Is Sheng Siong’s dividend policy sustainable?

The recent Sheng Siong kidnap trial did not create a negative publicity for the supermarket operator. Instead, shares of the groceries retailer surprisingly stormed to a record high of $1.10 in October 2016. Listed in SGX mainboard only in 2011, Sheng Siong has risen from a penny stock to an established player with strong dividend track record. But in today’s challenging operating environment, is Sheng Siong’s dividend policy sustainable?

Sheng Siong had committed to pay out dividend of up to 90% of their net profits after tax. Note that this is a commitment made by management and the company is not legally obliged to fulfill this promise. Nonetheless, since 2011, company has consistently met this target and investors were rewarded for their continued support in this home-grown enterprise.

But should management review this dividend policy and reinvest some of the excess cash to grow the company? The total amount of dividends paid out had been between 2 to 4 cents and to be frank, the amount is nothing to shout about. Nonetheless, when Sheng Siong shares were trading at $0.30 to $0.40 in the early days of listing, the dividends looked attractive relative to the share price. But now that the share price has run up substantially, the amount may be less appealing for dividend investors.

The quality of a management can be assessed on how well they utilize excess cash or profits. Some companies embark on shares buy-out or distribute excess cash to investors as dividends. And then there are companies which choose to reinvest the cash to grow the company’s market share. At this business stage, Sheng Siong definitely needs to continue to grow and in my opinion, the management should review the merits of the 90% dividend payout commitment. Instead of distributing so much profits to shareholder, the management should consider reinvesting excess cash to build a bigger Sheng Siong in the long run.

Sheng Siong is a fast growing company, with revenue increasing from $578 million in 2011 to $764 million in 2015. Judging from the 3Q16 results, revenue for 2016 is expected to surpass 2015’s record. But the company is currently at a cross-road.

In the third quarter results, current liabilities exceeded current assets by $9.1million as at 30 September 2016 due to business expansion. Payment of $84.8 million were made for purchases of equipment, plant and retail space in Yishun and Bedok. There was also a 50% call on capital from the Group’s 60% owned subsidiary in China.

As at 30 September 2016, the accumulated profits was $684,000, after distribution of dividend payment to shareholders. The retained earnings could have been $55 million if not for the dividend payout. If the payout ratio is reduced to 50%, the management could have used the fund to build its investment moat through acquisition of more retail space for expansion. The addition of stores would have contributed to even higher revenue growth and potentially led to higher capital appreciation for the share price.

Should investors forsake dividend payment in exchange for higher return from share price appreciation? This is an issue subject to debate but investors should not be worried about the recent liabilities exceeding assets. This is likely to be temporary and management has arranged for a standby facility with a financial institution. Furthermore, Sheng Siong’s business is still very profitable and cash flow remains positive.

Cash flow from operating activities for third quarter of 2016 was $24.4 million and net profit was $15.6 million. Gross margin stood at 25.9% for 3Q16, slightly higher than 3Q15. This is an impressive results given the tough operating environment.

The tightening of the foreign labour policy in Singapore continued to exert pressure on Sheng Siong’s manpower costs. To mitigate this, self-service automated payment machines were deployed in some of the stores to improve productivity. While this would help to enhance efficiency, the number of manpower is set to increase with the opening of more store. Thus, Sheng Siong needs to stay vigilant in managing staff costs.

There are a lot of hype among investors over Sheng Siong’s penetration into China. However, in my opinion, there should be calibrated expectation on this project. Indeed, China represents a very huge market but doing business over there can be very difficult if there is a lack of experience and network.

According to the latest report, the construction of Sheng Siong’s mall in Kunming has been delayed till second quarter of 2017. Thus, investors should be patient and not expect the joint venture in China to be a runaway success overnight.

Overall, I am not vested in Sheng Siong shares but has been tracking the company for several years. In my view, this is a family run business with good potential for explosive growth. Based on current price, the share price seems overvalued. I would probably enter this counter at $0.30.

Magically yours,

SG Wealth Builder