The biggest electronics retailers may have created some of the nation's richest tycoons, but their ambitious growth plans may not bode well for investors buying their stock.
Jockeying for ground in what could become the world's biggest electronics market, the three biggest electronics and home appliance retail chains - GOME Home Appliance Group, Suning Appliance Chain Store (Group) Co. and China Paradise Electronics Retail Ltd. - are playing a ruthless game of expansion, which is quickly eating away at profit margins.
While the three have enjoyed surging growth and explosive profits in the past few years, their future plans, which mirror the expansion strategy of most major retail chains in China, aren't winning over analysts, who suggest investors put their money to better use.
"As they are now becoming more dominant, it will be harder for them to sustain the same pace of growth in large tier-one and two cities," says Richard Cheung, associate principal at McKinsey & Co.
He adds that entering smaller cities requires a new strategy to cope with the lower spending power in the less-developed areas, another risk for the retailers.
Analysts also worry that price wars to win over customers are being waged even as the retailers bid against each other to secure land for new store sites.
Han Weijun, marketing manager of a commercial-use building in downtown Beijing, told Dow Jones Newswires that almost all big-name domestic electronics retailers and Best Buy Co. (BBY) of the U.S. are bidding for a 14,500-square meter mall owned by his company.
Rent for commercial space rent in some prime areas in Shanghai has jumped about 40% from the start of 2005 to 13 yuan per square meter a day, according to statistics from Centaline (China) Property Consultants Ltd.
But that's not stopping retailers from slashing their own prices. Suning, a relative late comer, made one of its biggest assaults on market leader GOME this year. On one of the busiest sales days for retailers, China's Oct. 1 National Day, it launched a flagship store in Shanghai directly across the street from a GOME store, with glitzy signs and big discounts.
While analysts don't see foreign electronics retailers as an immediate threat, retail giants such as Carrefour S.A. and Wal-Mart Stores Inc. (WMT) have become formidable competition for China's local supermarkets and hypermarkets, and there's no compelling reason for major electronics retailers not to follow suit.
In fact, Best Buy, one of the world's largest home appliance and consumer electronics retailers, told Dow Jones Newswires in an e-mail message that it plans to open "lab shops" in China next year. It's already opened offices in Shanghai, Beijing and the southern boomtown of Shenzhen.
Meanwhile, China's major electronics retailers are racing ahead.
GOME, China's leading electronics retailer, with about 420 stores in more than 100 cities, wants to have 1,000 stores by 2008. By that time, GOME expects to have a 15% share of the market and annual sales of CNY120 billion, said Lisa Du, executive director at GOME's Hong Kong-listed unit GOME Electrical Appliances Holding. Currently, GOME has a market share of just 5 percent.
"GOME Group spent 18 years to open about 200 stores in the past. This year alone, however, the whole group will have added that many stores," said Du.
Such explosive growth has made its 36-year-old founder Wong Kwong-yu the fourth-richest person in China, according to a list compiled this year by Forbes magazine.
But competitors are catching up. Suning, which was founded in 1990, opened a new store on average every 2.2 days in the first 11 months of this year; in 2001, it opened a new store every 40 days. It now has more than 200 stores in 75 cities.
China Paradise staged an initial public offering in Hong Kong in mid-October to raise money for new stores and acquisitions, and to build a distribution center on the outskirts of Shanghai.
"Every major player in the (electrical appliances retailing) sector will have similar expansion plans. So land grab will be the dominant theme in the short term," Merrill Lynch said in a report issued last month.
Already, the breakneck expansion is eating away at the retailers' margins.
In China Paradise's case, sales per outlet dropped significantly, by 52% last year from 2003 and 44 percent on year in the first half of 2005, Merrill Lynch said in another report issued in early December, adding that declining sales per square meter "has been a universal problem, affecting all major consumer electronics retailers in China." The investment bank has a "sell" recommendation on the stock.
GOME Group's Hong Kong-listed unit GOME Electrical Appliances Holding posted a 34% rise in core revenue in the first three quarters versus the same period last year, but its net profit rose a paltry 5.5% to HK$561.2 million.
Merrill Lynch forecasts GOME Holding will deliver earnings growth of 8% this year, 13% in 2006, and a slower 9% in 2007. It has a "neutral" rating on GOME, which traded at HK$5.20 on Monday, down 43% from its peak this year in March.
Suning's Shenzhen-listed A shares ended at CNY19.52 Monday, down 7% since hitting a historical peak of CNY21 in mid-October, but still more than double the price in July 2004, after accounting for share splits, when they listed on the Shenzhen Stock Exchange.
China Paradise's share price is down 6% from an all-time high of HK$2.925 hit in early December, but still up 22% from its offering price.
Orient Securities strategist James Teng said investors should think twice before getting swept away by the electronics retailing fever.
"Growth at these retailers won't be as easy as the past couple of years," Teng said, citing cutthroat competition and an operating format that is easy to copy for new comers.
But for 40-year-old Zhang Rongping, the electronics retail competition is good news. The CNY30 she saved in October buying her 29-inch Sony television at Suning's newly-open flagship store in Shanghai, instead of at GOME across the street, was enough for a cab ride home.