grocery penetration is the “last leg”
Source: Euromonitor DBS Asian Insights SECTOR BRIEFING 34 26
Rapid Development of Cold-Chain Logistics
Improving logistics The infrastructure development of cold-chain logistics has been picking up swiftly in the past few years, thanks to accelerated consumption of fresh, chilled, and frozen products, as well as favourable government policies to reduce cold-chain spoilage rate. The capacity of cold-chain logistics in China has grown by a 22% CAGR from 2011 to 20154, while the total number of chilled trucks has increased by a 33% CAGR from 2011 to 20145.
Favourable government policies were instrumental in supporting such growth, and the main target was to reduce the rate of wastage during the transportation of fresh supplies. According to the “Cold-Chain Logistics Development Plan for Agricultural Products” issued by the National Development and Reform Commission (NDRC) in 2010, the government targeted to lift the cold-chain flow rate for fruits & vegetables, meat, and seafood supplies to 20%, 30%, and 36%, respectively by 2015. Eventually, the target was achieved with respective rates hitting 22%, 34%, and 41%. To make the Chinese economy more competitive, the government unveiled a six-year plan in August 2016 to reduce domestic logistics costs, with a goal to lower such costs to 16% of its GDP by 2020 (2016: around 18%). In order to accomplish this, the government is promoting collaboration between different modes of transport for better synergies, reducing red tape and toll fees, vertical integration of transport and warehouse service providers, M&As among logistics operators, etc.
Bridging the last-mile Among all the segments, fresh food stood out as the fastest-growing in the rise of online gap grocery. According to the China National Information Infrastructure (CNII), China’s cold- chain logistics market ramped up from around 50 billion yuan in 2005 to more than 150 billion yuan in 2015, and is forecast to reach more than 250 billion yuan by 2017, equivalent to a CAGR of more than 30%. CNII expects China’s cold-chain logistics market to reach more than 450 billion yuan by 2020. In fact, the last-mile delivery of fresh supplies has been the cause of the bottleneck in the industry’s development as most of the products are not properly chilled. This has spurred the provision of community refrigerators by some big listed players, for example China International Marine Containers (中集集团) and Dalian Refrigeration Co. (大冷股份), to ensure that customers’ fresh orders can be properly stored in case they are not at home at the point of delivery.
Fresh food stood out as the fastest-growing segment in the rise of online grocery DBS Asian Insights SECTOR BRIEFING 34 27
Diagram 35. Market size of China cold-chain logistics industry (2003-2020)
Source: cniichina.com.cn, DBS Vickers
Diagram 36. Cold-chain logistics development in China (2010-2015)
Indicator Category Year 2010 Year 2015 Cold-chain flow Fruits & vegetables 5% 20% rate Meats 15% 30% Seafood products 23% 36% Cold-chain Fruits & vegetables 15% 30% transportation Meats 30% 50% rate Seafood products 40% 65% Products damage Fruits & vegetables 20-30% 15% rate Meats 12% 8% Seafood products 15% 10%
Source: Deloitte Research, <农产品冷链物流发展规划> DBS Asian Insights SECTOR BRIEFING 34 28
Diagram 37. Cold-chain spoilage rate – Diagram 38. Cold-chain flow rate comparison – China versus US China versus US/Europe
Sources: China Cold-Chain Logistics Association,中国物流协会冷链委员会, DBS Vickers
China’s grocery market reached 4.4 trillion yuan (or US$658 billion) in 2015, which was nearly triple the UK’s and more than 7x bigger than South Korea’s. On the back of a low e-grocery penetration rate and the rising popularity of e-commerce, coupled with overall expansion of grocery sales from an increasingly affluent population, we see immense growth potential in e-grocery development.
Diagram 39. Total grocery sales (2015)
Source: KOSIS, IGD.com, BBC, Euromonitor DBS Asian Insights SECTOR BRIEFING 34 29
E-Grocery Could Double in Two Years
Surpassing the UK Euromonitor projects that e-grocery sales in China will grow at a 22% CAGR in 2015-17. In view of the accelerated development in cold-chain logistics ahead, our view is that China’s e-grocery market could expand even faster at a 38% CAGR in 2015-17, as we benchmark with the UK’s 5% penetration rate (2015) that should be achievable. China has already surpassed the UK in terms of overall e-commerce penetration. South Korea also took two years to increase its e-grocery penetration by 2ppt, from 6% in 2013 to 8% in 2015. In short, e-grocery sales in China could nearly double in two years by 2017, and likely maintain double-digits’ annual growth thereafter over the medium term to unlock ample business opportunities in the segment.
Diagram 40. China online sales CAGR by category (2015-17F)
Source: Euromonitor, DBS Vickers
Other growth drivers Aside from e-grocery that is expected to achieve robust growth in China from a relatively low base, our studies of the UK’s and South Korea’s grocery markets have also enabled us to identify a few other business models that could become key future growth drivers in the mainland. These include (1) the rise in differentiated/niche products and services (including private labels, exclusive products, and premiumisation) to enhance shop traffic and customer loyalty; (2) strong expansion potential of the newer convenience store format, especially for those that sell more fresh F&B products to attract frequent traffic; and (3) possible emergence of discounters with small store-sizes and focused SKUs that offer low prices and exclusive daily merchandise. DBS Asian Insights SECTOR BRIEFING 34 30
Diagram 41. Future growth drivers in China’ grocery retailing sector
1) E-grocery (with strong 2) Niche products & 3) Convenience stores 4) Discounters fulfilment support) services (CVS) - the newer model
Supported by strong Private labels / exclusively Contains high proportion Low amount of SKUs and fulfilment (e.g. distributed products of niche products versus small store size to save automated fulfilment traditional CVS on rent centres)
Adequate store keeping Fresh foods / instant Low capital expenditure Extremely attractive units (SKUs) to ensure a foods (e.g. Home Meal and running costs to product prices offered; good variety; competitive Replacements) allow scalability more daily items for prices traffic
Effective promotion Premium / imported A good fit to Special sourcing to (e.g. Single's Day raised products complement O2O ensure low prices (e.g. strong awareness) development (e.g. pick- bulk sourcing, direct up points) sourcing)
IT competence (e.g. Special services (e.g. Diversification Strategic locations strong technical & design exclusive VIP services, enhancement (e.g. retail nearby its typical / team) specialised installation / brand / store location / mainstream customers repair services) product)
Suitable partners To better ensure food In line with rising Stocking a high level (especially for online- safety (e.g. direct demand for convenience of private labels could to-offline (O2O) sourcing) and better affordability increase the chance of development) success
Source: DBS Vickers Who Could Tap Faster Growth?
With the above in mind, we assess listed grocery retail companies to see which Chinese grocery plays could be in a relatively better position to experience faster growth.
Crowded market So far, we believe both Sun Art and Yonghui should have better revenue drivers than Lianhua Supermarket and Beijing Jingkelong. Sun Art’s self-developed e-commerce platform, feiniu. com, has reached more than 2 billion yuan in sales last year, and we believe it is looking at nearly 2x growth for 2017 to drive its O2O business. Yonghui has also partnered with JD.com (among the top e-commerce operators in China) since 2015 to ride on the latter’s online platform for new orders and last-mile deliveries to some extent. In terms of differentiated products, Sun Art offers slightly more private label merchandises (1H16: 11%) while Yonghui’s DBS Asian Insights SECTOR BRIEFING 34 31
strength in providing a huge variety of fresh foods (especially vegetables and fruits) has helped it to log the highest proportion of fresh products sold (46% of sales) versus peers. Yonghui has also introduced its premium food retail chain “Bravo” in selected cities for further brand diversification and differentiation. The company has also allied with Dairy Farm (now Yonghui’s largest shareholder with a 19.99% stake) for better sourcing of foreign products.
Diagram 42. Sun Art’s feiniu.com: Gross merchandise value
Source: DBS Vickers
As for convenience-store operations, Beijing Jingkelong has launched a newer format that offers a far higher percentage of fresh products versus its traditional convenience store model, and that has garnered good response. Lianhua Supermarket has also highlighted that one of its goals is to accelerate the expansion of its convenience store business as it is more scalable. As for hypermarket specialists, Sun Art and Yonghui, there are no plans to roll out convenience store businesses at this stage. But Sun Art has opened smaller format premium supermarkets (i.e. “RH Lavia” and “Hi! Auchan”) to tap new expansion opportunities ahead.
We have yet to see small format discounters that resemble Aldi and Lidl in China. Given China’s vast land mass, it makes more sense for food retailers to expand their sales network by entering into more lower-tier cities rather than rolling out newer store formats, and open big discount stores (e.g. warehouse clubs) rather than showcasing their private labels in a small discount store format. However, our conversations with various grocery players suggest that the small format discount store model could still work in China and has the potential to become another growth model in the future. DBS Asian Insights SECTOR BRIEFING 34 32
Industry Consolidation on the Cards
Various M&As, joint ventures or strategic alliances have taken place in China’s grocery retail sector and most of them were mainly for sales network expansion and market share. In the past two years, we have also seen an increasing number of M&As and collaboration between traditional food retailers and pure online operators, such as Walmart’s acquisition of Yihaodian, which then sold the latter to JD.com in return for a 5% stake in JD.com; as well as JD.com’s purchase of a 10% stake of Yonghui. We expect some similar deals to materialise in the medium term as the market consolidates further.
Key segments for We believe more M&As or alliances will come along with respect to the growth drivers outlined potential M&As earlier. These include:
1. Logistics players that plan to ride along the swift expansion in e-grocery, especially for the operation of cold-chain facilities;
2. Differentiated product suppliers, such as agricultural or F&B operators in the up-stream and mid-upstream to provide exclusive merchandises for specific grocery retailers, including the manufacturing of private labels;
3. Regional CVS retail chains: Grocery retailers that desire to pay for instant access into certain regions of China could negotiate to buy existing CVS chains out. Due to their small store sizes, convenience stores could also be quickly revamped to add more unique or exclusive product offerings (e.g. fresh foods from other provinces) to attract traffic; and
4. Small, local/regional e-commerce operators that are more specialised in their product- mix, such as fruitday.com (天天果园, focusing on the sale of fresh fruits), could also offer differentiation and could become acquisition targets of key grocery retailers. DBS Asian Insights SECTOR BRIEFING 34 33
Diagram 43. Major M&A in recent years
Date Buyer Target Deal size Remarks group Aug Beijing Beijing RMB 121 m Purchased 100% of Beijing Shoulian 2011 Jingkelong Shoulian Aug Dairy Farm Yonghui RMB 5.7 bn Dairy Farm acquired 19.9% stake in Yonghui, in a bid to further 2014 expand into China Mar Chengdu Chengdu RMB 238 m For group expansion 2015 Hongqi Hongyan Jul Walmart Yihaodian Not Walmart bought out the remaining 49% of Yihaodian (yhd. 2015 disclosed com), an e-grocery play that it invested in since 2011 Jul Chengdu Sichuan RMB 308 m For group expansion 2015 Hongqi Huhui
Aug Yonghui Lianhua RMB 744 m Shanghai Bailian sold its 21.17% stake of Lianhua to Yonghui 2015 Aug JD.com Yonghui RMB 4.3 bn JD.com made a RMB 4.3 bn strategic investment in Yonghui, 2015 acquiring a 10% stake Oct Wumei Wumarts HK$ 3.9 bn Parent Wumei Holdings privatised Wumart Stores in view of 2015 Holdings Stores challenging operating environments Oct Chengdu Leshan Not For group expansion 2015 Hongqi disclosed Dec Dashang Youhao RMB 570 m Dashang bought 16.15% of listed Youhao Group at RMB 11.34/ 2015 Group share, in a bid for expansion Jun JD.com Yihaodian RMB 20 bn JD.com acquired all Yihaodian assets from Walmart, by issuing 2016 145 million new shares, which was equivalent to 5% of its enlarged share capital.
Source: Baidu News, Bloomberg Finance L.P., Company data DBS Asian Insights SECTOR BRIEFING 34 34
References
1. Source: Internet World Stats
2. Source: Internet World Stats
3. Source: Koreajoongangdaily.com, Shinsegae Group
4. Source: China Cold Chain Logistics Association
5. Source: 中国产业信息网 www.chyxx.com DBS Asian Insights SECTOR BRIEFING 34 35
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