Gordon, Partner and Co-CEO, ventured to Manila last month with Singapore office colleague, David Goh, for the first time since the pandemic.
The macro picture
We were pleasantly surprised by how robust consumer sentiment was in the Philippines, even though the country is an outlier amidst the relatively good macro environment in the ASEAN region. As a food and oil-importing country, inflation is more marked in the Philippines (6.9% in September; fastest pace in four years) than for its neighbours. The country is the most food-insecure in Emerging Asia[1] and a reliance on imports means that Philippines will not have the tools available to countries like India and Indonesia to “protect” domestic consumers.
However, there have been some useful offsets in the form of strong demand for business process outsourcing (BPO) services (c.9% of GDP), as well as good remittance flows (also c. 9% of GDP) from overseas Filipino workers in places like the currently booming Gulf states. Moreover, people are simply very relieved to be moving on from the pandemic, especially given that the Philippines had the longest period of mobility restrictions globally[2] and in fact, public schools only recently went back to face-to-face lessons in August[3].
After this ordeal, getting back to work and being able to move freely has clearly been a huge boon to sentiment.
Philippine Seven: endurance investing
One of the main objectives of our visit was a deep-dive into Philippine Seven, the master franchisee for ‘7-Eleven’ in the Philippines. Specifically, we wanted to understand how the business and the landscape in which it operates have evolved since the pandemic.
This business is by far the dominant convenience store operator in the country. It is a highly cash-generative, owner-managed business that run exceptionally prudently even prior to COVID. The Philippines still has six times fewer 7-Eleven stores on a per capita basis than Thailand, illustrating the huge growth runway ahead.
However, the pandemic took its toll on the company. Manila is normally a very busy city with people constantly moving around and every mall we went to (no matter the time of the day) were filled with people. Two years of strict COVID lockdowns in the Philippines meant most 7-Eleven stores faced severe drops in footfall traffic. The convenience proposition of 7-Eleven was simply less relevant, and many of its stores – especially those in commercial and transit locations – looked like they could become non-viable in a structural sense if the pandemic really were to change work and mobility patterns. One third of 7-Eleven stores are in areas dependent on office workers and students. Meanwhile, another small format competitor by the name of ‘Alfamart’ (run by Indonesian retailer Sumber Alfaria) was making good headway with its minimart concept, thanks to cheaper, non-prime store locations in more residential areas and with a low-price, grocery-oriented offering.
Based on our trip, we believe there should be plenty of space for both companies to do well, simply because they do quite different things. Whilst there is some overlap in terms of products sold, the assortment and proposition are disparate. Alfamart is much more focused on frozen food and bulk goods, whilst 7- Eleven gets around one third of sales from ready-to-eat or ready-to-serve products, and around a quarter from impulse beverages. One could even say that 7-Eleven is a fast food and coffee outlet which also sells snacks and cold drinks. In other words, it sells convenience and on-the-goconsumption, whereas Alfamart is designed for lower frequency grocery shopping, mainly for future, planned consumption. Alfamart does offer a nominal ready-to-eat food selection, but, as the photos below illustrate, it is not really comparable with that of 7-Eleven.
Another difference between the companies is location. 7-Eleven is usually placed in the centre of trade areas, where the transport transit happens or where you’re closest to the most affluent within the trade area (and hence the higher rents); whereas for Alfamart, these stores are placed within neighbourhoods but because of its cost structure, often in less optimal locations within a trade area. As would be expected, Alfamart did better during the lockdown because its residential-neighbourhood stores were the logical choice for people stuck at home, whilst 7-Eleven’s locations were ill-suited for that environment. However, with Filipinos now returning to work, the convenience proposition of 7- Eleven is once again relevant and indeed is making a strong resurgence.
Also encouraging is the fact that the direct competition for 7-Eleven from ‘true’ convenience stores has basically evaporated. With Japanese franchises like ‘Lawson’ and ‘Family Mart’ together with local competitor ‘Ministop’ having given up and closed down over the pandemic period, 7-Eleven is now a quasi-monopolist in the convenience retail space. Moreover, on our trip we heard reports that numerous erstwhile franchisees of these rival chains are seeking to convert to 7-Eleven, recognising that it is now the only game in town.
Longer term, we think the main risk is that Alfamart somehow pivots towards offering more convenience products. However, to do this, it would need to re-model its supply chain in such a way that would allow the much higher frequency deliveries required by convenience stores (with much faster turning inventory) versus minimarts. We learned that most 7-Eleven stores are served by one delivery per day, whilst for most Alfamart stores this is probably more like 2-3x per week. We think it will be challenging to close this gap: 7-Eleven Philippines currently has 21 Distribution Centres versus just four for Alfamart. Another advantage of this logistics backbone was highlighted during a recent typhoon which caused a major landslide in the North of Luzon, making the usual distribution route inaccessible. Without its extensive distribution centre network, several 7-Eleven stores would have been unserviceable until the landslide was cleared. Instead, it was able to re-route deliveries from an alternative distribution centre with only minor service disruption. Such resilience will become more important in the face of increasingly severe weather events expected in the Philippines due to climate change[4].
On top of this advantage in ‘hard’ infrastructure, Philippine Seven has over the years developed a formidable back-end IT infrastructure and spent the pandemic period working to extend this advantage even further. From speaking with the CEO, we learned that he believed from the outset that the pandemic would be a two-year affair, and hence used the lull in front-end operations to focus efforts on strengthening back-end capabilities. For instance, he made the whole company learn Power BI, a visual analytics tool, and introduced dynamic planograms to give far more visibility and control over store by store merchandising.
We also spoke with Philippine Seven’s business development team, a key function for a small-box retailer given the imperative of finding suitable locations for new stores. From these conversations we learned that there is a pipeline of around 1,000 new store sites, and that it is an arduous nine month process to identify and negotiate a location, with a 40% success rate.
We therefore left Manila with a high level of confidence that Philippine Seven has created formidable moats in the shape of its supply chain, data-driven back-end processes, and location sourcing capabilities.
As we move on from the pandemic period, it is worth reflecting on where this business is today relative to the ‘before times’. Q2 2022 revenues were 14% higher than the comparable period in the preCOVID era (Q2 2019), whilst EBITDA is 36% higher. The company today has around 3,200 stores, as compared to c. 2,700 in June 2019. The balance sheet remains in net cash, as the company remained free cashflow positive in 2020 and 2021, and hence did not need to source any incremental outside funding to keep the lights on during lockdown.[5] In fact, the company used its strong balance sheet to support its franchisees, which account for around half of stores. It also renegotiated rent with landlords on more favourable terms. As mentioned above, the ‘true’ convenience store rivals did not survive the pandemic, leaving a more open competitive field for Philippine Seven. Both the CEO and the parent, President Chain Store, have been adding to their shareholdings.
While the trip gave us plenty of good insight into the company, we have more research planned. On our next visit to the Philippines, we intend to organise several consumer focus group sessions to hear first-hand their perceptions of Philippine Seven and what drives their decision-making around convenience shopping.
All in all, we think Philippine Seven is a classic example of the strong (surviving a crisis) and getting stronger. For us, cases such as this illustrate the virtues of ‘endurance investing’ – the ability to hold exceptional assets through adversity to capture significant long-term value creation which lies ahead.
[1] https://carnegieendowment.org/2022/07/13/why-philippines-is-so-vulnerable-to-food-inflation-pub-87467
[2] https://time.com/5945616/covid-philippines-pandemic-lockdown/
[3] https://www.cnnphilippines.com/news/2022/8/22/Face-to-face-classes-school-year-2022-2023-COVID-19-pandemic.html
[4] Climate Risk Country Profile: Philippines | SEADS (adb.org)
[5] Figures sourced from Philippine Seven company financial reports
