SHARES of Mercurius Capital Investment have seen active trading since it announced a planned diversification into the grocery business and ambitions for a network of over 500 stores across the region.

 

The proposed acquisition of a chain of grocery stores in Malaysia could provide some relief for the investment holding company, which currently focuses on property development and investment.

 

The company has not generated any revenue in at least the past four years. In FY2020, it incurred a net loss of S$2 million. As at end-2020, it had net current liabilities of S$4.2 million. Its independent auditor' s report contained a disclaimer of opinion, with the auditors highlighting losses and liabilities that cast doubt on the group' s ability to continue as a going concern.

 

The proposed acquisition of Songmart Holdings - which is in the business of trading of foodstuff, groceries, sundry goods and daily necessities and operates 12 mini-marts and convenience stores and a premium supermarket in Malaysia - could improve the fortunes of the company.

 

With the pandemic still raging in many parts of the world, uncertainty remains over whether its plans to develop resorts in Thailand would be able to commence and generate revenue any time soon.

 

The acquisition of a target group that is already profitable would likely be welcomed by investors.

 

Sensible move

 

Mercurius is acquiring Songmart via the issuance of 200 million shares at a price of S$0.18 per share for a total of S$36 million. Based on Wednesday' s closing price of S$0.085 the market value of these shares would be S$17 million.

 

According to Mercurius, the net tangible assets (NTA) of the target group was around RM13.8 million (S$4.4 million) as at end-FY2020. Songmart' s unaudited net profit for FY2020 was around S$3.1 million.

 

The deal includes after-tax profit targets for Songmart of RM15 million and RM16.5 million for FY2022 and FY2023, respectively. The acquisition consideration is being paid in three equal tranches, with adjustments if targets are not met.

 

The acquisition price does not seem unreasonable when compared to the valuations of other locally listed grocery players. Sheng Siong Group and Dairy Farm International Holdings currently trade at an average trailing price-to-earnings ratio of 18.8 times.

 

On a pro forma basis for FY2020, the acquisition would boost both earnings and NTA per share for Mercurius.

 

Diversifying into a defensive business that can provide stable cash flows is a sensible choice, particularly for a company whose core business is facing uncertainty as the pandemic continues.

 

Mercurius is not the only company doing this.

 

In recent weeks, mainboard-listed KTL Global - which is in the business of providing branding, operation and procurement services - has also taken steps to move into the fresh produce business.

 

It acquired Tianci Agritech in June for S$0.2 million, and said on Monday it is acquiring a 51 per cent stake in e-commerce platform and fresh produce distributor Ebuy.

 

Like Mercurius, KTL has been impacted by the Covid-19 pandemic. Revenue for FY2020 was down 71 per cent, and it had said that there was an urgent need to inject a new revenue-generating business into the company. It believes that entering into the business of supplying and distributing fresh produce would allow the group to tap an expanding consumer market in Singapore.

 

Mercurius has said it sees potential for Songmart to penetrate regional markets and is eyeing aggressive expansion. It plans to have a network of over 500 stores across the region in the next three years, and would look towards bank borrowings and placements to fund this.

 

Risks remain

 

Companies are right in pointing out that there are large addressable markets for such grocery services, and the sector has indeed performed well through the pandemic.

 

But investors would also need to consider whether companies are able to deliver on their aspirations, rather than simply choosing to diversify into the most popular segments of the moment when they face challenges.

 

The grocery sector has large incumbent players, and the industry is also seeing disruption from e-commerce.

 

In Singapore, even established players have exited the business in the past. French retailer Carrefour is one example.

 

Newer entrants may face challenges when trying to break into new markets and grow rapidly, particularly if they have insufficient expertise or resources.

 

It is worth noting that this is not the first time Mercurius is looking towards greener pastures. Its current core focus of property development and investment came following shareholders' approval for diversification in 2017. But this has not seen much success so far. Its past endeavours - when it was also known as CCFH and Friven & Co - include children' s fashion, bedding and bed linen, as well as renewable energy.

 

Investors should be mindful of the risks of diversification, even if they are bullish on potential returns from new business segments and ambitious growth targets.

 

Mercurius' shares have fallen 12.4 per cent in the past two days, but the counter is up 30.8 per cent since its plans to enter the groceries segment were first announced in April. On a year-to-date basis, the shares have more than tripled.

 

Investors hoping for exposure to potential returns from a growing groceries business would need to consider what would be a fair price at which to enter, taking into account the profit targets and the value of the existing business.

 

The acquisition of a profitable business in a defensive sector could herald a brighter future for Mercurius, and it appears to be a sensible choice given the current headwinds faced by its main business.

 

What remains is for the management to focus on making this latest diversification effort succeed where past endeavours have fallen short.