ST Group Food Industries - UOB Kay Hian 2020-10-07: F&B Group With Solid Portfolio Of Brands; Initiate Coverage With BUY


ST Group Food Industries - F&B Group With Solid Portfolio Of Brands

  • ST Group Food Industries (SGX:DRX)’s exclusive franchise rights to popular F&B brands has enabled it to rapidly scale up to 121 outlets while maintaining stable net margins at > 7% (prior to the COVID-19 impact).
  • With the ramp-up of new outlets, expansion of its franchise network and the gradual resumption of business activities in core markets of Australia and New Zealand, we expect net profit to grow at a 47.3% CAGR over FY20-23F.
  • Initiate coverage on ST Group Food Industries with BUY and target price of S$0.14.

ST Group Food Industries (SGX:DRX) - Company Background

Established F&B group with a strong portfolio of popular brands.

  • Founded in 2011, ST Group Food Industries (SGX:DRX) entered into a JV with PappaRich Group Sdn Bhd to establish PappaRich restaurants in Australia. ST Group Food Industries currently holds 50% in Papparich Australia Pty Ltd with the remaining being held by shareholders (Papparich Group Sdn Bhd and Agathisfour Sdn Bhd) of Papparich Malaysia Sdn Bhd. Since then, the group has expanded its portfolio of 11 master franchise/licence agreements for territories predominantly in Australia, New Zealand, the UK and Malaysia for various brands, including PappaRich, NeNe Chicken, Gong Cha, Hokkaido Baked Cheese Tart and IPPUDO.
  • ST Group Food Industries has also developed its own brand - Paffu and Kurimu. ST Group Food Industries’s ability to identify new trends and changes in consumer preferences has enabled it to expand its customer base and capture a larger audience. This can be seen from ST Group Food Industries’s introduction of the NeNe Chicken brand to Australia after observing the global trend of the Korean Wave (Hallyu) with demand being backed by the growing Asian population in Australia.
  • Other new markets that ST Group Food Industries recently expanded into include England, UK, through the Gong Cha brand (60% ownership interest in GC England Pte Ltd) where the group sees strong growth potential.

Central kitchen allows scalability and consistency across all brands.

  • ST Group Food Industries’s 3,000sqm central kitchen is located in Melbourne, Australia, which is also home to its warehouse. Apart from providing an additional revenue stream through procuring ingredients to sub-franchisees, the central kitchen is prominent in supporting the expansion plans of ST Group Food Industries.
  • Most of the food preparation and processing (eg key ingredients, sauce marinades and semi-finished food products) is done in the central kitchen and then delivered to the outlets across Australia and New Zealand where minimal preparation is required before serving to customers. This helps to reduce the manpower required at its outlets, shorten the time for store openings (since training for sub-franchisees is reduced) and allow for smaller restaurants/kiosks.

Good working relationships with major landlords.

  • ST Group Food Industries’s wide franchise network in Australia and New Zealand has enabled it to form good working relationships with landlords of various popular shopping malls and commercial spaces. Roughly 51% of its outlets in Australia and New Zealand is leased from landlords of major shopping centres, such as Westfield, Vicinity, GPT and Dexus.
  • ST Group Food Industries typically rents large spaces and subdivide them among its various brands. Therefore, it is able to negotiate for more competitive leasing rates.

ST Group Food Industries - Revenue Segments

  • ST Group Food Industries’s main revenue segments include:
    • F&B retail sales at outlets owned and operated by ST Group Food Industries, including dine-in, takeaway and delivery.
    • Supply chain sales which refer to sale of F&B ingredients and other supplies to sub-franchisees and sub-licensees.
    • Franchise revenue which consists of franchise fees, licence fees and royalty income from the sub-franchising and sub-licensing of various brands to sub-franchisees and sub-licensees. This also includes project income in relation to the renovation and fit-out of new outlets for sub-franchisees and sub-licensees.
    • Other revenue which consists of machine income derived from iDarts electronic dart machines.

ST Group Food Industries - Investment Highlights

Long-term master franchise agreements with strong brand names.

  • ST Group Food Industries has secured exclusive franchise rights to six popular F&B brands/concepts. In addition, through its own industry expertise, the group has also developed two of its own brands, PAFU and KURIMU. These agreements grant the group exclusive rights to operate and sub-franchise within defined territories and for durations of 4 to 20 years, typically with renewable terms. Through these agreements, ST Group Food Industries has rapidly scaled up and grown its number of outlets (includes sub-franchised outlets) to 121 as of 17 Sep 20, mainly in Australia and New Zealand, over a span of eight years.
  • Despite the rapid expansion of outlets, net margins remain largely stable at > 7%, in part due to its higher-margin sub-franchise business model.
  • Prior to the watershed FY20 resulting from COVID-19 when ST Group Food Industries reported its first drop in revenue and earnings, core net profit grew at a CAGR of 59% in FY16-19, driven by growing sales (CAGR of 29%) on the back of rapid expansion of outlets. With the gradual resumption of activities in its core markets, we expect net profit of A$2.5m in FY21, up from A$0.8m in F20.
  • Barring another round of stringent lo kdown measures, we see a stronger recovery in FY22 with net profit growing to A$4.1m.

Strong network of third-party sub-franchisees, potentially better margins.

  • ST Group Food Industries typically starts out by opening its own stores for new brands and moving on to use the sub-franchise model to expand once it successfully develops an efficient operating system. Sub-franchises (third-party owner operators) contribute to two of ST Group Food Industries’s core revenue streams - franchise revenue (13.6% of FY19 total revenue) and supply-chain sales (18.2% of FY19 total revenue).
  • With its developed franchise system supported by its central kitchen and logistics system, ST Group Food Industries is able to rapidly scale up proven brands and expand a network of restaurants and kiosks in different geographical regions to support earnings growth without the need of heavy capital expenditure. Its number of sub-franchise and licensed outlets stood at 72 as of end-FY20, more than double from 30 in FY16, which we believe is a testament to ST Group Food Industries’s ability to attract local partners to join as sub-franchisees
  • Apart from approaching new local partners, ST Group Food Industries is able to leverage its relationships with its existing network of sub-franchisees who are interested in owning multiple brands. We expect earnings quality to improve as the number of sub-franchised outlets grows, given that franchise revenue commands a high double-digit net margin.
  • ST Group Food Industries has in the pipeline five new sub-franchised outlets that are expected to open in 1HFY21. We understand the group has also received increased enquires from prospective sub-franchisees who are looking to lock in favourable lease terms.

Government wage support and rental waivers help to cushion COVID 19 impact on earnings.

  • The JobKeeper Payment scheme in Australia - introduced in Mar 20 to support businesses impacted by COVID-19 - was originally to run until end-Sep 20. This has since been extended to Mar 21, albeit at a slightly lower payment rate per eligible employee.
  • Additional, we understand that some of its major landlords have provided the group with rental waivers to tide through periods of lockdown in specific regions. Assuming a workforce of 70 eligible employees in Australia and rental waivers of 25%, we have accounted for ST Group Food Industries receiving cash grant and rent waivers of a total of A$0.7m in FY21, or 28% of FY21F earnings.

Gradual resumption of activities in core markets.

  • The drop in revenue and profit in FY20 was largely due to stringent lockdown measures implemented in ST Group Food Industries’s core markets in end-March to May 20. These economies have gradually reopened in phases since Jun-Jul 20.
  • Current restrictions are not being implemented nationwide and restrictions on a state level are being gradually eased. Restrictions in Auckland, New Zealand, will be lifted on 8 Oct 20 as state moves down to alert level 1, joining the rest of the country. Victoria, Australia, is also scheduled to gradually loosen restrictions beginning Oct 20. We also highlight that the daily COVID-19 cases in Australia and New Zealand were at/below 25 and 5 in the past week respectively, much lower than during the peak levels in Mar-Apr 20 (Australia: 400+, New Zealand: 80+).
  • Since the phased reopening of business activities in Jun 20, data released by these countries show a gradual recovery in F&B services sales. New Zealand’s electronic card spending on F&B services surged 10.6% y-o-y in Jun 20 but reversed to - 13% y-o-y in Aug 20 (May 20: -35% y-o-y) due to restrictions in Auckland. In Australia, F&B services sales narrowed its decline to 11.4% y-o-y in Jul 20 (Apr 20: -49.9% y-o-y).

New outlets to support earnings growth.

  • ST Group Food Industries targets to open eight outlets by Dec 20 (owned: 3, sub-franchise: 5) and we understand that there are increased enquiries from sub-franchisees which are looking to lock in favourable lease terms.
  • Due the disruption to sales in Victoria, Australia, in 2H20 and social distancing measures in restaurants, we account for a more gradual recovery in FY21 and forecast net profit at A$2.5m (including grants), up from A$0.8m in F20, before a stronger earnings recovery to A$4.1m in FY22, barring another round of lockdown measures.
  • Apart from the resumption of economic activities in core markets, earnings would be supported by higher contributions from the 10 outlets (net closure) opened in 1HFY20 and new outlets in FY21.

ST Group Food Industries - Industry Outlook

  • See PDF report attached below for details.

ST Group Food Industries - Earnings Outlook

Long-term master franchise agreements allow continued expansion of outlets to drive growth.

  • ST Group Food Industries targets to open eight new outlets in 1HFY21, consisting of three owned outlets and five sub-franchised outlets across brands, including
    • Gong Cha (1),
    • IPPUDO (1),
    • NeNe Chicken (1), and
    • PappaRich (3)
  • In the long run, we conservatively incorporate 12-15 new outlets (including sub-franchised outlets) per year which we believe is sustainable, given the variety of brands under its portfolio and opportunities for growth in key markets where it has a smaller presence, in our view.

Revenue CAGR of 14.9% in FY20-23F.

  • We expect ST Group Food Industries' revenue growth to be driven by new outlets coming on stream in 1HFY21 and stronger contributions from the 10 outlet (net of closure) that opened in FY21 which were hampered by the impact of COVID-19. As such, we forecast revenues at A$48.4m, A$59.9m and A$66.8m in FY21-23 respectively.

Core net profit CAGR of 47.3% in FY20-23F.

  • Besides revenue growth, we expect ST Group Food Industries' margin expansion to boost earnings on the back of:
    1. an increase in the number of sub-franchisee outlets as franchise revenue and supply-chain segment commands higher net margins of 15-20%;
    2. expansion of brands that are able to achieve higher margins; and
    3. higher operating margins and profitability from newer outlets as sales ramp up.
  • Due the disruption to sales in Victoria, Australia, in 2H20 and social distancing measures in restaurants, we conservatively account for a more gradual recovery in FY21 and forecast net profit at A$2.5m (including grants and rental waivers), up from A$0.8m in FY20 before a stronger earnings recovery of 65% y-o-y in FY22, barring another round of lockdown measures. With that, we forecast ST Group Food Industries's net profits at A$2.5m, A4.1m and A$4.8m in FY21-23 respectively.

Clean balance sheet and net cash position.

  • ST Group Food Industries has had low levels of net debt and over the years has shown notable improvements in balance sheet strength from a net cash position (including fixed deposits) of A$0.7m in FY16 to A$5.0m in FY20 which included cash from listing proceeds. The low gearing gives the group ample room to gear up for expansion.

Stable and improving operating cash flow.

  • Given the cash nature of F&B services, ST Group Food Industries has healthy operating cash flow, rising from A$3.1m in FY16 to A$7.2m in FY20. We expect this trend to continue through steady ramp-up of new and existing outlets.
  • Given that the outlet expansion will come partly from sub-franchised outlets and smaller brands for owned outlets (NeNe Chicken, Gong Cha), we incorporate moderate capital expenditure of A$2.5m-3m per year. We estimate capex per outlet at A$1.0m-1.1m for larger full service restaurants (IPPUDO, PappaRich full-service) and S$0.3m-0.5m for quick-service restaurants/kiosks (Gong Cha, NeNe Chicken, HBCT, Go Noodle).

ST Group Food Industries - Valuation & Recommendation

Clement Ho UOB Kay Hian Research | Joohijit Kaur UOB Kay Hian | https://research.uobkayhian.com/ 2020-10-07
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