Jumbo Group Ltd (JUMBO SP) - Maybank Kim Eng 2017-12-12: Time For Tasty Re-Rating

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JUMBO GROUP LIMITED 42R.SI

Jumbo Group Ltd (JUMBO SP) - Time For Tasty Re-Rating

Expansion catalysts; BUY 

• We resume coverage of JUMBO with a contrarian BUY and DCF TP of SGD0.70 (WACC 9%). Our TP implies 26x FY18E EPS, on par with regional F&B peers. 
• Leveraging its reputation and consistent quality, JUMBO aims to open 4-5 new outlets a year in FY18-20E, up from just one historically. Rapid profitability in just one month for its Beijing outlet opened in Jul 2017 demonstrates the Chinese consumer’s confidence in its brand and JUMBO’s execution ability, in our view. 
• We expect catalysts from a 3-year EPS CAGR of 15%, backed by:
  1. more new outlets;
  2. low upfront costs for expansion through JVs and franchises; and
  3. operating leverage. 
• Risks include execution missteps or delays.

INVESTMENT SUMMARY

Accelerating growth in traditional markets: Singapore and China 

• JUMBO is a leading restaurant operator in Singapore, which accounts for more than 80% of its revenue. Signature dishes at its eponymous seafood restaurants are the Singapore chilli crabs and black-pepper crabs. 
• After entering China in 2013, China has become its star market. China contributed 18% to its FY17 revenue, up from just 6% in FY14. After building up its brand, local knowledge and connections in its first city, Shanghai, JUMBO is turning more aggressive. It has moved out to Beijing, with plans to open more than one outlet a year in China. We expect JUMBO to open two new outlets in China in FY18E, which could lift China’s revenue contributions beyond 30% in FY20E. 
• Singapore remains its cash cow, at more than 80% of group revenue in FY17. Singapore’s typical revenue growth of 4-11% YoY pa slowed to just 2% in FY17, caused by the closure of a JPOT outlet at Parkway Parade. 
• We expect a return to high-single-digit growth from FY19, when JUMBO opens two new outlets: one Ng Ah Sio Bak Kut Teh in FY18 and one Jumbo seafood in FY19.

Entering new markets with low-risk, low-cost JVs & franchises 

• Beyond its traditional markets, JUMBO aims to form franchises and JVs in other Asian markets. It started its first franchise in Vietnam in May 2017. It plans to open a second in Hanoi with a local F&B partner. 
• It has formed a JV and franchises to open at least eight outlets in Taiwan. We expect one new outlet in Taiwan each in FY18-19E, followed by two more pa in the next three years after gaining market familiarity. 
• JVs and franchises should reduce the risk of failure for JUMBO as it harnesses the strength of its value-adding partners and cut upfront costs. JUMBO will receive 3-5% of revenue from its franchisees and a 49% share of earnings from its JV outlets. 
• It has identified five other potential markets: Thailand, Indonesia, Hong Kong, Macau and Korea. There is also potential to scale up non-Jumbo brands, including Ng Ah Sio Bak Kut Teh and Chui Huay Lim Teochew cuisine.

Foundation laid for new EPS growth 

• In FY17, JUMBO incurred considerable upfront costs for its regional expansion. It shifted to bigger head offices in Singapore and China and added headcount. The bulk of its upfront costs for two new China outlets was also incurred in FY17.
• These were opened in late FY17 and early FY18. Starting FY18E, we believe earnings growth will resume, from:
  1. more new outlets overseas; and
  2. operating leverage to cover increased head-office expenses.

Undervalued 

• JUMBO trades at 21x FY18E P/E, a discount to domestic peers’ 24x average. But we believe these are not good comparables due to Singapore’s smaller market.
• We think regional peers provide better comparisons, especially in view of JUMBO’s regional-expansion plans. They trade at 26x on average. Despite range-topping ROEs and margins, JUMBO trades at discounts to these peers. 
• Our DCF TP of SGD0.70 implies 26x FY18E EPS, on par with them. We believe our valuation is conservative, as we have assumed 1x beta vs Bloomberg’s 2-year beta of 0.6x to account for execution risks in its aggressive overseas expansion.

Accelerating Growth in Traditional Markets 

• JUMBO aims to open 4-5 new stores each year in FY18-20, including franchise stores. This is more than its one store pa before FY17. JUMBO started to open more outlets in FY17, adding three.
• In China, we expect two new outlets in FY18E, as JUMBO expands outside its beachhead of Shanghai. Although Singapore is its cash cow, JUMBO did not open any outlet here in the past three years, as it was busy with strengthening its presence in China and preparing for its IPO in Nov 2015. This is set to change. It plans to open one Ng Ah Sio Bak Kut Teh outlet in FY18E and one Jumbo seafood outlet in FY19E. We have not factored in new outlets for its other brands.

New Markets 

Refining its business for next phase 

• JUMBO so far has been able to: 
  1. Scale up, as it builds on its Jumbo seafood brand.
  2. Maintain consistent food quality amid expansion. It relies on central kitchens to produce important ingredients such as sauces and marinated food. It is also selective with partners and markets.
  3. Maintain net margins and earnings growth amid expansion. 
• Management has tested various expansion modes, including wholly-owned outlets, partnerships and franchising. It adopts different modes based on its degree of familiarity with its markets. It has been able to deliver good results partly thanks to its willingness to tie up with players with more experience in China. The latter include:
  1. BreadTalk (BREAD SP; NOT RATED), another major F&B player in Singapore with experience in China’s bakery and restaurant markets. BreadTalk holds a 30% stake in JUMBO’s Shanghai operations; and
  2. unlisted Beijing Hualian Group, the operator of the Beijing SKP mall, where JUMBO’s Beijing outlet is located. Beijing Hualian is a major mall operator in China with a focus on supermarkets and retail stores. It owns 49% of JUMBO’s Beijing SKP outlet.
• JUMBO intends to establish more seafood outlets in Singapore and other Chinese cities such as Shenzhen and Xi’an. It will expand in China either through acquisitions, JVs, franchises or strategic alliances.

Breaking into Taiwan & Vietnam 

• Beyond China and Singapore, JUMBO has an ambitious target to open at least eight seafood outlets in Taiwan. This could double is total seafood outlets to 18, assuming no forays into other countries. 
• JUMBO has secured a strategic partner, unlisted Baipin, which has a track record of introducing Michelin-star restaurants to Taiwan. The latter included Hong Kong’s “TimHoWan”, Japan’s “Tsuta” and Singapore’s “Hawker Chan”. JUMBO will expand in Taiwan via franchises and this JV. It will receive 3-5% of revenue from its franchisees and 49% of the earnings of its Taiwanese JV outlets. This approach should reduce the risk of failure for JUMBO as it harnesses the strength of its value-adding partners and reduce upfront costs. Sharing the topline of its franchisees also reduces earnings risks from marketing and start-up costs to promote awareness in new markets.
• JUMBO also started its first franchise in Vietnam in May 2017, with a property-related player. In FY18, it plans to open a second in Hanoi with an F&B partner.
• JUMBO has identified five more potential markets: Thailand, Indonesia, Hong Kong, Macau and Korea.
• Apart from its seafood brand, JUMBO hopes to open two Bak Kut Teh outlets and a Teochew cuisine outlet in Singapore in the next few years. It is also on the lookout for acquisition opportunities, particularly of F&B brands which complement its current businesses.

Central kitchen raises efficiency, consistency and quality 

• JUMBO’s existing 10k sf central kitchen in Singapore supplies its local and China outlets. Although located in the same building as its corporate offices and other kitchens, its premises are not owned by JUMBO. JUMBO intends to utilise SGD11.5m or 29% of its IPO proceeds to bring all its operations under one roof in acquired premises. 
• In China, Jumbo has a small facility for marinating ingredients, although its all-important pastes and spices are imported from Singapore to protect its recipes. It also imports live crabs and essential herbs such as lemongrass from Singapore. At some point, it may expand this kitchen.
• JUMBO’s central kitchens in Singapore and China prepare sauces and marinades, process certain food ingredients and roll out semi-finished food products such as marinated meats for its outlets. This way, quality and taste are controlled and standardised. According to management, it does not need to station a master chef at each outlet as its central kitchens are able to standardise its critical ingredients and food preparations.

FINANCIAL ANALYSIS

Foundation laid in FY17 

• In FY17, JUMBO’s earnings were down 7% YoY despite revenue growth of 6%. The culprits were considerable upfront costs for its regional expansion and start-up costs in China. These were reflected in a 17% YoY increase in its operating-lease expense and 30% YoY increase in depreciation expense. 
• Expansion and one-off costs came from:
  1. JUMBO’s shift to bigger head offices in Singapore and China and increased headcount; and
  2. upfront costs for its two new China outlets, largely incurred during their opening in late FY17 and early FY18.

EPS growth to accelerate from FY18E 

• Revenue growth of 6% in FY17 was its lowest in five years, which ranged from 6- 15%. This was due to:
  1. no meaningful contributions from new stores, as its new Beijing SKP Jumbo seafood outlet only opened in 3Q17. Its new Vietnamese outlet was also opened by a franchisee only in 2Q17 and contributed very little; 
  2. the closure of a JPOT outlet in 3Q17 at Singapore’s Parkway Parade due to slow traffic;
  3. smaller floor space at its East Coast seafood outlet following regulatory restrictions on table placement outside its store; and
  4. the expansion of its lower-profitability Ng Ah Sio Bak Kut Teh brand, with the opening of two outlets.
• Starting FY18E, we believe earnings growth will resume, from:
  1. two new China outlets: Beijing SKP and a fourth Shanghai outlet to be opened in Dec 2017;
  2. operating leverage to cover increased head-office expenses; and
  3. the absence of one-off expenses.

Margins & costs

• We expect gross margins to be stable, backed by operating leverage. Operating leverage should:
  1. improve its bargaining power in material purchases and rentals;
  2. reduce its wastage of raw materials;
  3. and reduce fixed costs as a percentage of sales.
• JUMBO’s main costs are: 
  • Raw materials & consumables. At 37% of revenue, these form the biggest chunk of its costs, presumably because seafood is behind more than 70% of its revenue. Such costs have been declining in the last few years, from 39% in FY13 to 37% in FY17. This was in part thanks to JUMBO’s ability to charge higher prices for its food as its brand value improved with more outlets and better execution. As JUMBO becomes an ever bigger buyer of seafood, we believe it should be able to attract better pricing from its suppliers. An expanded central kitchen should also help it optimise raw-material usage.
  • Staff costs. At 27-29% of its revenue, these are its second-biggest chunk of costs. JUMBO has consistently spent less on staffing than the industry, except BreadTalk. We attribute this to its lean staffing and savvy use of IT at the front of the house to maximise table turnover. Stable staff turnover is another positive, keeping staff costs in check. About 100 of its 700+ employees have been with JUMBO for more than 10 years. We believe its ERP system will further enhance efficiency, through real-time decisions on the deployment of temporary workers, in response to nightly takings.
  • Rentals. At 9% of revenue, rentals may creep higher. JUMBO generally signs 3-year leases. But as it expands, its rental expenses have been increasing every year. Its biggest Singapore outlet at the East Coast Seafood Centre is likely leased from the National Parks Board at competitive rates, since it has been there for more than 20 years. Still, we would watch for any changes in leasing conditions by National Parks that may affect JUMBO. In China, JUMBO has been able to secure competitive rates as it was invited by the landlords of the malls it operates in.
  • Other operating expenses. At 9-11% of revenue, these have been steadily declining as a percentage of revenue due to better operating leverage as JUMBO scales up. Other operating expenses include utilities, cleaning costs, credit-card costs, marketing & advertising, repairs & maintenance, etc.

Capex not an issue; ample FCF 

• Past capex for outlet expansion was low, thanks to its established presence in two markets which provide operating leverage and the experience for setting up new outlets. Capex should remain low relative to cash flows. Even in FY14 when it opened its first Jumbo outlet in China at IAPM Mall, its third JPOT outlet and its first J Café in Singapore, capex was less than SGD4m. Its IAPM Mall outlet is its second-largest at 12,239 sf, after Jumbo East Coast’s 20,484 sf. As such, we do not expect capex for new outlets to cost more than SGD2.5m each. 
• Capex per outlet in FY14-15 averaged SGD2.2m. Capex in FY16 accelerated to SGD8m due to one new outlet, expansion of existing outlets and the acquisition of new equipment for its central kitchens.
• Come FY19E, capex is expected to bulge to SGD23m, as we have assumed the acquisition of new premises to put its Singapore central kitchen and other functions in one location. Even then, we believe its strong FCF generation should stand JUMBO in good stead. Other than the above, we do not expect bulky capex, as a central kitchen in Shanghai would not be needed until it has at least 6-7 outlets up and running. This is not expected till FY20.
• JUMBO generates good FCF because: 
  1. Of its cash business. Customers pay by cash or credit cards and Jumbo is paid by their banks and card issuers within three days. JUMBO gives no credit terms except to corporate customers such as travel agencies. These account for less than 1% of its revenue.
  2. Nothing is kept in stock. Inventory is very low due to the perishable nature of its food ingredients. Meat, seafood and vegetables are purchased every day from wholesalers.
  3. Suppliers finance its business. Suppliers give JUMBO 30 days of credit. Essentially, its business is being financed by its suppliers.

Balancing dividends & capex 

• Although JUMBO has no formal dividend policy, it originally intended to pay out 30% of its annual earnings in FY16-17. It ended up paying 70-75%: 40-45% ordinary and 30% special. 
• From FY18E onwards, we have assumed 50%, premised on its robust FCF and ample net cash balance of SGD51m as at end-FY17. We estimate that it will have sufficient FCF to fund its dividends, excluding a potential SGD15m capex in FY19E for its acquisition of new premises for its central kitchen.

Healthy balance sheet 

• JUMBO had healthy net cash, with very little debt, even before its IPO in FY14. 
• In FY17, it fully paid off its debt and funded its expansion with internally generated cash.

VALUATION & TARGET PRICE

Undervalued to regional peers despite superior ROEs & margins 

• JUMBO trades at 21x FY18E P/E and 19x for FY19E. These represent discounts to domestic peers’ 24x and 26x averages. However, we believe local peers are not good comparables due to Singapore’s small market. 
• We think regional peers provide better comparisons, as JUMBO is expanding regionally. They include Café de Coral (341 HK; NOT RATED) and China Quanjude (002816 CN; NOT RATED). They trade at 26x and 23x on average. Despite range-topping ROEs and margins, JUMBO trades at discounts to these regional peers.

Deserves re-rating 

• We value JUMBO using DCF, at SGD0.70. We believe our DCF valuation (WACC 9%) captures the full value of its expansion that could take more than one year. It implies 26x FY18E, 23x FY19E and 20x FY20E P/Es, in line with its regional peers.
• We believe our valuation is conservative, as we have assumed 1x beta vs Bloomberg’s 2-year beta of 0.6x to account for execution risks in its aggressive overseas expansion.

RISKS

Slowdown in Singapore’s tourism 

• JUMBO’s seafood outlets are popular with tourists. Weaker tourist arrivals and extreme hot weather could affect its restaurant takings. 
• During the worst of Singapore’s haze conditions in 2013, takings at its Dempsey Hill outlet were down by as much as 40%, according to press reports. But on balance, we do not see this as a deal-breaker for JUMBO. This is borne out by our observation that its outlets are packed on most nights, although they are found outside shopping malls. At least two are out of the way at the East Coast Seafood Centre and Dempsey Hill.

Reputational risk 

• JUMBO sources ingredients such as meat, non-crab seafood, crabs and vegetables locally for its China restaurants. Management has to ensure the same food quality as for its Singapore restaurants. If it fails, it risks tarnishing its brand in an important market. 
• In recent years, China’s food supplies have come under scrutiny, ranging from a melamine-laced infant-milk scandal in 2008 to a gutter-oil scandal in 2010.

Crab shortages 

• Chilli crab is traditionally cooked using mud or mangrove crabs readily found in Africa, Australia and many parts of Asia. Those from Sri Lanka are highly prized for their larger size and sweeter meat. We believe there is no risk of shortages.
• Mud crabs are not an endangered species and are prolific breeders within their short lifespan of 3-4 years. JUMBO buys its crabs from Singapore wholesalers which import from diversified sources. We understand that Singapore’s seafood wholesalers import their crabs from three sources, depending on crab size: Sri Lanka (large crabs – 1.4-1.6kg), Indonesia (medium – 0.8-1.1kg) and Vietnam (small – 0.4-0.6kg).

Possible earnings volatility during gestation of new outlets 

• While we expect JUMBO’s China outlets to break even within their first year of operations, given their attractive locations and the success of JUMBO’s recent new outlets, quarterly earnings could be volatile before its new outlets are established enough to cover their initial operating costs.

John Cheong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-12-12

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