 Growth and margins could recover as
early as 2Q12
 Post the correction from 4Q11, the
sector is setting up for a rebound
 Remain OW(V) on Sun Art; upgrade
Wumart to N(V) from UW(V)
Going through a rough patch. Grocery retailers have had a
rough six months with consumer demand growth weakening on
high inflation in 3Q11 and remaining weak in 4Q11 as
consumers delayed purchases in anticipation that inflation
would continue to ease. This weakness is likely to continue
through 1Q12 due to a shorter Chinese New Year (CNY)
promotional period (CNY starts earlier this year, shortening the
promotional period to just 21 days for 2012 versus 31 days in
2011). At the same time, labour costs and rental costs growth
pressure have remained high.
But a rebound is just around the corner. Real disposable
income growth will be boosted by policy measures, such as
higher minimum wage levels and the increase in the income tax
threshold last year. Together with re-stocking by consumers
after CNY, we expect to see a volume recovery in 2Q12. The
comparative base for costs should normalize about the same
time, delivering a second operational boost.
Recent correction sets the sector up for outperformance.
Grocery retailer stocks have seen a significant correction since
4Q11 and now trade at a narrower premium / discount against
the MSCI China Consumer Staple Index. As fundamentals
improve in 2Q12, this valuation premium should revert towards
historical levels, leading to the outperformance of the sector.
Hypermarkets: the industry growth driver. Modern retail
channels are taking market share from traditional channels in
China, as seen by the continued growth in hypermarkets,
especially in lower-tier cities. Sun Art is the major beneficiary.
Reiterate OW(V) on Sun Art, our top pick. We think grocery
retailers with thinner margins will lead the share price rebound,
especially given the government’s abolishment of VAT on fresh
vegetables taking effect from January 2012. In the longer term,
we like companies, such as Sun Art, with high scalability, stable
costs, and pricing advantage. We upgrade Wumart from to
N(V) from UW(V), and reiterate OW(V) on Sun Art.