ParknShop sale looks a solid deal for Hutch shareholders

Focusing on the mainland health and beauty sector makes more sense when the cosy grocery duopoly is coming under pressure

PUBLISHED : Tuesday, 23 July, 2013, 12:00am
UPDATED : Tuesday, 23 July, 2013, 5:32am

Faithless! Just think of all the money we've all handed Li Ka-shing over the years, only for him scorn us like this.

Reports that Li-controlled conglomerate Hutchison Whampoa is pondering the sale of its ParknShop supermarket chain triggered howls of media outrage last week.

So shrill were the protests that Hutchison even felt obliged to deny that it was abandoning Hong Kong.

Yet despite the denial, don't be surprised if Hutch does indeed go ahead and sell ParknShop. There is a solid case for offloading the chain.

With 286 supermarkets in Hong Kong under brands ranging from Taste and Gourmet, to Great and Su-Pa-De-Pa, and a share of the local market estimated at around 35 per cent, ParknShop was long regarded as a cash-printing machine for AS Watson, the Hutchison retail subsidiary that owns the chain.

But times have changed lately, and so has AS Watson. In Hong Kong we might think of Hutch's retail business mainly as ParknShop together with electronics and appliance chain Fortress.

But after a spate of acquisitions in the early 2000s, including Superdrug in Britain, Rossmann in Germany and the upmarket Marionnaud chain in France, internationally AS Watson is known as a giant in the health and beauty sector.

More recently, AS Watson has been aggressively expanding into the same niche on the mainland. Between 2007 and last year, the company opened more than 1,000 shops there.

To put the speed of that growth into perspective, over the same period AS Watson's leading competitor, Jardine-owned Dairy Farm, opened just 157 mainland health and beauty shops.

Hong Kong is a mature market, and the city is fully saturated with supermarkets

It's easy to see why Hutch is so keen on the business. According to analysts at Morgan Stanley, AS Watson's mainland health and beauty shops enjoy an operating margin - here defined as their margin on earnings before interest and tax, or ebit - of 18 per cent.

Outside China, AS Watson's health and beauty business earns an operating margin of around 6 per cent. And as the first chart shows, the company's other retail concerns, including ParknShop, together make a niggardly 4 per cent.

As a result, last year AS Watson's health and beauty chains were responsible for more than 80 per cent of the company's operating profit. ParknShop, along with its other retail businesses, contributed just 18 per cent.

Worse, ParknShop offers few growth prospects. Hong Kong is a mature market, and the city is fully saturated with supermarkets. And with a new competition law casting an unwelcome glare of publicity on to the city's cosy grocery duopoly, there is a fair chance that local margins could come under further pressure in the near future.

Meanwhile, with international supermarket titans like Walmart and Carrefour, as well as home-grown players like Wumart and China Resources, well entrenched in the mainland market, adding to the chain's few dozen mainland shops looks both expensive and relatively unrewarding.

As a result, Hutch may well have concluded it makes excellent sense to cash out of its mature, low-margin supermarket business.

The HK$25 billion to HK$30 billion Hutch might hope to raise by selling ParknShop could be far better deployed concentrating AS Watson on the mainland health and beauty sector, where the company can hope to capture a sizable share of a market that is both fast-growing and highly lucrative, yet remains deeply fragmented.

A ParknShop sale wouldn't mean Li Ka-shing is turning his back on Hong Kong.

But it would mean he is trying to generate value for Hutchison's shareholders - of which he is by far the largest.