Japan Foods Holding - RHB Invest 2018-05-04: Enterprising Japanese Restaurant Chain

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JAPAN FOODS HOLDING LTD. SGX: 5OI

Japan Foods Holding - Enterprising Japanese Restaurant Chain

• Initiate coverage with a BUY and SGD0.63 Target Price, offering a 24% upside.
• We expect Japan Foods Holding (JFH) to deliver 10-15% annual profit growth with the addition of new restaurants, launching of new brands, and continued focus on cost control, aided by a recovery in consumer sentiment.
• The group’s multi-brand concept allows it to capture wider consumer segments and continually cater to changing tastes, making its business highly adaptable.
• With a strong net cash balance, industry-leading dividend yield of 4% and an improving margin outlook, we believe JPH deserves to trade at least at industry average multiples.
• Our Target Price suggests FY19F P/E of 20x, putting JFH’s valuation closer to its peers.

An adaptable multi-brand business model.

• Japan Foods Holding’s (JFH) multi-brand concept allows it to capture wider consumer segments and continually cater to changing consumer tastes. 
• With its large portfolio of brands, JFH is able to mix and match food & beverage (F&B) brands, and do so quickly in response to market demand. The extensive brand portfolio also enables the group to quickly replace brands that are not doing well with ones that can yield better results. This strategy has made JFH very popular with landlords and has allowed it to maximise its revenue on a per restaurant basis.

Strong profit growth outlook.

• We assess that JFH could open 4-5 new restaurants each year during FY19-20 (Mar). 
• While its historical focus on cost control had boosted gross margins to an industry-leading 85%, we believe that improving revenue per store for its key brands on improving consumer sentiment should enable JFH to deliver annual earnings growth of 10-15%.

Looking to grow overseas.

• Japan Foods Holding (JFH) has aggressively expanded into Hong Kong and China through investments in associates during FY13-17. The number of restaurants in Hong Kong has increased to eight (FY13: 5). China has witnessed much faster growth, where JFH’s associates now operate 10 restaurants. It had no business presence there in FY13. 
• It is in discussions to set up a JV in Indonesia, a market where it has not had a presence since 2015. Earnings contributions from this JV are not in our estimates.

Superior financial metrics compared to its peers.

• Japan Foods Holding’s dividend yield of 4% is the highest amongst SGX-listed peers. Given its strong FCF-generation ability, we believe there is potential for further upside to its dividend yield. While its net margin of 7.1% may not be the highest in the industry, it is still superior to that of most peers. We believe margins could expand further in FY19-20.

Trading at undemanding valuations.

• Japan Foods Holding is trading at a FY19F P/E of 14.8x, which is at a significant discount to the industry average 2FY P/E of 19.5x. With its net cash position accounting for 23% of the group’s market cap, JFH is trading at an ex-cash FY19F P/E of 11.3x. 
• Given the strong growth outlook and superior financial metrics, we believe it deserves to trade closer to the industry average, if not higher. Our SGD0.63 Target Price (derived from an average of P/E, P/BV, EV/EBITDA and DCF of adjusted FCFs) implies 20x FY19F P/E.
• Key risks include rising labour costs and rental expenses, lower consumer spending, and non-renewal of franchise agreements.

INVESTMENT MERITS

Growth aided by expansion and recovery in consumer sentiment

• We assess that Japan Foods Holding (JFH) could open 4-5 new restaurants each year and add a few more brands to its operations over FY19F-20F. Management assessed that, if successful, a new brand could achieve full breakeven point (ie recover operating and initial set-up costs) within 12-18 months. Moreover, strong economic growth and improving consumer sentiment in Singapore should enable JFH to report steady improvements in revenue growth.
• Strong cost control measures undertaken in the past have enabled JFH to expand its gross margin to 84% in FY17 from 78% in FY10. While the group continues to find ways to reduce costs, we believe further gross margin improvements from cost savings would not be material. However, we assess that greater control on other opex and a continued focus on improving revenues from its key brands would lead to net margin growth over FY19F- 20F. This should enable JFH to deliver 10-15% net profit growth pa during our forecast period.
• In Feb 2018, JFH entered into an agreement with Arena Gourmet (AG) to set up a JV for the expansion of its Menya Musashi ramen restaurant brand in Indonesia. The timeline set for the creation of the JV entity was 16 Apr 2018. However, due to the longer-than- expected time required for the fulfilment of certain conditions precedent to the creation of the JV, the agreement’s long stop date was extended to 14 May 2018.
• We believe the JV offers strong growth potential in a market where JFH has not had a presence since 2015. The JV would not only contribute profits for the company, but also generate cash flow – as the JV agreement entails that 30% of post-tax earnings be paid as dividends from the fourth year of the JV’s operation. Potential earnings and cash flow contributions from the Indonesian JV are not in our estimates yet.

Superior financial metrics compared to its peers

• Starting May 2017, Japan Foods Holding (JFH) increased its target dividend payout ratio to 50% from 40%. In FY17, JFH paid a dividend of SGD0.02 per share. This translates into a dividend yield of 4% and is the highest amongst SGX-listed restaurant operators that pay dividends. 
• While management wishes to maintain its dividend payments at SGD0.02 per share, we believe its strong FCF generation ability and limited capex requirements do point to significant upside potential for our dividend forecast, either in the form of an increase in absolute DPS or through the payout of special dividends.
• A historical focus on cost and quality controls via central kitchens, utilising bulk purchasing and achieving economies of scale, have enabled JFH to achieve industry-leading gross margins of more than 80%. While its net margin of 7.1% may not be the highest in the industry, it is still superior to most SGX-listed restaurants. 
• The group has already reported 3QFY18 and 9MFY18 net margins of 13.3% and 9.4% respectively. We assess that there is scope for further expansion in its net margins during FY18F-20F.

Undemanding valuations – deserves to trade closer to the industry average

• Japan Foods Holding (JFH) is trading at 14.8x FY19F P/E and 4.8x FY19F EV/EBITDA, which are at significant discounts to the industry multiples of 19.5x 2FY P/E and 8.6x 2FY EV/EBITDA. With a net cash position of SGD20.5m (c.23% of the group’s market cap), the stock is trading at FY19F of 11.3x ex-cash P/E and 3.7x ex-cash EV/EBITDA.
• We believe that, given its potential to deliver strong earnings growth and superior financial metrics when compared to its SGX-listed peers, it deserves to trade closer to industry average valuations, if not higher.
• We value JFH using an average of forward P/E, P/BV, EV/EBITDA and DCF of adjusted FCFs. Our Target Price of SGD0.63 implies FY19F P/E of 20x, which puts the group’s valuation closer to that of its listed peers.

A resilient and adaptable multi-brand business model

• Japan Foods Holding (JFH)’s multi-brand concept allows the group to capture wider consumer segments and continually cater to changing tastes. With its large portfolio of brands, it is able to mix and match F&B brands and do so quickly in response to market demand. Its extensive brand portfolio also enables the group to quickly replace brands that are not doing well at a location with ones that can yield better results. This strategy has made it very popular with retail landlords and has allowed JFH to maximise its revenue on a per restaurant basis.
• The group’s four-pronged strategy has enabled it to not only sustain but also grow its F&B business in Singapore and around the region. This strategy includes:
  1. Development of new concepts through franchised or self-developed brands;
  2. Strong focus on cost and quality controls;
  3. Overseas expansion via acquisitions, JVs or the franchise model;
  4. Prudent approach, with constant rationalisation of stores or brands.

KEY RISKS

Competitive business sector

• The F&B business in Singapore is a highly competitive sector as restaurants fight for a share of the consumer’s pocket. Not all restaurants do well – such as Soup Restaurant, Sakae Sushi and Tung Lok. The high rental costs and lack of manpower means that restaurants have to manage their operations well to survive the cut-throat competition. 
• However, with Japan Foods Holding (JFH)’s long-term focus on cost and quality controls via central kitchens, utilising bulk purchasing, and achieving economies of scale, we believe it should enable the group to not only sustain current operations but also register growth.

Relatively small float and liquidity

• Despite its strong business credentials and growth potential, a market cap of less than USD100m means that Japan Foods Holding (JFH) has not been able to find its way into the equity screens of most investors. 
• While the group does have a free float of more than 20%, very low trading liquidity could be one of the key concerns for some investors. However, we remain confident that credible management, a resilient business model, a strong balance sheet, undemanding valuations and strong earnings growth would enable JFH to grow into a credible SGX-listed mid-cap F&B operator.

Non-renewal of its master franchise agreement for key brands

• Japan Foods Holding (JFH)’s key restaurant brands include Ajisen Ramen, Menya Musashi and Osaka Ohsho. Together, these franchise brands accounted for c.70% of FY17 revenue. 
• While there is a likelihood of the group losing its master franchise agreement for these key brands, we see limited likelihood of such an event occurring in the near term. This is mainly because the master agreements for these key brands are signed for longer periods. 
• The group has an exclusive licence to operate the businesses under the Ajisen Ramen brand in Singapore, Malaysia, Indonesia and Vietnam for a term of 50 years commencing Sep 2008.
• For Menya Musashi, the master agreement is for a period of 10 years, and the agreement is renewed automatically. Similarly, for Osaka Ohsho, the master agreement is for a period of five years, and it also gets renewed automatically. The Menya Musashi agreement was signed in Mar 2012, and the Osaka Ohsho agreement in Sep 2012.

Non-renewal of sub-franchisee agreements

• Japan Foods Holding (JFH) signed a sub-franchise agreement with an Indonesian partner for the promotion of the Ajisen Ramen brand in 2008. The initial validity period of the agreement was from Dec 2008 to Dec 2013. This was further extended to Aug 2014. However, after the group’s sub-franchisee decided not to renew the agreement, JFH lost its business presence in Indonesia in early 2015.
• We do acknowledge the risk of JFH struggling to grow its key franchised brands beyond Singapore if sub-franchisees do not renew the agreements. While this may lead to slower potential for overseas growth, the financial impact on its current earnings are likely to be limited. This is because the group’s total sub-franchised operations accounted for only 0.2% of revenue and 2.9% of EBIT in FY17.

VALUATION

Target Price derivation

• We value Japan Foods Holding (JFH) using an average of forward P/E, P/BV, EV/EBITDA and DCF of adjusted FCFs. Our Target Price of SGD0.63 implies 20x FY19F P/E, which puts its valuation closer to that of its listed peers. 
• As compared to its SGX-listed restaurant peers that have forward-looking estimates on Bloomberg, the group offers one of the highest net profit margins and ROEs. Its dividend yield of 4% is also superior when compared to its peers. However, we do acknowledge that there are SGX-listed restaurants that have historically offered higher ROEs and net margins when compared to the group. 
• We looked at average multiples for its peers, which are trading at 2FY P/E of 19.5x, 8.6x EV/EBITDA and 3.8x P/BV averages. Given JFH's smaller market cap and liquidity constraints, we ascribed a discount to the peer average multiples to arrive at the target multiples.
• We also compared our target multiples with average sector multiples for periods when Singapore witnessed an improvement in consumer sentiment (measured by the y-o-y rise in retail sales). These periods were 2001-2004, 2009-2011, and 2013-2015. During these periods, the MSCI Singapore Consumer Discretionary Index traded at the multiples identified in Figure 4:

Financials

Steady improvement in earnings outlook

• We expect F&B operators in Singapore to benefit from strong economic growth and improving consumer sentiment over the next few years. Japan Foods Holding (JFH), with its strong presence in mass market Japanese restaurant brands, should also witness similar benefits. Its revenue has recovered in FY17, and we expect this rebound to be sustained during the forecast period.
• During 3QFY18, JFH’s revenue grew 11.8% y-o-y, while – for 9MFY18 – revenue grew 2.7% y-o-y. The first quarter of each calendar year tends to be the weakest for the group, amidst short working hours during the Lunar New Year festival. Attributing a slightly weaker y-o-y growth for 4QFY18, we estimate FY18F revenue to grow by 2.4% y-o-y. However, this growth should improve to 4.5% each in FY19F-FY20F.
• Given the strong net cash position, we assess that JFH could easily open 4-5 new restaurants each year and add a few more brands to its operations during the forecast period. Management assesses that, if successful, a new brand could achieve full breakeven point (operating plus initial setup costs) within 12-18 months.
• While we do not expect a significant expansion in gross profit margin, the group’s strong operating cost control and focus on improving revenues of its key brands should enable it to report growth in EBITDA and net profit during the forecast years. We estimate recurring net profit growth of 10-15% during the forecast period, in line with management’s focus to grow the bottomline by high single-digits.

Potential expansion into Indonesia through JV is not in our estimates yet

• In February, Japan Foods Holding (JFH) announced that it entered into an agreement with AG to setup a JV entity for expansion of its business in Indonesia. As part of the agreement, the group is to invest approximately SGD146,259 to subscribe to new shares for a 30% stake in Indonesia- incorporated Menya Musashi Indonesia (MMI, or the JV entity). At the same time, AG is purchase existing vendor shares and subscribe for new shares with a resulting majority stake of 70%.
• MMI is to undertake the business of managing and operating Japanese ramen restaurants under the Menya Musashi brand, including setting up restaurants at locations it identifies and selects. The JV enables JFH and AG to leverage on each other’s strengths in their respective areas. The latter would also gain access to the former’s experience and know- how in managing Japanese restaurants, while JFH would be able to tap into AG’s local knowledge, business network and familiarity, as well as its resources in Indonesia.
• AG is an established restaurant operator in Indonesia, with over 20 restaurants under eight brands including Penang Bistro, Seribu Rasa, Greyhound Café, Miyagi, Maison Tatsuya, Hong Kong Café, La Hoya and Sari Bagindo. Its brands embody various ethnic concepts, namely Malaysian, South-East Asian, Indonesian, Chinese, Japanese and Mexican.
• Menya Musashi is a popular ramen brand that originated in Tokyo, Japan. JFH holds the license rights to operate restaurants under the brand in Singapore, Hong Kong, China and Indonesia.
• The timeline set of completion creation of JV entity was 16 Apr. However, on that date, JFH announced that – due to the longer-than-expected time required for the fulfilment of certain conditions precedent to creation of JV – the group, along with AG and MMI, agreed to extend the agreement’s long stop date to 14 May.
• We believe the JV offers strong growth potential in a market where JFH has not had a presence since early 2015, when a sub-franchisee arrangement for its flagship Ajisen Ramen brand expired. The JV would not only contribute profits for JFH, but also generate cash flow, as the JV agreement entails that – after the third anniversary following completion – MMI is to distribute dividends at 30% of its profits – this is after deduction of interest, tax paid or accrued, and any other exceptional items – as shown in the accounts for each financial year.

High profit margins…

• Similar to any other F&B operator, Japan Foods Holding (JFH) faces constant challenges from the persistent uptrend in raw material costs, rental charges and labour costs. However, the group has actively looked for avenues to drive down costs without compromising on quality. Improving operational efficiency, using raw materials more effectively, building economies of scale and achieving greater bulk purchase discounts are some of the ways through which JFH has looked to mitigate the increase in costs.
• In 2007, the group set up its central kitchen facility to support the operations of its restaurants. It centralised the processing of certain food ingredients used by all of its restaurants at this kitchen. JFH also used this facility to store the inventory of food ingredients that are purchased centrally.
• In Apr 2012, the group established its own noodle production facility at its central kitchen at a cost of about SGD450,000. The main objective of the noodle production facility was to enable JFH to manage its costs better, reduce its reliance on suppliers, and improve the freshness, quality and consistency of the noodles used at its various restaurants.
• Through various cost-saving initiatives, JFH has managed to improve its gross margins to 85% in FY17 from 78% in FY10. While the group continues to find ways to further enhance its profit margin, we believe further GPM growth would be miniscule in nature.
• However, we assess that greater control on selling and distribution expenses, continued focus on improving revenues of its key brands, and slightly higher contributions from its associates ought to lead to improvements in its NPMs during the forecast period. We estimate JFH’s net margins to expand to 9% in FY20 from 7.1% in FY17.

…translates into high ROEs

• Japan Foods Holding (JFH) offers a high ROE of 14.9% despite having a net cash balance sheet. 
• Although its ROE is not the highest amongst SGX-listed restaurant operators, we assess that strong growth in earnings during FY18F-20F would lead to improvements in its ROE. We estimate the group’s ROEs to improve to 17.6% in FY20 from 14.9% in FY17.

Net cash position accounts for 23% of market cap

• Japan Foods Holding (JFH) has managed to generate SGD2-10m of annual FCFs during FY12-17. This has led to a gradual improvement in the group’s net cash position to SGD20.5m as at end-Dec 2017 from SGD6.1m in FY11. This net cash position accounts for about 23% of its market cap.
• We believe JFH may consider opening 4-5 new restaurants each year during the forecast period. This would translate into an annual capex of SGD2.5-3m. However, we have factored in a higher capex of SGD4.5m each year for FY19F-20F.
• Despite our conservative estimates, we assess that the group could generate SGD7.7- 10.5m in annual FCFs over FY18F-20F. Adjusting for dividend payments, its net cash balance sheet could swell to SGD32.3m by FY20 (ie about 40% of its current market cap).

Superior dividend yield of 4%

• Japan Foods Holding (JFH) has always focused on growing long-term shareholder value, and has been consistently rewarding shareholders with cash dividends since FY09. Excluding the special dividends paid in FY13 and FY14, total DPS has gradually increased to about SGD0.02 in FY14 from SGD0.002 in FY09. Since FY14, JFH has been consistently paying about SGD0.02 in DPS (cash) to its shareholders.
• Until FY16, JFH had a dividend policy to distribute not less than 40% of its consolidated net profits to shareholders annually. However, in May 2017, it announced its intention to raise the target dividend payout ratio to at least 50% of earnings annually.
• During our meeting with the group, we sensed that management wished to maintain its DPS around SGD0.02 over the next year. Hence, although its dividend payout ratio stood at 74-92% during FY15-17, we are forecasting a dividend payout ratio of only 55-65% for FY18F-20F, which complies with its latest dividend policy.
• While JFH’s 4% yield remains the highest as compared to its peers, we believe there could be upside to our yield estimates. With expectations of strong rise in cash balance during FY18-20, we believe higher dividends could come from either an increase in absolute DPS, or through the payment of special dividends.

COMPANY BACKGROUND

Company Introduction

• Established in 1997, Japan Foods Holding (JFH) is one of the leading F&B groups in Singapore specialising in quality and authentic Japanese cuisine. As at 31 Dec 2017, the group, together with its sub-franchisees, operates a total of 53 restaurants and food court outlets under various brands in Singapore, Malaysia and Vietnam. It also has interests in 18 restaurants in Hong Kong and China through associated companies.
• The group’s franchise restaurant brands include its flagship Ajisen Ramen brand, as well as the Menya Musashi and Osaka Ohsho brands, which together accounted for c.70% of revenue in FY17.
• Going beyond the traditional Japanese cuisine, in 2015, JFH launched New ManLee Bak Kut Teh, a brand franchised from Malaysia. As at 31 Dec 2017, JFH operates two New ManLee Bak Kut Teh restaurants in Singapore. Besides franchise brands, the Group has also developed its own brands including Fruit Paradise and Japanese Gourmet Town. These two restaurant brands together accounted for c.9% of JFH’s revenue in FY17.
• JFH’s network extends beyond Singapore to include Ajisen Ramen restaurants in Malaysia and Vietnam operated by sub franchisees and Menya Musashi restaurants in China and Hong Kong operated by associated companies. The group has its own production facility located at its central kitchen in Kampong Ampat, Singapore.

Management Team and their history

• Japan Foods Holding (JFH)’s management has a long history with the group. CEO Mr Takahashi Kenichi founded JFH in 1997. Current COO Ms Chan Chau Mui has been with the group since 1999 while current CFO Mr Kenneth Liew Kian Er has been with the firm since 2008.
• Transparency in JFH’s reporting standards have been commendable. We seldom come across companies that provide detailed information on the success and failure of their new ventures on a quarterly basis. Not surprisingly, the group won the Transparency Award for small and medium enterprises (SMEs) at the 18th Securities Investors Association (SIAS) Investors’ Choice Awards 2017.

Shekhar Jaiswal RHB Invest | https://www.rhbinvest.com.sg/ 2018-05-04

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