Kimly Ltd - RHB Invest 2018-04-15: Defensive Staple On Verge Of Inorganic Expansion

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KIMLY LIMITED 1D0.SI

Kimly Ltd - Defensive Staple On Verge Of Inorganic Expansion

• Kimly operates and manages coffee shops and food courts locally, which have a defensive nature accompanied by rich cash flows. 
• Going forward, we expect Kimly to add up to 1-2 coffee shops a year, as well as ramp up on operating third party brands, which could contribute 5-8% growth pa during FY19F-20F. In addition, with M&As in the pipeline, we believe that growth would be exciting in the coming years. 
• As a result, we initiate coverage with a BUY with DCF-derived Target Price of SGD0.43 (30% upside), implying FY18F P/E of 22.8x.

Defensive business with rich cash flows. 

• The nature of Kimly’s business is defensive and cash generative, as it provides staple food to general consumers.
• Gross margins have also been stable at above 20% since FY14, and are expected to stay around this region going forward.

INVESTMENT MERITS

Defensive and resilient business model. 

• Kimly is trading at 2018F P/E of 18.1x, which is below the peer average of 24x. However, the group has minimal debt, and a reasonable net cash pile of SGD91m. This is despite capex spent on opening new outlets that require 2-3 years to turn profitable due to the high depreciation load in earlier years.
• The group also deals with low cost food staples sold to general consumers, which can be viewed as a necessity by many families in Singapore. In the event of an economic downturn or recession, we think that Kimly would not be significantly impacted as general consumers would still have to spend on food, and coffee shops sell among the lowest cost food in Singapore. As a result, we feel that Kimly has a defensive business model, which would attract conservative investors.

M&As – a key area for growth. 

• During the IPO, Kimly raised about SGD40m, of which the majority or SGD30m has been earmarked for acquisitions and JVs, as well as for the establishment of new outlets. 
• With a strong net cash balance of SGD91m, as well as consistent and recurring positive cash flows of SGD28m per year, management has expressed interest in looking at acquisition targets for vertical integration, and may look for value accretive acquisitions or JV in the region of SGD10-20m to boost its value chain proposition in 2018-2019. This may potentially boost its EPS growth by 10-15%.

Outlets at strategic locations. 

• Kimly’s outlets have commendable occupancy rates of above 95% due to the high variety of products sold at the stalls, as well as the strategic locations of those shops, which are mainly located at heartland areas. 
• In addition, the group has 10 outlets in the Jurong area, which will likely benefit from being primed by the Government as the country’s second central business district (CBD) in the future.

Great potential as a consolidator of coffee shops. 

• We understand that the coffee shop industry is highly fragmented in Singapore, with the top four largest players commanding only a 13% share of the market. 
• With the advantages of being listed where it could issue equity to raise cash for M&As, we believe Kimly could actually be the first mover to consolidate the industry by acquiring private coffee shops or its operational rights. Its net cash balance and healthy operational cash flows further improve its credentials as a potential consolidator.

Organic growth at steady rate with opening of new outlets. 

• Kimly currently operates and manages 68 outlets (+6.4% y-o-y) under its outlet management division, and 129 food stalls (+6.6% y-o-y) under its food retail division. This compares with 64 outlets and 121 food stalls in FY16. Management is looking to add up to 1-2 coffee shops a year, as well as ramp up on third party brands, which it has been doing. We are expecting at least 3-4 new additions to its portfolio in FY18, resulting in a 5% y-o-y growth in outlets and stall openings between FY18F-23F. 
• Revenue earned per outlet under management and revenue earned per food retail stall increased by 7.3% y-o-y and 1.7% y-o-y respectively in FY17. We anticipate revenue earned per outlet and stall to improve modestly by 1% annually between FY 18F-23F. As such, our forecasted revenue is expected to increase by 6.1-6.8% pa for the next six years. Revenue grew by 4.8%, 10.4% and 11.6% during FY15-17 respectively.

Net cash balance with positive cash flows from operations. 

• As of 1Q18, Kimly had a net cash position of SGD91m, and it generated SGD29m of positive cash flows in FY17 and SGD28.4m in FY16. 
• As the coffee shop trade is generally a cash upfront trade, and due to the defensive nature of the business, we expect such steady cash flows to continue for Kimly going forward.

Higher dividends a possibility. 

• The group intends to declare an annual dividend of not less than 50% of net profits attributable to shareholders as dividends. This would translate into an estimated dividend yield of 2.7% in FY18F and 2.9% in FY19F.
• Due to its net cash position, low capex requirements and cash flow generative business, we think that there is a possibility of higher dividends in the future. In addition, with more accretive M&As expected to boost earnings, prospective dividends would also be positively lifted as a result.

KEY RISKS

Shortage of manpower. 

• The group’s business is labour intensive. It is heavily reliant on skilled and experienced personnel for its operations. The food & beverage (F&B) industry itself is facing a shortage of manpower, especially qualified individuals with requisite skills such as chefs. If Kimly is unable to retain or employ suitable personnel for its operations, it will not be able to deliver quality food and good customer service to its customers. As a result, it may lose its customers, which may affect its sales.

Not being able to renew or obtain new leases and increases in rental cost. 

• Kimly leases premises for all its food outlets from the Housing and Development Board (HDB), interested persons and other private landlords. Most of the leases have tenures of 3-4 years. Upon expiry, the landlord may put the premises up for open tender or solicit alternative bids. 
• It is not guaranteed that the group will be able to renew the existing premises or secure new leases. Failure to do so may affect Kimly’s ability to retain or expand its market share. 
• The landlord may also increase rental when the lease is due for renewal, which may cause Kimly to experience higher operational costs.

Possible food contamination and tampering risks. 

• Food safety scandals could harm its reputation. This is an inherent risk faced by all F&B operations. Food safety issues can originate from different sources. Raw ingredients, if not handled properly, are highly susceptible to contamination and tampering. Contaminated ingredients or the use of unauthorised ingredients may result in customers falling ill and in the worst case, it may cause death. This will bring negative publicity to the group and damage its brand and reputation. It may also cause substantial financial losses if it faces an order by the relevant authorities to pay fines, be suspended, or cease all or part of its business operations.

Intense competition in the F&B industry. 

• The barriers to entry are relatively low for new entrants, thus inviting many new players into the market and competing for market share.
• The F&B industry in Singapore is extremely competitive. The market is fragmented with many players offering a wide range of food and food services. Kimly competes based on factors such as the location of its food outlets, quality and price of food, customer service, and overall dining experience. If it is unable to maintain or improve these aspects, it may risk losing its competitiveness as customers would not choose to patronise its outlets, which would in turn result in loss of market share.

Theft, fraud and corruption risks. 

• Sales from the food and drinks stalls are conducted on a cash basis. Mishandling of cash may happen at any point, from the customer’s payment to the handing over of cash back to the corporate headquarters. 
• Theft is another prominent risk among companies in the F&B industry. For example, employees may steal cash or inventory such as cigarettes from the drinks stall. The group also faces the possibility of fraud or collusion between employees and third parties. For instance, procurement fraud could result in unexplained large orders and increasing frequency of orders from the same supplier.

VALUATION

Initiating coverage with BUY and Target Price of SGD0.43 

• DCF-derived Target Price of SGD0.43 with WACC of 7.5%. 
• We initiate coverage on Kimly with a DCF-derived Target Price of SGD0.43, and a Conviction BUY on the stock. 
• Our assumptions are: 
  1. Bloomberg WACC of 7.5%;
  2. Terminal growth rate of 1%.
• Kimly had a net cash position of about SGD0.08 per share or SGD91m in total as of 1Q18, which makes up over 23% of its existing market cap. We believe its management will likely utilise the cash pile for accretive acquisitions to boost NPAT. 
• Our DCF-derived Target Price suggests a 2018F P/E of 18.1x or ex-cash P/E of 15x, which we believe is fair when compared to the peer average P/E of 24x.

Peer Comparison 

• Kimly operates in a highly competitive industry. Its direct competitors within the food outlet management division include Broadway Food Centre Holdings Pte Ltd, Chang Cheng Group Pte Ltd, S-11 F&B Holdings Pte Ltd, Badaling Holdings Pte Ltd, Kim San Leng (Soon Lee) Food Centre Pte Ltd, Koufu Pte Ltd, and Kopitiam Investment Pte Ltd.
• Other than direct competition, it also faces fierce competition from other food establishments such as restaurants and fast food outlets in the F&B space. Being the pioneer to list on the SGX, there is limited information on the revenue and earnings of its direct peers for comparison purposes.
• Based on peer comparison, Kimly has a P/E ratio (trailing 12 months) of 18.1x which is lower than the industry average of 24x. Its ex-cash P/E for FY18F is 15x, based on our estimates.
• Kimly also has a superior net profit margin of 10.3% vs its peers, which have an average profit margin of 6.2%.

FINANCIAL FORECASTS

Outlet and stall count continues to expand. 

• Kimly currently operates and manages 68 outlets (+6.4% y-o-y) under its outlet management division, and 129 food stalls (+6.6% YoY) under its food retail division. This compares with 64 outlets and 121 food stalls in FY16. 
• We expect management to continue with its expansion plan and have projected an increase of 5% y-o-y growth in outlet and stall openings between FY18F-23F.

Revenue per outlet/stall is improving. 

• Revenue earned per outlet under management and revenue earned per food retail stall have increased by 7.3% and 1.7% respectively in FY17, as compared to FY16. 
• We anticipate revenue earned per outlet/stall to improve modestly by 1% annually between FY18F-23F. As such, our forecasted revenue is estimated to increase between 6-6.1% pa for the next six years. Revenue grew by 4.8%, 10.4% and 11.6% during FY15-17 respectively.

Synergy between the two business segments. 

• Management has identified the importance for its coffee shops to have good quality tenants offering a wide variety of food choices to attract new customers as well as to keep existing customers. As a result, it took matters into its own hands and opened up food stalls in the coffee shops that it manages. 
• By doing so, the group is able to improve on operational efficiency and offer quality food to its patrons.

COMPANY BACKGROUND

• Kimly is the largest traditional coffee shop operator in Singapore, founded by the current executive chairman Mr Lim Hee Liat in 1990, together with several of his friends, including Mr Peh Oon Kee.
• Kimly started by operating a single coffee shop to being the largest traditional coffee shop operator in Singapore. From 1990 to 2003, the group added about 25 self-managed coffee shops to its portfolio of coffee shops, island wide.
• From the experience of managing coffee shops, management became aware of the importance of having good food tenants to enhance the vibrancy of each coffee shop. Hence, the group started the food retail division in 2003, with its first seafood “Zi Char” stall in Bukit Batok. Within a year, it opened its first mixed vegetables rice stall in Marsiling.
• In 2006, the group set up its current corporate headquarters at 13 Woodlands Link to house the central kitchen and central support office.
• In 2008, Kimly expanded its retail division with the acquisition of a chain of dim sum stalls. It also expanded the central kitchen production line to supply to the dim sum stalls, seafood “Zi Char” stalls, and mixed vegetables rice stalls.
• In 2011, the group diversified into the food court business under its outlet management division. The group opened its first food court in Ngee Ann Polytechnic under the foodclique brand. It continued to grow its food court management business by opening up three more food courts in other premier institutions of higher learning in Singapore – University Town in NUS in 2013, UniSIm in 2014, and another one at Prince George’s Park in NUS in 2016.
• The coffee shop operator partnered with NTUC Foodfare Co-operative Ltd, the social enterprise food arm of the National Trade Union Congress (NTUC), to operate Rice Garden (mixed vegetables rice stall) in Ang Mo Kio and Serangoon North in 2015.
• Today, Kimly manages an extensive network of 68 food outlets under the Kimly, foodclique and third party brands, and 129 food stalls selling mixed vegetables rice, Teochew porridge, dim sum, seafood “Zi Char”, and a live seafood restaurant.
• As at 30 Sep 2017, Kimly enjoyed a 98% occupancy rate across nearly 500 stalls within its managed food outlets. 
• The coffee shop management division is primarily managed by Kimly Makan Place while the food court management division is managed by Foodclique Pte Ltd.
• The business process of its outlet management division involves, but is not limited to: 
  1. Ensuring a sufficient variety of food choices for patrons;
  2. Carrying out maintenance and repair works at all food outlets; 
  3. Regularly upgrading premises to meet customers’ expectation;
  4. Achieving and maintaining high occupancy rates for the food stalls;
  5. Being responsible for the cleanliness of common areas and toilets at all outlets; 
  6. Ensuring the smooth operation of food stalls and food outlets as a whole.
• Rental invoice will be issued to the tenants on a monthly basis by the group, which consists of the following components: 
  1. Monthly stall rent;
  2. Cleaning fees; i
  3. Pest control fees;
  4. Utilities fees;
  5. Maintenance fees (only applicable for food courts); 
  6. Applicable government taxes.
• Catering to a broad and varied customer base and supported by its central kitchen, the group’s 130 stalls under its food retail portfolio comprises: 
  1. 32 mixed vegetables rice stalls
  2. 16 Rice Garden stalls;
  3. 3 Teochew porridge stalls;
  4. 47 dim sum stalls;
  5. 31 seafood “Zi Char” stalls; 
  6. 1 live seafood restaurant.
• The mixed vegetables rice stalls usually operate from 10am to 9pm with some operating on a 24-hour basis. The menu comprises 20-25 fixed staple dishes and approximately 10 dishes that are changed daily.
• The rice garden concept is a business community partnership between NTUC Foodfare (NTUC) and Kimly. NTUC provides monthly grants to the partners to cover part of its costs and to keep the prices of its food affordable.
• The Teochew porridge stalls operate on a 24-hour basis. These stalls offer a great variety of up to 60 different dishes. The group is considering an expansion in this area if it is feasible.
• The seafood “Zi Char” stalls have dishes that are cooked to order. “Zi Char” stalls usually operate from 4pm to 11pm. Stalls that attract a good lunch crowd would operate between 11.30am to 2pm, and then from 5pm to 11pm.
• At the live seafood restaurant, customers get to watch how their food is prepared by a team of chefs through glass panels. In addition, there are tanks of live seafood in the restaurant so customers can be assured of the freshness of food served at the restaurant.
• All the dim sum stalls are operated under the Kimly brand. Kimly aims to provide affordable dim sum to neighbourhoods. Most of the dim sum stalls operate on a 24-hour basis. A central kitchen is responsible for the production of good quality dim sum and supplies it to the stalls. With the production centralised, Kimly is able to expand its dim sum stalls without compromising on the quality of its food offerings.

Jarick Seet RHB Invest | Lee Cai Ling RHB Invest | http://www.rhbinvest.com.sg/ 2018-04-15

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