Extended dry spell for Chinese grocery retailers

Another quarter of weak sales foreseen after six months of hardship with recovery likely to start only by 2Q12.

The only bright light, acording to OCBC? The hypermarkets segment, which have been steadily amassing market share in spite of the slumping demand.

Here's more from OCBC:

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.