How instant noodles reflect where you’re from?

When I say “Instant Noodles”, what’s the first image that comes to your mind?

Do you think of the cake of instant noodles that you cook in boiling water and add the packet of MSG? Or do you think of something more along the lines of “Cup noodles?”

Your choice of instant noodle says a lot about you

Before we go into how the type of instant noodle reflect who you are, let’s start by firstly reviewing the instant noodle market in Hong Kong and China.

Instant Noodle Market Growth is Anaemic in both HK & China

According to an industry report from Frost & Sullivan, Hong Kong’s instant noodle market was worth around HK$1.8bn. Over the past four years, growth has been anaemic with sales value only rising 0.5% p.a. while sales volumes have actually contracted by 1.3% p.a.

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Although China’s instant noodle market is much bigger, it is also not growing much. The Rmb81bn of instant noodle sales in 2016 only represent a p.a. growth rate of 0.4% over the 2012-2016 period. Volume wise, the number of instant noodle serving has actually fallen by 3.9% p.a.

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Who eats more instant noodles?

In absolute terms, China’s 37.2bn serving of instant noodles is 90x larger than Hong Kong’s 415mn servings. However, if you consider that China’s 1.3bn population is actually 186x larger than Hong Kong’s 7 mn population, the data actually shows that Hong Kong people actually eat more instant noodle than their mainland cousins.

HK 59.2 servings Vs. China 28.6 servings

In 2016, Hong Kong people ate 59.2 servings of instant noodles, almost twice as much as the average 28.6 servings consumed by those in China.

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What do you eat? Cups, Bowls or Bags

When we examine the data further, we see another interesting distinction between Hong Kong and China’s instant noodle connoisseurs. In Hong Kong, bag-type instant noodles make up nearly two-thirds of the overall sales volume. In China, the mix is almost 50/50 with bags taking up 53% of sales.

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In this respect, if you associate instant noodle with those that come in a little plastic bag that you cook yourself, then you’re most likely from Hong Kong. Conversely, if you think about pouring water into a little cup/bowl then you’re most likely from China.

What brand do you prefer? 出前一丁 or 康師傅

If you go to a Cha Chan Teng in Hong Kong and order instant noodle for breakfast, you are usually given a choice of upgrading to 丁麵 (Demae Iccho) for a few extra bucks. But what you may not realise is that in Hong Kong, 出前一丁, 公仔麵, 福麵 and Cup Noodles are all carried by Nissin Foods.

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The multiple brand strategy has helped Nissin Group become a clear leader in the Hong Kong market with a market share of 65.3%. Nong Shim (maker of Shim Ramyun) and Sau Tao, are a very distant second and third and only have a 5.5% and 5.4% market share respectively.

In China, the names are very different. Taiwanese noodle makers like Tingyi (康師傅) and Uni-President dominate the instant noodle market and hold market shares of 46.5% and 17.8% respectively. Nissin Foods is much smaller and only holds a market share of 2.8%.

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So if you associate instant noodle with Cup Noodle and 出前一丁, you’re most likely from Hong Kong. On the other hand, if you think of 康師傅 or 來一客, then you are most likely from China.

These two distinction is even more stark when you consider the revenue breakdown of Nissin Foods in the two areas. In Hong Kong, the revenue split between Bag type instant noodles, cup/bowl type and frozen foods are almost even at 39/28/33. Whereas, in China, the revenue split for Nissin Foods is 85/13/2 .

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The Premium-isation of Instant Noodles

In a way, China’s instant noodle market is very unique. Unlike the other industries that we have looked at in our Mass Consumption series (travel, beer, coffee and fried chicken, online games), the instant noodle market is NOT growing. In fact, Frost and Sullivan forecast that the number of instant noodle servings will decline from 2016’s 37.2bn to 34.5bn in 2021E.

With volume in decline, the only way to make more money is to try to raise ASP through the premium-isation of instant noodles.

As the bowls get bigger…

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…and fancier…

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…so does the ASP. In China, over the past four years, the average selling price of instant noodles have risen by 4.4% p.a. since 2012 (faster than Hong Kong’s 1.75% ASP growth). chart (16)

However, with the “Big Cup” noodle now weighing in 80 grams, 450 calories and 1,600mg of sodium, I suspect this premium-isation trend could be hard to sustain. Furthermore, while the past few years’ increase in ASP appear to have helped with gross profit margins, the benefits do not appear to have flowed to the bottom line.

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I am Satay Flavour出前一丁

As for me, I’ve been told that I make the best instant noodles with the exact right balance of soup to noodle. If I had to choose one type of noodle to eat, it would be the satay flavour 出前一丁.

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Now what does that say about me?

 

P.S. In the first collage, there is one picture that does not belong, can you spot it.

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How well do you know luxury goods? Hermes Edition

How well do you know your luxury goods? After looking at LVMH’s 3Q results, in part 2, we turn to the highly sought after Hermes. Do you know which region generates the most sales, which one is growing the fastest and what are the key similarities and differences between Hermes and LVMH? Find out.

LVMH is one of the largest luxury brands in the world with a market cap around €129bn but it is not the most sought after. I think the honour goes to Hermes (market cap €47bn).

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Its iconic Birkin and Kelly handbags are so sought after that strategy books have been written on how to obtain one. Similar to our earlier post “How well do you know luxury goods?”, today, we test your knowledge on “How well do you know Hermes?”

The answers are posted after the various photos. Don’t peak.

1. Which region contributes the most to Hermes revenues through the first nine months of 2017?

  • A) Asia,
  • B) Europe,
  • C) US,
  • D) Others

2. Which region had the strongest revenue growth rate in 3Q 2017?

  • A) Asia ex Japan,
  • B) Japan,
  • C) Europe,
  • D) US

3. Rank the revenue contribution by product segment from largest to smallest?

  • A) Leather goods,
  • B) Fashion and accessories,
  • C) Silk and textiles,
  • D) Other Hermes sector (i.e. Jewellery and home products)
  • E) Perfumes
  • F) Watches
  • G) Other products (i.e. production activities for non-group brands)

4. Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

  • A) Leather goods
  • B) Fashion and accessories,
  • C) Silk and textiles,
  • D) Jewellery and home products
  • E) Perfumes
  • F) Watches
  • G) Other products
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Which region contributes the most to Hermes revenues through the first nine months of 2017?

  • The answer is Asia. Combining Asia ex-Japan (36%) and Japan (13%), Asia contributed 49% to Hermes’ overall revenues in 9M 2017. (Recall that for LVMH, Asia was 36%). Europe was the second largest region with 32% of sales (LVMH was 27% exposed to Europe). the Americas was third at 17.5%

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Which region had the strongest revenue growth rate in 3Q 2017?

  • Not counting the “Others” region, the strongest growth came out of Europe ex-France which rose 14% YoY in 3Q 2017. Notably, while Japan showed very strong growth for LVMH in 3Q 2017, for Hermes, 3Q growth in Japan was only 7%. For the full 9M 2017, Asia Pacific was the fastest growing region with sales rising 14% YoY in local currency terms.

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Rank the revenue contribution by product segment from largest to smallest?

  • This was another obvious one. Leather goods was the clear leader and accounted for 50.8% of overall sales. Fashion and accessories contributed around 21.8% in 9M 2017. In the third to fifth place, the gap is quite small with Silk & Textiles at 8.9%, Jewellery and home at 6.3% and Perfumes at 5.4%.

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Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

This is another area where we saw some departure from LVMH’s results. For LVMH, its largest segment were also its fastest growing segment (Fashion and Leather Goods at 35.5% of sales and rising 14% YoY). But for Hermes, it was the smaller categories. Perfumes (5.4% of sales) grew the fastest at 13% YoY. This was then followed by steady growth of 11% across Leather goods, Fashion and accessories and jewellery and homes. Notably, for 3Q 2017, Silk and Textiles sales surged by 17% YoY.

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Key Takeaways – Very strong Asia performance, watch Japan in 4Q and affordable luxury

When we compare and contrast the 3Q results from LVMH and Hermes, there are two key takeaway messages.

1) The divergent performance between LVMH and Hermes out of Japan. In 3Q, Japan sales rose by 21% for LVMH and only up 7% for Hermes. In comparison, Asia Pacific ex Japan sales were strong for both LVMH and Hermes (up 21% and 14%). This would seem to validate that luxury consumption growth is more broad-based in Asia ex-Japan and points to a bullish story for China. For Japan, given the higher price points of its products, it would be interesting to see if the continued rally of the Nikkei will help Hermes sales growth to surge in 4Q 17.

2) On the other hand, a key similarity is the strong performance out of the smaller ticket item of perfume. For Hermes, Perfume and Silk and Textiles showed the strongest growth in 3Q (up by 23% and 17%). At LVMH, perfume and cosmetics was also the strongest growth category in 3Q, up 17%. This reinforces our belief that consumers love the luxury brands. In the case of Hermes, where supply cannot rise to meet demand, consumers will go after the affordable luxury items like perfumes, scarfs and pashmina.

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Mass Consumption Part 7: Who’s got game?

Computer games is big business. Gaming has been the key driver behind some of the best performing stocks like Tencent and Nvidia. As an entertainment industry, games is the third largest and brought in US$101.1bn. We take a snapshot to see (i) Who’s playing, (ii) What are they playing, and (iii) What are they spending money on?

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Plants Vs. Zombies 2 – Screenshot from my phone

If you ask me what is my favourite computer game, I would probably say Plants Vs. Zombies or MarioKart 8. Although I’m not a serious gamer, gaming is big business.

Gaming is big business

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According to the prospectus that I came across today, the global gaming industry brought in US$101.1bn of revenues in 2016, making it the third biggest segment of the global entertainment industry behind TV & Video (US$314.3bn) and, surprisingly, Publishing (US$329.3bn). Going forward, the Publishing industry is expected to contract by 0.5% p.a. between 2017-2021 but the Gaming industry is expected to grow 5.1% p.a.

Who’s playing?

Among the geographies, Asia Pacific (including China) is the biggest market, contributing 46.4% of the US$101.1bn of gaming revenue in 2016. The Americas and Europe contribute 29.6% and 20.9% respectively.

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While the Rest of the World only contribute 3.2% of games revenue, they make up 14.8% of active gamers in 2016. On a standalone country basis, China make up 25.4% of active gamers and 24.3% of games revenues.

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What are they playing?

As expected, mobile games are the most popular. In 2016, there were 1.973bn active mobile gamers, which is like 95% of all active gamers. PC gamers (1.162bn) make up 56% of all gamers while console gamers make up around 30%. Among the three categories, mobile games is expected to remain the fastest growing segment with a CAGR of 6.2% between 2017-2021, followed by PC games at 3.6% CAGR and console games at only 1.5%.

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Who’s watching?

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While the number of gamers is expected to grow 5.4% p.a., there is one aspect of gaming that is expected to grow at almost 3x the speed. The global eSports audience (those watching televised computer games) is expected to increase from 322.2mn in 2016 to 665.3mn in 2021, a CAGR of 14.6%. In 2016, China had the largest eSports audience at 106.2mn people and is expected to remain the leader with 217.6mn eSports audience in 2021.

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In terms of prize money, the richest tournament appears to be Dota 2 with a purse of  US$88.33mn, followed by League of Legends at US$36.61mn.

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Source: HKEJ

Serious machines for serious gamers

Just like how professional cyclist need serious bikes, serious gamers also need serious machines. In 2016, the global gaming systems market was worth US19.3bn with revenues evenly split between Asia, the Americas and Europe.

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In addition to getting machines with the fastest processors, the best graphics card and memory, peripherals are also an important component. If you’re trying to navigate through Doom, you need the best mouse and the best keyboards. But one thing that I did not appreciate was the importance of sound quality.

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Among the US$2.2bn gaming peripherals sales in 2016, headsets accounted for nearly half, more than the sales of  mice (US$526.8mn) and keyboards (US$458.6mn) combined. Look closely at the picture below, everyone has a headset on and if you’ve seen the prices of some of the latest Bose headsets, it is probably an ASP thing.

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China is very much mobile games driven

One thing that is interesting is that while China accounts for around 25% of active gamers and also 25% of global gaming revenues, their spending seems to be concentrated on the actual games. Among gaming peripheral sales, China only make up 14.3%. For Asia Pacific ex China, the stat is even lower. Asia Pacific ex China gaming peripherals sales is only 7.8% compared to its 22% market share in global gaming revenues.

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This suggest that gaming in China and Asia Pacific likely takes place on mobile devices rather than PC or consoles. I guess that’s why this company in question is now planning to launch its own mobile phone, adding it to its stable of mice, keyboard, headphones and laptop computers.

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Postcards from Xian

Greetings from Xian. The first time I visited this ancient city was 17 years ago. Coming back this second time, here’s what struck me from this trip (1) red bikes, yellow bikes, green bikes and bikes of all colours, (2) cleaner and more orderly and not just the toilets, (3) coffee vs. fried chicken – chalk up a win for Starbucks, (4) mobile technology is huge but there is a catch, (5) rise of the domestic brands – watch out Apple, (6) best and worst food experience of the trip.

Greetings from Xian, China.

Background on Xian, China

Xian is located in the Shaanxi Province in China. Geographically, it is almost right smack in the middle of China, located around the same latitude as Shanghai and almost directly above Chengdu.

Historically, Xian was the capital of China during many of the early dynasties like the Qin and the Tang Dynasty. Back in the day, it used to be known as Chang’An. Today, Xian has a population of 8.7 million and according to our driver, its key industries are (1) aerospace and defence, (2) higher education and (3) tourism.

To most people, when they think of Xian, they think of the Terracotta Warriors from the tomb of Qin Shi Huang, the first emperor of China and founder of the Qin Dynasty.

What’s changed from 17 years ago?

This was my second time visiting Xian. The first time was about 17 years ago. I remember visiting the Terracotta Warriors but other than that the only other memory was the proliferation of internet cafes in the city centre.

Fast forwarding 17 years to 2017, here’s what struck me from this time around.

Red bikes, yellow bikes, green bikes and bikes of all colours

We previously wrote about China’s sharing economy. While we did not see any umbrella sharing schemes in Xian, we did see a ton of shared bicycles. There were green bikes, yellow bikes, orange bikes and silver and red bikes. On the positive side, the bikes were being used. People were scanning the QR code, unlocking bikes, riding them and then leaving them behind once they reached their destination. On the negative side, there is a lot of excess capacity. Competition is very intense and until one or two of these operators out-spend and out-live the others, I struggle to see how they would recoup their capital.

Cleaner and more orderly and not just the toilets

My second key impression was how much cleaner and more orderly Xian has become. In the past, when I visited some of China’s tier 2 cities, the two things that I dread the most were (i) visiting the smelly toilets and (ii) crossing the street. In many emerging markets, although there may be traffic lights, crossing the street is always an adventure. Drivers  never give way to pedestrians. This time, to my surprise, half of the cars actually slowed down when we crossed at the cross walk.

Secondly, the streets were a lot cleaner than I remember. There were many trash and recycle bins around town and they were being used for the most part. That said, there are some major hygiene issues (I’ve saved this for the ending) but China and Xian has come a long way.

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Guess where this was taken

Coffee Vs. Fried Chicken – Chalk up a win for Starbucks

Given our previous post on the fast food industry, we wanted to see how Starbucks and KFC were doing. By our rough count, Starbucks seems outnumbered KFC by a ratio of 5-to-3 in Xian. In total, I think we saw nine or 10 Starbucks and like six KFCs.

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Starbucks in Xian

As a coffee lover, my first thought is that Starbucks is still very under-penetrated. Granted, Xian is not going to be like a typical US city where there are Starbucks around every corner but for a city of 8.7 million to only have a handful of stores clearly shows that there is scope for a higher concentration.

This impression was corroborated by what I saw when I visited the local Starbucks one day around 5pm. The first thing I noticed was that every single table was full. Secondly, the price point for a Grande Black Coffee in Xian (Rmb 22) is only 10% lower than that of Hong Kong (HK$29). Given the difference in overall cost of living, this gap is remarkably small. Overall, I came away feeling more optimistic that China will be the future growth engine of Starbucks.

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Dicos – Local competitor to KFC

Mobile technology is huge in China but there is a catch

Ahead of this trip, we’ve heard and read about how China is evolving into a cashless society where everything can be paid for using your mobile phone. Unlike the West where credit cards dominate, in China, it is all about AliPay and WeChat Pay. We were eager to try this out but there’s a catch. You need to have a local bank account.

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As Hong Kong residents, it is possible to set up an account with AliPay HK or WeChat Pay but that account would only allow us to transact in Hong Kong dollars. Since we could not top up our account in Rmb, we were stuck paying for most things using good old fashion cash. Although this is a problem for foreigners, with 1.3bn consumers, the domestic opportunity is arguably already big enough.

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Delivering one of the many online shopping parcels

Rise of the domestic brands – Watch out Apple

There’s good news and bad news for Apple from our trip. The good news is that despite the early knocks against the iPhone 8, the phone is actually pretty good. Despite only having one lens, the camera was a marked improvement over the dual camera of the iPhone 7-Plus.

The bad news is that China’s domestic consumers don’t seem to care about Apple much. When we asked our guide about the upcoming launch of the iPhone X, his response was  “I’m more looking forward to the Huawei Mate 10”. Around town, we also noted many more ads and store fronts featuring Vivo and Oppo mobile phones.

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Hua Shan – Taken with iPhone 8

Best and worst food experience of the trip

To finish off this post, we share our best and worst food experience from Xian.

One of the best foods that we tried was the Rou Jiaomo (肉夾饃). This is kind of like a Chinese hamburger. It can be filled with either beef, lamb or pork. It was delicious and only costs about Rmb 8. Definitely worth trying.

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Rou Jiamo – Chinese Burger

I’m a big fan of lamb and also a big fan of barbecue. So when you put them together in the form of roast lamb skewers, this combination is hard to beat. It was delicious, juicy and fragrant. It was really enjoyable until….(HEALTH WARNING: You might not want to read on if you have a weak stomach).

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Lamb skewers

I finished it and after walking down a couple of streets, I saw a lady rummaging through the trash and recovering the used sticks.

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Source: Piccsy

Aaargghhh....I guess the cleanliness and orderly part has not reached everyone yet.

 

 

 

 

 

 

How well do you know luxury goods?

LVMH is one of the biggest luxury brand in the world. Under its stable, you’ll find the likes of Louis Vuitton, Rimowa, Loro Piana, DFS and Sephora. In 2016, it had annual sales of €37.6bn and as I write this its market cap stood at €122bn.

Today, I came across its 3Q results and it was interesting.

To see if you know luxury as well as you thought, take the following quiz. The answers are posted after the various photos. Don’t peak.

1. Which region contributes the most to LVMH’s revenues through the first nine months of 2017?

  • A) Asia,
  • B) Europe,
  • C) US,
  • D) Others

2. Which region had the strongest revenue growth rate in 3Q 2017?

  • A) Asia ex Japan,
  • B) Japan,
  • C) Europe and
  • D) US

3. Rank the revenue contribution by product segment from largest to smallest?

  • A) Wine and Spirits,
  • B) Fashion and Leather Goods,
  • C) Perfume and Cosmetics,
  • D) Watches and Jewellery and
  • E) Selective Retailing (i.e. DFS and Sephora)

4. Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

  • A) Wine and Spirits,
  • B) Fashion and Leather Goods,
  • C) Perfume and Cosmetics,
  • D) Watches and Jewellery and
  • E) Selective Retailing (i.e. DFS and Sephora)
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Which region contributes the most to LVMH’s revenues through the first nine months of 2017?

  • The answer is Asia. Combining Asia ex-Japan (29%) and Japan (7%), Asia contributed 36% to LVMH’s overall revenues in 9M 2017. Europe was the second largest region with 27% of sales (9% France and 18% Europe ex-France). The US was the third largest region at 25%.

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Which region had the strongest revenue growth rate in 3Q 2017?

  • The surprising answer was Japan and Asia ex-Japan. Both regions saw top line sales growth of 21% in 3Q 2017. For the year-to-date, Asia ex-Japan was still stronger at 19% while Japan is only at 11%. However, given all the talk about Japan still struggling with its lost decades, a 21% YoY growth was most unexpected.

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Rank the revenue contribution by product segment from largest to smallest?

  • This question should be the easiest one. I’m pretty sure that 90% of you knew that Fashion and Leather Goods would be the biggest category (at 35.5%) but how many knew that Selective Retailing (i.e. DFS and Sephora, etc) would be the second largest category at 30.6%. Perfume and Cosmetics was third at 13.3% while the Moet-Hennessy part of LVMH was only fourth largest at 11.5% of revenues. Watches and Jewellery was the smallest segment at 9.1%.

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Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

For the first nine months of 2017, LVMH’s largest segment was also its fastest growing. The Fashion and Leather Goods segment (35.5% of sales) grew 14% YoY in 9M 2017. AS Perfume and Cosmetics also grew 14% (with 17% YoY growth in 3Q 2017), this suggest that luxury branding is very strong. On the flip side, although wine and spirits grew 8% YoY, 3Q growth of 4% YoY made it the slowest growing segment in the group.

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Key Takeaways – Japan and Asia might be getting its Mojo back

As a generalist data point gatherer, the most interesting takeaways were:

1) The very strong performance out of Japan and Asia ex-Japan. Japan was supposed to be struggling to show inflation while Asia was supposed to be still dealing with the anti-corruption curbs. For both regions to show 21% YoY growth in 3Q and 11% and 19% YoY growth in 9M 2017 suggest that Asian consumers seems to have found their mojo and are back to their happy spending ways.

2) Branding remains effective. Usually with the law of the large numbers, as sales reach a certain critical mass, growth would inevitably slow. However, in the case of LVMH, although Fashion and Leather Goods is its largest segment at 35.5%, it growth has remained the strongest among the categories. Further, as many perfumes and cosmetics are branded along the same lines, the strong growth in those two categories suggest that consumers still love the luxury brands.

On point 1), if Japanese and Asian consumers have indeed gotten their mojo back, then the recent catch up of Japanese equities might have more room to go.

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Source: Yahoo Finance

 

 

Mass Consumption Part 6B – How do you build the FedEx of China?

Last week, we discussed the economics of China’s express delivery industry. This week, we review their balance sheet to gauge who is likely to become the next UPS/FedEx of China.

Last week we discussed China’s rising express delivery market and how it has grown together with China’s massive online retailers. As a quick recap, in 2016, online retail sales made up 14.30% of China’s overall retail sales and for the express delivery industry, it delivered 27.9bn parcels and generated overall revenues of US$59.8bn.  chart (29)

With China’s express delivery market expected to double in the next five years, everyone is vying to become the UPS or FedEx of China.

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When we reviewed the economics of China’s top express delivery companies and compared their margins and profitability to the top US operators like UPS and FedEx, we came away with mixed feelings (see full discussion here). While we were very positive about the express delivery market’s overall growth, we are concerned that competition from new operators vying for market share would compress margins.

Crunching the balance sheet

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After having some time to digest our initial thoughts, we are still scratching our heads. Something is missing. Why is there such a big divergence in valuation?

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One could argue that the high PE ratio of SF Express and Best (net loss) was because of companies sacrificing near-term earnings for long-term market share. But in order to emerge from this fight, you need to either have (1) strong underlying cash flow or (2) a strong balance sheet to sustain you for the long haul.

A look at another conventional valuation metric, price-to-book, shows an even greater divergence. To me, the 3.1x-7.0x price-to-book ratio that ZTO, FedEx, STO and YTO are trading at would be within my range of expectations. But what about UPS at 81.6x and SF Express at 11.3x PB?

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Although labour costs is a major component of the express business but there are also a lot of hard assets as well. What about the trucks, the planes, the computer systems, the conveyor belts, not to mention the drones?

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PPE make up 50% of US express company assets and only 13-28% for China

This is where we see one of the big differences between the US and China express companies. For UPS and FedEx, property, plant and equipment (PPE) was the largest component of their assets. Even after accumulated deprecation, PPE still made up around 50% of UPS and FedEx’s total assets. For the Chinese express companies, SF, ZTO and YTO have PPE around 26-28%. Best and STO’s PPE are only 13-15% of assets.

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Since some companies sometimes classify their software as intangible assets, we further consider intangible assets and goodwill. Again, we see that UPS and FedEx are fairly close with intangible and goodwill making up around 14% of assets. Grouping PPE and intangibles together, we see that these make up around 65% of the US express companies’ asset base.

Need to buy more trucks and build more sorting facilities

For the China express companies, SF, ZTO and YTO are hovering around 39-45% but STO and Best are only around 20-22%. This suggest to me that if these companies want to institutionalize their business and expand their market share, more investments and capex is needed. They must buy more trucks, more planes, build more sorting facilities and build out their logistics network.

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On this basis, it is no surprise that SF Express and YTO have higher PPE and intangible assets. Their revenues have already started to scale.

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Capital structures reflect the early stages of investment

For the China express sector, one silver lining is that they appear to have anticipated this need and have already tapped the capital markets. As of June 2017, four of the five China express companies are sitting on net cash. Although SF Express had US$73mn net debt, its 2% net-debt-to-equity ratio suggest there is lots of scope for it to borrow.chart (42)

In comparison, given the relative maturity of FedEx and UPS business, their capital structure is optimised to boost ROEs.

Incumbents best positioned to become China’s UPS/FedEx

If we apply the filter of (1) normalised margins and (2) high PPE-intangibles, this would suggest that the two largest incumbent operators, SF Express and YTO, best resemble FedEx and UPS. That said, one would still have to decide whether the current PE ratios of 52.8x and 37.2x is too high a price to pay for that potential future.

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Mass Consumption Part 6 – Getting your online purchases from Point A to Point B

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Online shopping. This is the trend behind massive internet companies like Alibaba and Amazon. The picture above is from last year’s “Singles’ Day” sales event where Alibaba pulled in Rmb120.7bn of online sales just within 24 hours on November 11, 2016.

But behind the glamour of online shopping, there is a less glamorous but equally important service that drives this mega trend – express delivery. I have often wondered how the heck do they manage to ship goods so quickly. Didn’t I just click confirm payment yesterday and bam the goods are already at my home.

Here is a picture of how it happens.

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China’s e-commerce expected to rise from US$2.8trn in 2016 to US$5.9trn in 2021

According to iResearch, the gross merchandise value (GMV) of China’s e-commerce market has increased 3x from US$988bn in 2011 to US$2,825bn in 2016. In the next five years, it expects the GMV of China’s e-commerce market to double to US$5,785bn by 2021.

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Source: iResearch.

In terms of online penetration, online retail sales now account for 14.3% of China’s overall retail sales, a higher penetration rate than the 11.7% in the US.

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Logistics and shipping are the new landlords

Intuitively, we know the draw of online shopping, namely, cheaper goods and greater convenience. But why are goods cheaper? One big reason is the removal of rental costs from the retail equation.

A while back, I came across an interesting illustration in the WSJ. Using a pair of US$150 jeans as example, the offline “bricks-and-mortar” retail sales would net US$24 after the various operating expenses, a net margin of 16%. By comparison, through the online sales channel, the residual profit is almost double that at US$45, or a 30% margin

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What was interesting in the illustration was where the two channels differ. As you can see from the above, there is no difference in Cost of Goods Sold and there is also no difference in Marketing expenses. Although there is no “Store Payroll” in the online sales channel, one could argue that the software maintenance operating costs is almost the same. Similarly, freight to retail store has been replaced by warehouse/fulfilment.

The key difference is Rent and other retail operating costs being replaced by free standards shipping and return. In the traditional model, rent accounted for 15% of sales and other retail operating costs made up 8%. In the online model, free shipping and return make up 7%.

What this cost comparison suggest to me is that in the new online environment, the shipping and logistics companies are the new landlords in the virtual distribution channel.

China Express Delivery Market – 27.9bn parcels and US$59.8bn

While China’s e-commerce has tripled in size over the past five years, its express delivery market has grown even faster. The number of parcels delivered has increased 7.5x from 3.7bn in 2011 to 27.9bn in 2016.chart (29)

In dollar value, China’s express delivery market has quintupled from US$12bn to US$59.8bn in 2016. According to iResearch, in the next five years, the number of parcels are expected to double, reaching 60bn parcels and US$124.5bn by 2020. Although these numbers may seem big, they are actually quite conservative if one were to consider that FedEx and UPS each generated revenues in excess of US$60bn last year.

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Business model – Network Partner Vs. Direct Model

Unlike the US where express delivery is dominated by two players (FedEx and UPS), China’s express delivery market is more fragmented.

China’s express delivery companies tend to follow one of two business models, namely the network partner model or the direct model.

  • Under the direct model, the likes of SF Express and EMS (related to China post) manage the entire delivery channel from parcel collection to sorting to transportation to delivery.
  • Under the network partner model, companies like ZTO, YTO, STO and Yuanda only manage the centralise sorting and transportation. The last mile pick-up and delivery is left to smaller local network partners to handle.

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Growing pie but profitability being squeezed by rising competition

Looking at the financials released by five express delivery operators, the pie is clearly growing. Among the likes of SF Express, YTO, ZTO, STO and Best, their collective revenue increased by 29.7% in 2016 to Rmb103bn and in the 1H of 2017, their revenues has grown another 30.6% to Rmb60bn.

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Among these five operators, SF Express is the clear leader. In 1H 2017, SF Express earned Rmb32.2bn revenue, giving it a 54% market share among these five operators. YTO Express was the second largest revenue earner at Rmb8.2bn with Best Inc a close number three at Rmb8.1bn.

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As with most things in China, if there is money to be made, competition will sniff it out. When we compare 1H 2017 revenue growth with 2016, only SF Express and Best Inc were able to accelerate sales growth. It is clear that Best Inc’s market share gain is coming at the expense of the other operators.

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More worrying is the manner by which Best Inc is going after market share. In 2016, Best Inc’s gross margin was -6%, some 25pp lower than SF Express’s 19% gross margin.

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With competition aggressively going after top line growth, profitability has suffered with four of the five operators showing a decline in 1H 2017 gross and net profit margins.

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The other key notable from the above gross and net margin chart is the dispersion among operators. Gross margins range from ZTO’s 33% to Best’s -0.6%.

Comparison to FedEx and UPS

In order to gauge what longer term sustainable margins may be like, we turn to the US operators. As we alluded to earlier, FedEx and UPS generated revenues of US$60.3bn and US$60.9bn in their last financial year. This is roughly 7x larger than SF Express’ US$8.6bn 2016 revenues. From a market capitalisation perspective, UPS is nearly 72% larger than FedEx and 2.86x the size of SF Express.  chart (37)

From a profitability perspective, in their last financial year, UPS and FedEx recorded operating margin around 8.3%-9.0% and net margin around 5.0-5.6%. Among the Chinese operators, SF Express and YTO Express’ margins most resemble the US operators. SF Express had operating margin of 6.8% and net margin of 7.2% (it had some non-operating gains) while YTO Express generated operating and net margin of 10% and 8.1% respectively.

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China express sector – Strong sales growth but margins likely to compress further

Based on the, we would come away with the following initial impressions:

  • (1) Strong top line growth for China’s express operator – China’s top express delivery operator, SF Express, currently only generate sales that is one-seventh that of UPS and FedEx. Given the expected rise of China’s overall economy and e-commerce, there should be ample runaway before China’s express delivery sector’s growth peaks.
  • (2) Margins likely to come down – Normally, in a fragmented market, one would expect strong competition and low margins to be the norm. However, in this case, China’s express delivery sector margins are much higher than the US duopoly. As new operators vie for a piece of the express action, margins are likely to come down. Among China’s express operators, only the two larger operators of SF Express and YTO Express have margins that resemble those of the mature US operators.