Jumbo Group Ltd - Maybank Kim Eng 2016-05-18: Two-way China Play

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JUMBO GROUP LIMITED 42R.SI 

Jumbo Group Ltd (JUMBO SP) - Two-way China Play 

Post-results luncheon; maintain BUY 

• We hosted a well-attended post-results luncheon for Jumbo’s CEO Ang Kiam Meng, CFO Tay Peng Huat and Director of Operations Jacqueline Tan, where it became clear that Jumbo is not just a direct China play but also a reverse China play. 
• PRC consumption power is strong, benefiting Jumbo’s outlets both in Shanghai and Singapore. 
• An additional catalyst should be its faster-to-market franchising which will allow it to add outlets more rapidly. 
• We raise our blended P/E (20x FY16 EPS) and DCF TP (WACC 9.3%, LTG 1%) to SGD0.65 on the back of a 50% capacity expansion at its second-biggest outlet by revenue. 
• Maintain BUY.

Positive forecast changes 

• 2H16 is expected to remain strong. We forecast 14% YoY EPS growth, which could be stronger if its underperforming Raffles City outlet can be brought up to speed. 
• We raise FY17 revenue by 8% and EPS by 7% on the back of 50% more capacity at its Jumbo Riverside outlet. We think Jumbo should have no problems filling its additional 150 seats. 
• We now expect 18% EPS growth in FY17, up from 10% previously.

1.1 2Q strong but can be repeated, in our view

• Management shared that 2Q16 results were boosted by strong sales in Singapore and strong contributions from China, especially its newest outlet in IFC Mall, Shanghai.
  • Singapore faring better this year. Singapore revenue grew 12% YoY, above last year’s mid-teens. Reasons were: 
    1. increased patronage by PRC visitors now that mainland Chinese visitors to Singapore are rebounding; and 
    2. better lunch-time business which management attributed to stronger corporate patronage and a spillover of tourists unable to secure dinner reservations.
  • China operations profitable and surging. All three outlets in Shanghai were profitable, with IAPM Mall and IFC Mall the clear outperformers. The markets they target are the prosperous middle class and deep-pocketed business clientele, respectively. Combined monthly revenue is very promising and management believes the run rate can be sustained in 2H16. IFC was outstanding. Although opened only in late January, business was so good that it was able to turn in a profit in the same quarter. Recall that IAPM broke even only at the end of its first year and made a profit only in its second.
• Given the strong 2Q base, management is understandably conservative on 2H, cautioning that it may not match 1H16 due to near-term challenges such as the relative underperformance of its Raffles City outlet and the higher cost of crab. This caution is already reflected in our core net profit forecast of SGD16.6m, implying a 2H profit of SGD8m vs 1H’s SGD8.6m. This still implies YoY growth of 14% for 2H16.
• Still, as management recognises these challenges and is already working to fix them, we believe Jumbo has scope to do better:
  • Raffles City branch needs a fix. While profitable in 2Q, management believes Raffles City can do better. It is stabilising operations there to make sure that it stays profitable in future quarters. Its menu and pricing, for example, are being tweaked to a faster-turn, casual- dining concept that better suits a younger, shallower-pocket crowd. To build awareness, it will run promotions such as smaller crabs sold at lower prices. It could take about six months to stabilise sales.
  • Rising mud-crab costs. Mud-crab prices have been rising due to high demand from China. Prices for some shipments have risen as much as SGD7/kg since last year. For now, Jumbo is holding its selling prices but if prices remain high, it will probably pass them on. We believe the market is price-inelastic enough to accept higher prices. Higher crab costs will affect the whole industry but if diners want the best crabs, Jumbo is still the place to go. As the biggest seafood buyer in Singapore, it has been able to get enough supply with the choice picks: read, the fleshiest claws!
• On the bright side, management believes that mud-crab prices may be peaking, as they near the cost of traditionally more expensive crabs such as dungeness and Alaskan crabs. Also, China provides a hedge as crab sales there are a mix of 50:50 mud crabs and other types of crabs, unlike the Singapore market where it serves almost all mud crabs.

1.2 Plenty of catalysts for outperformance

• We see ample catalysts for Jumbo to continue to outperform, not just in 2H16 but in the years to come. Some that management talked about which we deem especially relevant are:
  • More franchising and strategic partnerships to create a new wave of growth beyond what Jumbo’s own resources can achieve;
  • Room for improvements even in the mature Singapore market, aided by more PRC visitors and their unique social-marketing mechanisms;
  • Potential M&As in catering etc; and
  • A strong balance sheet with the cashflow generation capacity to support faster organic and M&A growth, while rewarding shareholders at the same time.

1.3 Fresh wave of growth from overseas, especially China 

• First, Jumbo is keen to develop its China market further. It is scouring for locations to open more Jumbo seafood outlets in Shanghai. Management believes Shanghai can comfortably accommodate as many as eight of its seafood restaurants. Its current three are in Pudong and Puxi; other areas of interest include Xujiahui, a precinct in Shanghai renowned for its shopping and entertainment.
• Second, Jumbo is keen to bring its other dining concepts to China, as well as expand its Jumbo seafood brand to Taiwan, Korea and Thailand in Asia. In China, it believes that Singapore’s cuisine is well-suited to the taste of the Chinese. This includes its Ng Ah Sio bak kut teh and Chui Huay Lim Teochew food. Its market studies suggest opportunities for Singapore-style Teochew food in Shanghai and Beijing.
• In expanding:
  • Management prefers franchises over direct ownership as they are faster to market. More future Jumbo outlets will be opened by franchisees. This will accelerate the group’s next wave of growth, as management is cognisant that Jumbo does not have enough resources to cover every market or segment. Other than breaking into new markets, it plans to diversify its range of restaurants to cover different market segments, from high end to the mid-market and casual. Jumbo IFC Mall could be considered high-end while Jumbo IAPM Mall would be considered mid-market and Raffles City, the “kitchen” concept targeted at the casual segment.
    To this end, it is looking for strategic partners, which ideally should be reputable, listed F&B operators with good track records. It has talked to potential partners for franchising or to help it import its other brands into China. Jumbo hopes to be an equity partner in these ventures, with stakes of up to 30%. We could see developments in the near future. In addition, it has identified potential locations for future Jumbo outlets, although nothing has been firmed up yet.
  • Ambitious but risk-aware. Management hastened to assure investors that Jumbo will not expand recklessly. Mr Ang said he has seen the consequences of over-rapid expansion unaccompanied by proper controls or strategy. In the long run, management believes franchising can help it plant the flag of at least one of its brands in each top-tier city in the region. To minimise risks, it is interested in partners that are willing to commit to a 5-year horizon.

1.4 More room for Singapore market to grow

• Singapore still accounted for 86% of group revenue in 2Q16. While China’s contributions have risen fast, Singapore remains a substantial market for Jumbo.
• Growth rates in Singapore fell to the mid-single digits in FY15. Partially, this could be traced to a lack of seating capacity at existing outlets, a problem that can be resolved to some extent by taking over adjacent space as and when this becomes available. Management will be taking over and leasing Chen Fu Ji Fried Rice’s vacated space above its Riverside outlet. This will add 50% to its capacity of 300 pax at a minimal capital cost of SGD1.75m. Renovation should be completed by Jul 2016.
• Riverside is Jumbo’s third-biggest outlet by size but the second in profitability. Its expansion will involve adding private rooms on the second floor and installing a new kitchen and serving equipment on the ground floor. It will allow Jumbo to add revenue without additional A&P. By our estimates, group revenue and EPS could be lifted by 7% in FY17.
• Jumbo also sees room for at least one more full-service Jumbo outlet in Singapore. It is eyeing the CBD in places such as Shenton Way and Tanjong Pagar. The location must be able to cater to day-time corporate diners and night-time/weekend diners. Our FY17 forecast already assumes a 6- month impact from a new Jumbo outlet in Singapore.

Jumbo’s secrets to success. 

• CEO Mr Ang shared that Jumbo’s recipe for success boils down to three things: 
  1. the brand’s ability to draw in tourists; 
  2. its growing appeal to corporate diners; 
  3. the tourist- and business-friendly locations of its biggest outlets. 
• Mr Ang readily admitted that some Jumbo seafood outlets such as the two at Riverside and the one in Dempsey perform much better than say, NSRCC Changi. This is because the former two cater to more tourists and business diners.

Beneficiary of Chinese tourists. 

• Mainland Chinese visitors are Jumbo’s single biggest observable customer group. PRC visitorships in Singapore have rebounded strongly from the slump in 2014 and 2015, caused by MAS’s aircraft incidents. This is a trend management believes is sustainable due to the Singapore government’s welcoming attitude, unlike countries such as Hong Kong. To serve them better, Jumbo has provided more payment options for this group since last December. These include Alipay, which boasts 400m registered users in China. Next could be WeChat Wallet. Further upside from engaging these platforms is their free social marketing, as their apps will push-notify PRC Chinese about supporting merchants in Singapore such as Jumbo.
• Finally, the opening of a new Ng Ah Sio outlet in Marina Bay Sands costing SGD0.5m is in the works. Management sees enough demand for bak kut teh in this catchment area to justify an outlet. It believes that Ng Ah Sio is a scalable brand which can also be taken overseas.

1.5 Work balance sheet harder, pay out more, or both! 

• Jumbo generated SGD4.5m in FCF in 1H16, after capex of SGD3.6m. It closed with net cash of more than SGD50m, even after paying almost SGD52m in dividends. Cash on hand is one of the reasons we remain confident of its ability to manage any crab shortages, as suppliers prefer to sell to customers with the proven ability to pay on time.
• Some other potential uses of its cash are:
  • M&As. Management is on the lookout for acquisitions in food catering, a high-margin market where it believes it can leverage its brand. It is not interested in school or home catering where per pax spending is less than SGD10, but rather in high-end or corporate catering with per pax spending of c.SGD50.
  • Dividends. Higher payouts are also possible and probable, in our opinion. Consequently, we raise our assumption from 30% to 50% for FY16E. The stock now yields c.3%.

1.6 Other updates

 Food costs in China. 

• Higher because Jumbo imports seafood and
• certain ingredients into China. There are extra logistics costs and import duties. Stronger China sales accounted for the drop in its gross margins in 2Q16.

 Lower staff & utility costs. 

• The higher import costs were compensated by lower costs elsewhere, particularly staff and utility costs following better cost management.

 Central kitchen. 

• In Singapore, management is still searching for a suitable location in the eastern part of the island to consolidate its central kitchen. This is currently non-optimally housed in three different units. However, it is prepared to take its time given a weak property market. Likely investment is SGD20-30m with SGD12m funded by IPO proceeds of SGD38m. 
• In China, management believes it will not need a full central kitchen until it reaches a critical mass of eight restaurants. Even then, it thinks it does not need a standalone central kitchen. Instead, a bigger kitchen within an existing restaurant can double up as a central kitchen.

 Franchising with three sources of income: 

1. royalties; 
2. sales of ingredients such as sauces; and 
3. equity stakes of at least 30% in JVs with franchisors.

 Alipay/WeChat. 

• Alipay support was added in Dec 2015. All Jumbo outlets currently support Alipay. JPOT will be added next. 
• Support for WeChat Wallet is in the works. Benefits to merchants from Alipay include next-day payment and lower costs than credit cards, where banks normally take three days to pay merchants and charge higher commissions to boot!

 A&P. 

• Jumbo does not spend much on advertising & promotions. It relies more on word of mouth. A powerful feature of Alipay is its free advertising for merchants that support its payment service. 
• Jumbo is also implementing a successful CRM system in China akin to what it has in Singapore. It hopes this will provide the same bang for the buck as in Singapore.

Gregory Yap Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-05-18

Maybank Kim Eng SGX Stock Analyst Report BUY Maintain BUY 0.65 Up 0.62