Koufu Group - CGS-CIMB Research 2020-06-12: Serving Up Delights In Your Vicinity; Initiate Coverage with ADD

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KOUFU GROUP LIMITED (SGX:VL6)

Koufu Group - Serving Up Delights In Your Vicinity

• We like Koufu for its relatively resilient business, strong cash flow generation, superior net margins and ROE. Initiate with ADD rating and S$0.86 Target Price.
• Despite Covid-19, we expect Koufu to remain profitable in FY20F, thanks to c.S$10m budget support and c.3 months of rental relief from landlords.
• Our FY21-22F EPS growth of 13.6-52.5% is premised on consumption recovery, continual new store wins and opening of integrated facility.

KOUFU - COMPANY OVERVIEW

• Koufu Group (SGX:VL6) is a multi-brand food and beverage (F&B) player with two key business verticals -
  1. outlet & mall management and
  2. F&B retail.
• Established in 2002 and listed on the Singapore Exchange (SGX) Mainboard in Jul 2018, Koufu has grown from only two food courts and one coffee shop, to 50 food courts, 16 coffee shops, a hawker centre and a mall (Punggol Plaza) as of end-Dec 2019.
• Apart from entering into new markets (e.g. Macau), Koufu has also diversified into new outlet types (F&B kiosks, quick service restaurants and full-service restaurants), as well as dining concepts (Elemen, R&B tea, etc.).

Outlet & mall management

• Under the outlet & mall management segment, the group operates and manages food courts, coffee shops, a hawker centre and a commercial mall. Similar to a master-tenant, Koufu sub-divides the gross floor area (GFA), and charges rent and auxiliary fees to its tenants.
• Lease duration - Koufu leases food spaces from landlords such as Housing Development Board (HDB) and mall operators, and rents out divided spaces to its food operators. Leases span from 3-4 years at heartlands, c.7 years for casinos and 1-2 years at commercial malls.
• Revenue model - Stall operators of Koufu’s food courts are typically charged the higher of a fixed monthly fee, or variable monthly fee pegged to gross turnover (we estimate 18-22%), depending on the location of the food court, the mix of stall operators, or the type of F&B products sold. For stall operators of its coffee shops and hawker centres, there is a fixed monthly rent, as well as other charges for cleaning of premises, provision of point-of-sale (POS) systems, administrative, insurance, marketing campaigns, renovation on a reimbursement basis and other ancillary items.
• Occupancy level - Based on the total number of F&B stalls in the food courts and coffee shops that Koufu operates and/or manages, it has achieved more than 93% occupancy rate in FY19.
• Sales collection - All sales are transacted via the POS system that is provided by Koufu, and all sales are retained by the group. Koufu issues statements of accounts twice a month to stall operators and makes payment of gross sales after deducting monthly fees.
• Value-added services that Koufu provides include
  1. pre-opening inspection of kitchen, ensuring sufficient utensils,
  2. mid-day closing, collecting physical cash, reconciling with POS system receipts, collecting feedback from customers and inspecting dishwashing,
  3. collecting float money and sales from cashiers at the end of day, safe keeping of sales collection, cleaning of stalls, washing of crockery and locking/securing premises.
• No significant seasonality - Koufu’s F&B business in heartland areas caters to the mass market with little seasonality, but its food courts in Singapore’s Marina Bay Sands (MBS) and Macau’s Sands Cotai Central are susceptible to tourist volumes during holiday seasons.

F&B retail

• For the F&B retail segment, Koufu runs F&B stalls that are located inside food courts/coffee shops, F&B kiosks, quick-service restaurants (“QSRs”) and full-service restaurants.
• Koufu operates the drink stalls in all the food courts and coffee shops that it operates. The group usually sells a mixture of fruits, desserts and dim sum, depending on the space availability and demand. These drink stalls typically have the highest margins and are very replicable.
• Koufu's F&B stalls also offer a variety of F&B products across different cuisines, some under its own brands (1983, A Taste of Nanyang, The Western Plate, Hungry Jack and Hock Kee Hainanese Chicken Rice).
• All stalls have attained the “A” or “B” grade under NEA’s grading system. This grading system is a food hygiene recognition system, in which all food retail establishments are graded from “A”, “B”,”C” or “D” based on an annual snapshot assessment of the hygiene standards. The grading is on an objective metric scale, in which the best hygiene standard is 100%: ‘A’ represents a score of more than 85%, ‘B’ represents a score of 70-84%, ‘C’ represents a score of 50-69% and ‘D’ represents a score of 40-49%.
• F&B Kiosks serve food and beverages mainly for takeaway.

Well-positioned to tap into domestic mass market

• The majority of Koufu’s F&B outlets are located in the heartland areas (approximately 70% of FY19 revenue is from heartlands, according to the management), where 81% of Singapore population resides (in HDBs), based on 2018 statistics from the Department of Statistics Singapore.
• Coupled with its wide variety of food options at affordable prices, Koufu is able to tap into this growing customer base. Koufu has also exemplified a more established track record of store wins, which should underpin future net profit growth in FY21-22F and potentially grow its market share in the domestic F&B scene (in terms of stall count).
• Unlike some of its peers with predominant presence in commercial malls, coffee shops and food courts in heartlands tend to require smaller capex (S$0.8m-1.5m vs. S$2.5m) and achieve breakeven faster. Koufu continues to seek and secure suitable locations for its F&B outlets, focusing on new housing estates, hospitals, malls and tertiary educational institutions.

Bringing in new concepts and exporting to new markets

• In 2012, Koufu expanded from its Singapore food court operations into Macau, setting up its first overseas food court at Sands Cotai Central. Following that in 2015, the group broadened its F&B portfolio and established its first full-service restaurant under a new Elemen brand concept, catering to a different market segment at different price ranges.
• Capitalising on Southeast Asians’ craze with bubble tea and increasing demand for healthier food options, Koufu formed a joint venture in 2017 with “R&B Tea” and “Supertea”, both established brands in China to bring these outlets into Singapore, Macau, Malaysia, Indonesia, Myanmar and the Philippines.
• Going forward in FY20-21F, Koufu expects to open its third Koufu food court in Macau (target: 3Q20F), as well as launch more outlets for its tea beverage business in Indonesia, as guided by management.

Upcoming integrated facility in 2H20F

• A household F&B brand among the Singapore consumer industry, Koufu was listed on the SGX in July 2018 and raised c.S$43m net IPO proceeds to fund the proposed integrated facility, refurbishment of F&B outlets and to expand the business overseas.
• Koufu conducts its current operations at two central kitchens (address: 18 and 20 Woodlands Terrace), to cater for non-halal and halal food preparation. The group plans to move into a bigger central kitchen once the integrated facility attains the temporary occupation permit (TOP) in 3Q20F (previously in May 2020 but delayed due to Covid-19) and we estimate the facility to be operational by FY21F latest. This is a 7-storey building with a gross floor area (GFA) of 20,000 sqm, more than five times larger than the aggregate GFA of approximately 3,500 sqm of its existing central kitchens and corporate headquarters combined. The lease is granted by Jurong Town Council (JTC) and will have a lease period of 30 years from 2018. This new central kitchen will expand central procurement, preparation processing and distribution, offer a centralised dishwashing facility and a research and development centre.
• See Appendix in PDF report attached below for details on Koufu's management team and board of directors.

INDUSTRY OUTLOOK

Hawker fare a staple in Singapore’s culture; demographic and lifestyle changes as tailwinds..

Limited supply of coffee shop properties; Industry consolidation underway…

• With limited supply of coffee shops and the desire to achieve greater economies of scale, F&B players have embarked on an acquisition spree in the past few years, giving rise to industry consolidation which could make competition more intense, in our view. The acquisition of Kopitiam helped propel NTUC to its market leader position in Singapore with 56 Kopitiam outlets and 11 Foodfare outlets. This is followed by Koufu with a chain of 49 food courts, while BreadTalk (SGX:CTN) became the third largest food court operator after its buyout of Food Junction (12 Food Junction outlets, 14 food courts under the Food Republic and Food Opera brands).
• The low barriers to entry into this business have also made it easier for other food vendors to expand their businesses into becoming master lessors of coffee shops and food courts, such as Chang Cheng Food Paradise and Yu Kee Group.

See PDF report attached below for more details on Singapore F&B industry outlook.

KOUFU - COMPANY OUTLOOK

Impact of Covid-19 - Food courts less affected than full service restaurants in Singapore.

• With the closure of borders on 23 Mar and the enforcement of circuit breaker from 7 Apr, footfall in food courts, hawker centres, kiosks and restaurants has been affected by varying degrees. Koufu’s Elemen restaurants and Rasapura Masters food court at MBS have been most badly impacted due to the restrictions on dine-in, work from home (WFH) and travel for overseas visitors; we estimate a sales value decline of 80-90% in those affected months.
• Meanwhile, same-store-sales growth (SSSG) in food courts fell by a smaller extent of 20-30%, thanks to their convenient locations in heartlands and affordability as people turned to more takeaways. This was also partly mitigated by its enlarged online presence which reported more food deliveries.

Bubble tea , Macau .

• Due to the temporary ban of standalone bubble tea outlets with effect from 22 Apr 2020, Koufu had to suspend operations at all its 27 stalls, except for the 1 stall which was allowed to remain open in a food court. But the pent-up demand for bubble tea nationwide drove higher sales at the sole operational outlet, which singlehandedly made up close to half of the combined sales value at its 27 outlets prior to the mandatory closure.
• Koufu’s operations in Macau (two food courts at Sands Cotai and University of Macau) were similarly affected by a significant drop in tourist arrivals and shutdown of gaming properties for 15 days in Feb, followed by the Mar implementation of border restrictions. Total number of visitors to Macau fell 90.6% y-o-y in Apr, according to the local Statistics and Census Bureau (DSEC).

2Q20F could see bigger earnings impact; overall occupancy remains stable.

• Based on Koufu’s 1Q20 business updates, the group has temporarily shut 10 food courts, 3 quick-service restaurants and 2 full restaurants since the start of the circuit breaker in Singapore. Management also guided that SSSG decreased by 15% for the period of Jan to Apr 2020, as compared to the same period in 2019, with the decline expected to be more significant in Apr; we estimate SSSG for 2Q20F to be down 30-40%.
• Overall occupancy in its Singapore food courts remains stable at c.90% (92% as at end-2019), as the group has secured new tenants to replace those whose leases have expired. With the rental support from landlords, and reopening of Greater China, Koufu continues to see full occupancy at its Macau food courts.

Government relief and rental waivers help.

• We believe Koufu will also benefit from recent government budget support, particularly the jobs support scheme (JSS). Approximately 70% of its Singapore-based workforce is eligible for 10 months of JSS (grant varies from 50-75% of monthly salary capped at S$4,600), while its foreign workers (FWs) could qualify for 2 months of FW levy waiver and 1 month of FW levy rebate; we estimate Koufu could receive a total of c.S$10m from these support measures in FY20F.
• For the property tax rebate and other rental waivers/discounts given by its landlords, we expect Koufu to pass on most of the waivers/discounts to its tenants (c.2.5 months, based on our projections).

Deferred expansion plans.

• Initially slated for opening in 2Q20F, the opening of 2 new food courts and 2 new R&B tea kiosks in Singapore and Macau has been tentatively moved to 3Q20F, based on Koufu's recent announcements via SGX. The construction progress of Koufu’s integrated facility has also been delayed to Covid-19 measures in Singapore and Malaysia; management now expects TOP to be in 3Q20F at the earliest, and opening in 4Q20F or 2021F.

Expanding online presence

• Koufu has recently started an in-house online delivery platform on its KOUFU app, enabling customers to order through the mobile app and purchase food from its food courts. As compared to the third-party delivery platforms, the mobile app enables its tenants to save on the 20% commission fees.
• While it is still in a nascent stage, having only started services for the Punggol and Sengkang region as at May-2020, overall online food ordering and deliveries have doubled according to the management. The group continues to tap into third-party delivery platforms like Deliveroo, Food Panda and Grabfood, for its F&B tenants to list their food offerings; these tenants, however, have to bear their delivery commission fees, which are usually offset by the higher food selling prices.
• We expect more stallholders to sign up with Koufu’s or third-party online delivery platforms even after the circuit breaker, with the one-time funding of S$500 from the NEA to help with the onboarding costs, as announced by the government on 18 Apr 2020. This is in line with a recent study conducted by the online dining platform Chope, which found that 42% of restaurants surveyed had to offer delivery for the first time due to circuit breaker measures, while delivery and takeaways used to contribute less than 10% of revenue for 88% of restaurants surveyed prior.
• But having a new revenue channel is not sufficient, as 62% of restaurants that have continued to operate on a takeaway and delivery basis have seen significant y-o-y falls (50% or more) in revenue in Apr 2020. We believe the operating models for food courts and coffee shops would stay resilient and relevant in the foreseeable future, while the sustainability of delivery model remains to be seen.

Consumption returns, new stores to drive FY21-22F recovery

• With more people returning to workplaces at the end of the circuit breaker, and possible resumption of dine-in F&B services in phase 2 of Singapore’s economy reopening (from Jul 2020F onwards), we think kiosks and food court business could see fastest consumption recovery in 2H20F, followed by full-service restaurants. However, overall capacity could be lower (vs. pre-Covid-19 levels) due to social distancing measures, in our view.
• We expect similar trends in Macau as the local authorities continue to loosen travel restrictions and reopen its economy. Coupled with new store openings, we think the gradual normalisation of consumer behaviour will drive FY21-22F EPS recovery for Koufu.

Contribution from integrated facility

• With the integrated facility (Woodlands Avenue 12) slated to be operational by 4Q20F, the 7-storey building with a GFA of 20,000 sqm could drive the long-term growth for the group. Apart from utilising 70% of the total floor area for its business, Koufu’s management plans to sublet the remaining 30% area to third parties (for e.g. tenant stall operators at its food courts and coffee shops).
• We project annual rental income of S$2m-3m to contribute to Koufu’s FY21-22F revenue, partially offsetting the depreciation expenses of S$3.4m p.a. We also expect productivity and operational efficiencies to gradually kick in, and the central kitchen might be used to supply food products to third parties, which would provide an additional source of revenue.

KOUFU - FINANCIALS

Decline in FY20F revenue followed by a recovery in FY21F

• Since its listing in 2015, Koufu has consistently grown its topline for four consecutive years, led by more stall openings and steady improvement in SSSG. We expect revenue from outlet & mall management and F&B retail to decline by 24% y-o-y and 25% y-o-y respectively in FY20F, on the back of :-
  • Lower average sales per outlet arising from the circuit breaker, temporary closure of restaurants and some food courts, fewer visitor arrivals, as well as reduced dine-in capacity due to social distancing measures in 2H20F;
  • Loss of variable rental income from its tenants under the outlet & mall management segment;
  • 3 months of fixed rental waiver (on average across its HDB outlets and those in commercial malls) that are passed on to its tenants; and
  • Deferred new store openings in 2H20F.

Expect 9.4%-24.7% y-o-y sales growth in FY21-22F.

• We project average sales value per outlet for both the outlet & management and F&B retail segments to stage a strong rebound in FY21F, returning close to pre-Covid-19 levels. This is underpinned by full-year contribution of existing stores, as well as positive contribution from new outlets opened in FY19.
• The consumption recovery should also extend into FY22F, boosted by an average of 2-3 new food court openings per year as Koufu continues to participate in HDB tenders. We also project an annual rental income of c.S$2m-3m a year in FY21-22F from partial leasing of its integrated facility to external vendors.
• We expect the average sales per outlet for the F&B retail to taper off slightly to S$0.8m-0.9m/outlet over FY20-22F as Koufu starts to add more bubble tea kiosks, which has a smaller sales volume per outlet compared to other food offerings.

Expect FY20F to be profitable; growth returns in FY21-22F

• We expect Koufu to remain profitable in FY20F despite the sharp decline in revenue, as the group turns prudent and focuses on tighter cost management during this period. In FY19, its three largest expenses came from depreciation (32% of sales), rental costs (18% of sales) and staff overheads (17% of sales).
• Our key assumptions on FY20F costs are:
  • c.S$10m in wage support from JSS and FW levy waiver and rebates to mitigate its staff costs;
  • An average of 3 months of rental support from landlords on a blended basis, which we estimate to be S$30m to offset its property rental expenses.
  • Expiry of Jurong West hawker centre on 6 Aug 2020 is positive for Koufu as this 3-year management contract had been a drag on FY17-19 net profit (estimated S$1m net loss).
• Our 14%-52% net profit growth forecasts for FY21-22F are premised on sales recovery from consumption normalising, as well as new stores and food courts in the pipeline. We also assume that the additional rental income from the integrated facility of S$2m-3m p.a. could partially offset the increase in depreciation expenses (c.S$3.4m per year).
• We expect Koufu’s OPM to dip to 12.4% in FY20F followed by a normalisation to 14.5%/14.8% in 2021F/22F, which is below FY19 level of 15.7%. While the expansion in R&B kiosk format stalls and improved efficiency from the integrated facility could help margin improvement in the medium term, we expect these efficiencies to have a gestation period. The initial capital expenditure and depreciation charges, alongside the introduction of new brand concepts and new outlets in overseas markets are also likely to weigh on the OPM over FY20-22F.

Robust balance sheet with zero debt

• Koufu has maintained a net cash position since its listing, with net cash of S$85.7m or S$0.15 per share (as of end-FY19). This puts it in a prime position to weather through Covid-19, as well as pursue any synergistic M&A opportunity, in our view.

Strong cash generation

• Koufu operates a highly cash-generative business with a negative cash conversion cycle of 20-30 days. As the inventory mainly comprises of perishable items, inventory turnover days range from 11 to 14 on average; transactions (F&B retail) are conducted on a cash basis while the group usually negotiates credit terms of 30 to 60 days with its suppliers.
• For the outlets and malls management segment, Koufu usually collects an initial deposit followed by monthly rental payments. The group has a very efficient structure on its accounts receivables, due to the upfront cash collection via its POS machines. This keeps its receivable turnover days low, and reduces risk of bad debt from its stall tenants.
• Koufu has been consistently generating positive free cash flow (FCF) from FY15-19. It has set aside S$50m capex needs (of which S$37m is allocated for the integrated facility) in FY20F; post the expansionary phase, we expect the group to return to positive FCF in FY21-22F on minimal maintenance needs and investments for 2-3 new food courts every year (c.S$11m-20m).

Steady 3-4% dividend yield with upside potential

• While Koufu has not adopted any fixed dividend policy, it has paid DPS of 2.2- 2.5Scts over FY18-19, at 46-50% payout ratio since its IPO. See Koufu Dividend History. Given the cash-generating ability, strong net cash position and steady income stream, we think Koufu is likely to maintain a 50% payout ratio for FY20-22F, translating into a dividend yield of 2.2% - 3.9% over FY20F-22F.
• We also see upside potential to its dividend payout, from possible plans to sell two of its investment properties upon relocation of its headquarters to the integrated facility, which we think could materialise in FY21F.
• Management estimates a c.S$10m gain (~1.8Scts per share) and is likely to reward shareholders with special dividends, possibly over a period of 2-3 years.

Superior margins vs. peers

• Koufu had the highest net margin in FY18-19, and the highest ROE in FY19 among peers. Notably, the F&B sector is generally cash generative, with low debt, and a cash pile, resulting in a negative net gearing. Exceptions would be Breadtalk and K2 F&B, due to their aggressive expansion strategies and reliance on debt financing.

KOUFU - VALUATION AND RECOMMENDATION

Initiate with ADD and Target Price of S$0.86

• We like Koufu as a resilient, cash-generative F&B business given its focus on affordable meals at heartland locations; it also has one of the highest ROE and net margins when compared to other Singapore listed F&B players. Post Covid-19, we believe Koufu is a proxy to domestic F&B consumption recovery, with future growth engines in overseas markets and new concepts (e.g. bubble tea, premium vegetarian brand Elemen). Hence, we initiate coverage with an ADD rating, premised on a sharp earnings recovery in 2021F, strong net cash position and decent dividend yield of 2-4% over FY20-22F.
• Our target price of S$0.86 is derived using P/E valuation to better reflect its EPS improvement, pegged to 19x FY21F EPS of 4.5Sct, which is at 10% discount to the sector average of 21x.
• See Koufu Share Price; Koufu Target Price; Koufu Analyst Reports; Koufu Dividend History; Koufu Announcements; Koufu Latest News.
• Koufu currently trades at 3.3x FY20F P/BV and 14.7x FY21F P/E. We believe a faster recovery in domestic consumption could re-rate the stock.
• A worsening of Covid-19 or poor execution of its integrated facility could pose downside risks to our ADD rating.

Click on "view full report" button below to see the 34-page PDF report for complete analysis on Koufu Group (SGX:VL6).

NGOH Yi Sin CGS-CIMB Research | Caleb PANG Huan Zhong CGS-CIMB Research | https://www.cgs-cimb.com 2020-06-12

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