BreadTalk Group Ltd - DBS Research 2018-05-07: Margin Expansion To Drive Growth

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BREADTALK GROUP LIMITED SGX: 5DA

BreadTalk Group Ltd - Margin Expansion To Drive Growth

• BreadTalk Group's 1Q18 core earnings in line, headline below due to absence of one-off gains from property sales last year. 
• Growth driven by better margins from higher mix from restaurant sales, and Food Atrium earnings recovery. 
• Cut FY18-19F earnings by 8-10% on higher interest. 
• Maintain BUY, with lower S$1.98 Target Price based on SOTP. 

Maintain BUY, Target Price at S$1.98.

• We maintain our positive stance on BreadTalk with S$1.98 Target Price and 16% total return including dividends. 
• We are positive on BreadTalk’s outlook of better margins from higher restaurant contribution and turnaround of its Food Atrium business. It is also strengthening its Bakery business in China and expanding Din Tai Fung into the UK. 
• While operating profit continues to be resilient, we have factored in higher interest costs from increased borrowings which leads us to lower our earnings forecast and hence lower our Target price. Nevertheless, BreadTalk’s valuation remains attractive with core business excluding property investments now trading at close to 19x FY19F PE. 

Where we differ.

• Our earnings forecast is below consensus as we factor in higher interest costs from increased borrowings in FY18F. 
• BreadTalk has plans to build a larger central kitchen in Shanghai to cater to its future China expansion plans. Capex this year is expected to be higher at c.S$60m, up from S$36.5m last year. 

Potential catalyst. 

• We see potential for special dividends if Perennial sells AXA Tower. BreadTalk could potentially pay c.4.5 Scts in special dividend upon the sale of AXA Tower based on our estimates. 

Key Risks to Our View: 

• Operational risks include food safety and licences as well as negative publicity. In extreme cases, food operating licences can be revoked for lapse in food safety procedures. 
• Negative publicity may also result in weaker demand and poorer marketability when selling its franchises as the public and franchisees shy away from their association with BreadTalk. 

WHAT’S NEW - 1Q18 results

1Q18 core operations in line.

• Revenue was S$149m (+0.5% y-o-y) with EBIT at S$8.7m (+53% y-o-y) and headline earnings at S$1.2m (-89% y-o-y, due to absence of non-core one off gains mainly from sale of 111 Somerset of S$8m in 1Q17 last year). 
• Margins also improved as gross margins added 1.1ppt to 56%, driving EBIT margins improvement to 5.9% vs 1Q17’s 3.9%.

Restaurant and Foodcourt segments lead revenue growth, bakery declined. 

• Revenue was driven by Restaurant (+6% y-o- y, S$36.9m) and Foodcourt divisions (+3% y-o-y, S$37.5m). New division named 4orth (division for So Ramen, Song Fa Bak Kut Teh and other new JV brands) grew 42% to S$2.7m. 
• Bakery division saw decline of 4% y-o-y to S$70.4m. Store count was at 943, relatively flat from 942 in 1Q17 but down sequentially from 4Q17 led by a drop of 14 outlets from both direct and franchised stores in the bakery division, and lower revenue from direct operated stores at Shanghai, Beijing and Hong Kong. The lower outlet count was due to closure of non-performing bakery stores and the continued reduction in the number of franchisees in China.

Core profit before tax supported by restaurant and turnaround in Foodcourt division. 

• Core profit before tax of the three key divisions (excluding real estate investment, group elimination and others including corporate treasury, investments, associated companies etc.) grew 18% y-o-y to S$10.1m. 
• PBT growth was supported again by Restaurants (+26% y-o-y, S$7.4m) and Foodcourt (+136% y-o-y, S$2.1m). Bakery division’s segment PBT was down 49% y-o-y to S$1m on lower franchise revenue/income from lesser number of franchise stores in China.

Higher net interest expense. 

• Interest cost was higher at S$2.4m from S$1m last year as borrowings increased by S$75m to S$260m from 4Q17. BreadTalk has plans to build a larger central kitchen in Shanghai to cater to its China expansion plans. 
• The higher borrowings was also due to S$100m increase medium term notes.

Decent core performance.

• This was a decent quarter on a core earnings perspective. While headline earnings disappointed (due to absence of one off gains), core operations remained healthy. Although there will be some drag in the Bakery business in China in the immediate term, we believe the outlook is positive in the longer term as continued restructuring including closing non-performing stores and franchisees will strengthen its operations.
• Nonetheless, margin improvement in Foodcourt and Restaurants were more than able to offset by the drag in the Bakery division.

Cut FY18-19F earnings by 8-10% to factor in higher interest costs.

• We have left our core EBIT projections largely unchanged, but have imputed higher interest costs to reflect the increase in net borrowings. Capex this year is expected to be higher at c.S$60m, up from S$36.5m last year, mainly for the construction of the new central kitchen. 
• The S$100m medium term notes with a 4% coupon is due on 17 January 2023.

More expansion drivers in place.

• BreadTalk in 1Q18 announced a slew of expansion developments, starting with BreadTalk awarding the franchise rights in India for Delhi and National Capital Region, following by the opening of the first Song Fa Bak Ku Teh in Shanghai. 
• Recently, BreadTalk announced its signing of the JV agreement to operate Taiwanese bakery, Wu Pao Chun Bakery in Beijing, Shanghai, Shenzhen and Guangzhou. Toast Box also entered Indonesia through a JV agreement with PT. Pura Indah Berkat.

Maintain BUY, S$1.98 Target Price.

• The share price currently values the core F&B business excluding properties at under 19x core FY19F PE. We remain positive on the stock and see growth ahead driven by margin expansion. 
• Asset sale continues to be a stock catalyst. A potential sale of its stakes in properties such as CHIJMES and AXA Tower will unlock shareholder value if they materialise. 
• Our Target Price based on SOTP is S$1.98, comprising of core F&B business at 22x FY19F PE at S$1.67, investment properties at S$0.49 based on market value, and net debt at -S$0.18 per share. 
• Maintain BUY for 16% total upside.

Alfie YEO DBS Vickers | Andy SIM CFA DBS Vickers | https://www.dbsvickers.com/ 2018-05-07

SGX Stock Analyst Report BUY Maintain BUY 1.98 Down 2.050