China trips up retail grocery chains; “The reality is that growing a grocery store chain in Asia is very difficult – ParknShop is dominant in Hong Kong but has struggled elsewhere”

August 11, 2013 2:26 pm

China trips up retail grocery chains

By Paul J Davies in Hong Kong

If Tesco’s joint venture with China Resources is an admission of defeat for the UK supermarket group in the world’s second-largest economy, it is also a warning to potential bidders for ParknShop.

Foreign grocery store operators might be tempted to see the Hong Kong-based chain – the subject of a recently announced “strategic review” by parent Hutchison Whampoa – as a stepping stone into China, but the costs and difficulties of growing a fresh food business in such a vast country are easily underestimated.Bankers at Bank of America Merrill Lynch and Goldman Sachs are seeking potential bidders for the business as part of the review.

“The reality is that growing a grocery store chain in Asia is very difficult – ParknShop is dominant in Hong Kong but has struggled elsewhere,” says one banker familiar with the business.

The fact that the going in mainland China has been tough for a company from the stable of Asia’s richest man, Li Ka-shing – with all his connections and his vast Hutchison conglomerate – says something about the chances of success for groups from beyond Greater China.

Almost every name in grocery has been mentioned as a potential bidder for ParknShop – from Aeon of Japan to Walmart of the US. However, local bankers who have been pitching to advise potential buyers say many of the rumoured names are not really interested.

“For Walmart there is not enough overlap, it is too big for Wesfarmers [of Australia] and Carrefour [of France] is exploring a sale of its China business,” says one.

On top of that, Tesco and China Resources now look to have taken themselves out of the running – if they were ever in it – by negotiating their own deal.

The reason Hutchison decided to launch a strategic review of ParknShop – which may or may not lead to a sale – is because its other retail businesses are proving so much more successful, according to bankers close to the company.

The supermarket chain is part of Hutchison’s AS Watson division, which is mainly focused on health and beauty stores in China, Asia and Europe. Through brands such as Watsons, Superdrug and Rossmann it already has more than 11,000 stores and expects to open 500 in the second half of this year alone, according to its interim results presentation earlier in August.

ParknShop in comparison has 345 stores in total – 270 of which are in Hong Kong and only 56 in China. Last year it accounted for just HK$21.7bn (US$2.8bn) in revenues out of HK$148.6bn in all of the Hutchison retail businesses. ParknShop has refocused its China business almost entirely on the Guangdong province – just across the border from Hong Kong – in recent years, closing some stores in a bid to make the arm profitable.

“Watsons is much easier,” says Jonathan Galligan, analyst at CLSA in Hong Kong. “You don’t need cold-chain logistics, you don’t need fresh foods and you don’t need to import some of that from very far away.”

The thinking at Hutchison is that while ParknShop is a decent business, the group might be better focusing its time and money on a much bigger and faster growing asset, according to bankers close to the company.

In Hong Kong, the business is dominant with somewhere between a 30 and 40 per cent market share among supermarkets – depending on whether you look at Euromonitor or AC Nielsen data. It holds an effective duopoly position with rival Wellcome, although bankers insist it is still a growing business as it takes share from traditional “wet markets”, or street stalls.

Its margin on earnings before interest, tax, depreciation and amortisation is a healthy 6 per cent, according to one banker close to the company. The business is talked about as being worth US$3bn-US$4bn – the lower end of that would put it on a similar near 20-times multiple of last year’s earnings as rival Dairy Farms International, which runs Wellcome. That business is much bigger, with more diverse businesses and a greater presence in fast growing markets in southeast Asia, however.

ParknShop represents a very big chip in a good market for a strategic buyer, bankers say, however it might ultimately prove more interesting to private equity. The reason is not so much because there is a huge amount that can be done with the business, but more that there are hardly any buyout opportunities in the family-controlled Asian business arena.

“For sponsors, the overriding concern is that you can exit and with something like ParknShop there is a very clear path to listing,” says one banker not involved in the deal. “What you can really do with the business is less important than putting money to work and realising a return.”

But if listing ParknShop is the answer, Li Ka-shing might as well do that himself.