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Morningstar | Sun Art Retail is facing challenges from changing trends in retail formats.

Sun Art Retail is one of the leading hypermarket operators in China, and has the highest profit margin in the hypermarket sector due to its economies of scale and well-controlled operating cost. However, in recent years, Sun Art has been facing headwinds, including aggressive expansion of e-commerce players, intensifying competition among existing offline players, and the emergence of new retailing formats.In the medium to long term, we think China’s retail competitive landscape will remain challenging to Sun Art. The Chinese offline retailing market is still fragmented, including both national players and regional leaders. We think Sun Art will face intense competition in its expansion to lower-tier cities. For example, the firm had secured 78 sites to open hypermarket complexes in 2018-20, while Yonghui had secured 183 sites. Owing to minimal customer switching costs, increased store openings may drive intense price competition and weigh on retailers’ profitability. Moreover, both Alibaba and JD have been expanding to offer grocery merchandise and investing in online-to-offline, or O2O, businesses aggressively. Although Sun Art started its own e-commerce site (Feiniu.com) in 2014, we don’t think it can compete with the leading e-commerce marketplaces. Meanwhile, both Alibaba and JD.com have invested in O2O businesses through investing in their own O2O platforms, as well as collaborating with offline retailers. In August 2016, JD.com acquired a 10% stake in Yonghui, and the two have been collaborating in an O2O business. Alibaba has also invested in several online and O2O sales platforms for fresh food.In the near term, we believe Sun Art will see some recovery in same-store sales growth, or SSSG, due to the increase in the Chinese consumer price index, especially the food CPI. In addition, the firm will see a decrease in margin pressure from aggressive e-commerce investment, as a result of its change in strategy. Sun Art’s SSSG recovered from negative 3.6% in 2015 to negative 0.3% 2016.