The DBS Vickers Securities led deal is currently in pre-marketing and comprises 132 million H shares, or 36% of the company. Jingkelong will be only the fourth IPO on the GEM board this year and the largest since Tom Online raised HK$1.5 billion in March 2004. Wumart pocketed HK$547 million from its IPO in November 2003, but currently has a market cap of about HK$9.2 billion after its share price has soared 383%.
About 90% of JingkelongÆs shares are new, while the remainder will be sold by parent company Beijing Chaoyang Auxillary Food Co. The deal will have the typical Hong Kong split with 10% earmarked for retail investors and the rest for institutions.
Although this is not a requirement on the GEM board, the company has decided apply a clawback mechanism that could boost the retail tranche to a maximum 50% of the total offer in case the retail portion is more than 100 times subscribed.
The formal roadshow will kick off in the middle of next week with the pricing expected on April 21 or 22. The current aim is for the shares to start trading on April 28.
Fund managers believe the company needs to come at a reasonable valuation since it is a lot smaller and much less profitable than its main Beijing competitor, Wumart Stores, which is also listed on the GEM board.
Wumart currently trades at a 2005 price to earnings ratio of 53.8 times, but this falls to 37.3 times for 2006 amid expectations of strong earnings growth.
Jingkelong is being tested in the market at a 2005 PE multiple in the mid-20s, placing it in between Wumart and Lianhua Supermarket. The latter is a nationwide chain store operator with more than 2,000 self-managed stores that currently trades at 23.2 times 2005 earnings and 19.5 times its projected 2006 earnings.
Other mainland retailers outside the food sector trade at an average 2005 PE multiple of 33 times and a 2006 PE of 27 times.
Jingkelong operates hypermarkets, supermarkets and convenience stores in the Chinese capital and is unique among its supermarket peers as it also has a wholesale and distribution business, which contributes half its revenues. According to syndicate research this gives the company better purchasing power, more stable product sources, more effective inventory control and lower likelihood of running out of stock, while also serving as a buffer should consumers choose to shop in other retail outlets than its own.
Among other clients, the wholesale business counts Wumart as a customer.
The company has said that it will devote the next few years to growing its retail operations. Previously it was mainly focused on building out the back-end including a ôlive and fresh product logistics centreö and a ôdry product logistics centre."
Jingkelong currently has 158 retail outlets (65 directly operated), including four hypermarkets, 31 supermarkets and 123 convenience stores, located primarily in BeijingÆs Chaoyang business district and on the eastern side of the city. Wumart, on the other hand, operates mainly in the western part of Beijing, so the two companies are not yet competing with each other in a geographical sense.
In the next three years (2006-2008) Jingkelong is planning to grow its retail sales network by about 60% through the addition each year of at least two hypermarkets, six supermarkets and seven to 10 convenience stores, as well as 46 franchised outlets.
According to syndicate research, it has budgeted about Rmb707 million ($88 million) to achieve this target and for further brand-building.
The company is able to keep its expansion costs down as it leases most of its properties from its parent, with the typical lease being 20 years. Rents account for only about 1% of the companyÆs total revenue and it has an agreement that they cannot go up more than 5% every five years.
Favourable as this may sound, the companyÆs asset-light structure is actually what is preventing it from listing on the Hong Kong main board. According to Chinese regulations, a mainland enterprise cannot list on main boards outside of China unless it has a net asset value of more than Rmb400 million ($50 million).
The companyÆs focus on Beijing can be seen as both a strength and a weakness, say observers, who note that the company lacks the nationwide brand awareness and volumes advantages of other national or global players operating in China, including Carrefour and Wal-Mart. On the other hand, Beijing has the highest retail sales growth among major Chinese cities and the Chaoyang district is also one of the most affluent areas in the city.
ôMore and more people in Beijing are shopping in supermarkets rather than in the wet markets or neighbourhood stores because as the population becomes more affluent, people become more conscious about health issues and the quality of their produce,ö one observer notes.
At the end of last year, Jingkelong ranked only 34th among the top 35 retail enterprises in China, but thanks to its niche focus it was the second largest supermarket chain operator in Beijing - although its sales were only a quarter of those generated by Wumart.
Jingkelong has recorded a compound annual growth rate of 20% in revenues and about 40% in net profit over the past three years. According to one fund manager the management expects earnings to continue to grow ôas fast, if not faster, than the growth rate of consumer goods in Beijing,ö which is expanding at a CAGR of 16%.ö
In 2005 it posted a 37% rise in net profit to about Rmb75.1 million (not counting a Rmb18.4 million one-off exchange gain on fixed assets in 2004.) Revenues improved 15.5% to Rmb4.12 billion.
The net profit margin has improved to 1.8% at the end of 2005 from 1.3% in 2003 and is now in line with that of Lianhua, although both remain low. Still, Wumart is towering above with a net profit margin of about 4%.
However, as the company speeds up its expansion the margin should improve further, according to a syndicate research report.
ôIncreasing economies of scale offer advantages on pricing, unit costs, as well as rebates and credit from suppliers and these are expected to lift its profitability,ö the report notes.
Another point to note is the high gearing, which stood at 128% at the end of last year (compared with net cash positions at both Wumart and Lianhua) as a result of investments into capital-intensive infrastructure for its back-end wholesale and distribution facilities in recent years.
However, the share offer should be underpinned by a scarcity value in mainland retail stocks. This is one reason why there have which have been sharp share price gains for department store operators such Parkson Retail and Golden Eagle, as well as home appliance retailers Gome and China Paradise and sports goods seller Li Ning.
ôEssentially there are no willing sellers of these stocks so the share price is pushed up whenever somebody wants to buy,ö one observer comments.
Or as one fund manager puts it, ôThe stock looks a bit expensive and IÆm sceptical about the business model - as there are no guarantees it will be able to continue leasing enough space at the current low rents in order to meet the pace of its planned expansion. But if you treat the listing as a trading event you may well make some money short-term.ö