Beijing Jingkelong

Jingkelong has really taken a beating this year, when the management guided for FY2012 net profit to be below FY2011. The supermart/hypermart business is one which I have always been curious and interested about, and this popped up on my watchlist when I was scanning stocks that have fallen from 52week high. But, is this really cheap now at trailing 7.8x PE (1H 2012 Annualised EPS of RMB 18.8c)? Let’s take a deeper look.

Now, the supermarket/hypermarket sector in China has been consolidating for some time. Euromonitor shows that 2000-2010 revenue CAGR for small scale grocery formats only averages 0.7% a year. Whereas for supermarket/convenience stores it averages 22-23%. In this business, big is beautiful. Hypermarkets has an average CAGR of 37.9%. Generally, one would prefer large format grocery retailers over the smaller ones.

Income Statement (Rmb m)	2007	2008	2009	2010	2011
Revenue	5,641	6,684	6,691	7,439	8,633
COGs	(4,919)	(5,760)	(5,759)	(6,397)	(7,335)
Gross profit	722	924	932	1,041	1,297
Other income, gains and losses	346	346	424	495	576
Sales and marketing exenses	(680)	(670)	(745)	(880)	(1,140)
Admin and general expenses	(195)	(195)	(227)	(213)	(202)
Other expenses	(33)	(33)	(45)	(44)	(53)
EBIT	158	371	339	399	478
Financial expenses	(91)	(91)	(85)	(94)	(125)
Profit before Tax	67	280	254	305	353
Tax	(77)	(77)	(65)	(77)	(80)
Net Profit	(9)	204	189	229	273
Net Profit attributable to equitu holders	125	157	148	181	210

Revenue growth has decent for Jingkelong, averaging above 10%. Not spectacular, especially if you take into account how fast the rest of the industry is growing. 

	2007	2008	2009	2010	2011
JKL No. of Hypermarkets	11	10	9	8	8
JKL No. of Supermart	64	71	72	76	80
JKL No. of Convenience Store	137	159	163	150	161
Lianhua No. of Hypermarts	111	127	132	143	152
Lianhua No. of Supermarts	1,731	1,788	2,818	3,014	2,984
Lianhua No. of Convenience Stores	1,880	1,957	1,980	2,015	2,014
Sun Art No. of Hypermarts	103	124	156	183	230

The thing is, if you look at store expansions vs other listed peers such as Lianhua Supermarket or Sun Art Retail, JKL is severely lacking. Competitors have been aggressively building new stores while the JKL management has been caught asleep at the wheel. 

	2007	2008	2009	2010	2011
JKL Inventory Days	44	45	50	57	70
Lianhua Inventory Days	45	46	43	46	53
Sun Art Inventory Days	N.A.	58	51	60	69

Comparing Inventory days, a key performance metric for supermarts or hypermarts, JKL has seen a significant deterioration from 2007. A lengthening of inventory days can be a warning sign for supermarts. This means that groceries sit longer on their shelves and warehouse, and are no longer as fresh. Ask any regular housewife and she can always tell you where to find the freshest fruits/vegetables/meat. Any deterioration in quality and consumers will vote with their feet.

The final nail in the coffin for me were the capex and acquisitions which levered up the balance sheet, bringing debt/equity ratio from 1.1x in 2007 (including operating leases) to 2.41x in 2011. They resulted in subpar growth for the company. In this aspect, Lianhua/ Wumart/ Sun Art Retail were far better managers/operators.

Verdict? When its cheap, it is usually cheap for a reason. If you are looking for exposure for the chinese consumer, you should probably look elsewhere.