Restaurants in China
Written on: 8th August 2023
It seems that the restaurants in China and Hong Kong are booming. with most announcing positive profit alert.
The biggest question is if this is a one off due to pent up demand or a normalisation of earning for all the listed catering companies in China.
The beauty of investing in the catering trade is that there is no limit to imagination and ambition. A company can continue expand and grow as long as they are able to offer a particular concept with the right taste at the right place and at the right price point.
There is also a certain market size for each concept at each geographical location. If any of your concept goes stagnant, be prepared to lose customers quickly or if the concept had over expanded, be prepared to SHRINK to less losses or profitability.
The other possibility is that the concept have almost exhausted it’s addressable market. Then the company will need to go on the DEFENSIVE to maintain or even try to expand their share of their existing customer’ wallet.
The best business is the AGGRESSIVE, where they are growing and taking market shares from existing players. This is usually a multi-brand concept operation where they are launching new brands and taking on new leases. The worry is of course that their operational capabilities got too stretched and they started to lose control over their sprawling empire.
This is a cut throat business and every qualitative and quantitative metric matters.
So pick wisely…
There is a huge list of such companies to pick from the HKEX and this is a small subset of companies that you can start researching on?
Ajisen (China) (SHRINK)
Cafe De Coral
Fairwood Holding
Future Bright
LH Group
Tai Hing Group
Tam Jai International
Tang Palace (DEFENSIVE)
Tao Heung Holdings
Taste Gourmet (AGGRESSIVE)
Tsui Wah
AJISEN (CHINA) 0538.HK:
Written on: 8th August 2023
2023 August: Ajisen (China) 0538.HK purchased at an average price of HKD 1.09 operates a chain of fast casual Japanese restaurants in the China. It operates through Operation of Restaurants; Manufacture and Sales of Packaged Noodles and Related Products; and has a bunch of Investment Holding. The company’s restaurants primarily offer Japanese ramen and Japanese-style dishes under the Ajisen brand. On December 31, 2019, it had a retail network of 799 restaurants and 7.31m members on their membership platform.
In FY2022, 0538 operates a much reduced 597 restaurants with a 24.63m members on their membership platform. This is a turnaround play betting that the closing of sub-optimal outlets only meant that the 0538 is left with the higher performing outlets, which operates at a much higher revenue per outlet, leads to lower operating cost and higher net profit margin on a group level. In addition, around 20-30% of their revenue comes from delivery which meant that they would be able to serve their customers despite having lesser footprint around China.
One of the main reason to avoid 0538 is that they have been plagued by the write down in their investment in their associates and unlisted equity investment. Their investments in the past reeks of more bad judgement than bad luck. Their persistence to continue investing (sunk cost fallacy) despite losses do looks perplexing at times. The good news is that they seem to be slowing down that aspect of their business.
The other risk is the operation of Japanese themed restaurants in China. You will never know when nationalistic feeling got stirred up (again) and consumers in China stop patronising Japanese restaurant.
The most recent incident include the release of the Fukushima water and possibly the boycott of most Japanese restaurants. While 0538 do not have much ingredient sourced from the sea, I would not be surprised that sales would be affected by the fallout of the Fukushima issue.
There is not much competitive advantage in operating restaurants but operating restaurants in China at scale is another matter. 0538 have the experience and pedigree to operate restaurants at scale throughout China. Their 6 central kitchen which is distributed around China gave them the advantage to open and scale successful brands at will. Ramen is one of those food where there is advantage in cooking at scale. The dish is only assembled at site with all the ingredients prepared at the central kitchen.
In the latest profit alert dated on 2023 4th August, 0538 has indicated that profit should range between RMB 80m - 140m. Assuming that the profit stands at the midpoint of RMB 100m (6 months), the PE will be around 6x. 0538 pays around RMB 0.10 (FY2021) per share in dividend in a normalised year and we should expect a similar level of dividend for FY 2023. Net cash holding should be around RMB 1,400 which is already more than the current market cap of RMB 1,100m (HKD 1,200).
The bet here is that there is a good chance that the full year earnings would be closer to FY2019 than FY2021. In addition, we could be getting RMB 0.10 (HKD 0.11) in around 6 months time.
0538 will definitely be a sell if they starts to irrationally open up new restaurants or start to put all their newly minted cashflow into new investment.
TANG PALACE 1181.HK:
Written on: 8th June 2023
2023 June: Tang Palace 1181.HK purchased at an average price of HKD 0.54 is a operator of multiple brand restaurants in China. The company operates restaurants under the Tang Palace Seafood Restaurant, Tang's Cuisine, Tang Palace, Social Place, Canton Tea Room, Pepper Lunch, Soup Delice, and PappaRich brands.
1181 has been profitable every year since 2008 except for FY2022 (It takes a lockdown in China to throw them into losses). In the past, 1181 has been great dividend payers while growing their topline from RMB 393m (FY2008) to RMB 1,492m (FY2018) and bottomline from RMB 25m (FY2008) to RMB117m (FY2018). ROE in FY 2016 - FY2018 averages above 20%. If history is any indication of the future, think there is a good chance that this trend continues post FY 2022.
There are risk in operating restaurants in the post pandemic world and there are risk operating restaurants in China.
Has the consumption pattern for Chinese have changed?
Consumers want delivery which delivers lower margin for the restaurant businesses
Experience dining meant that higher end restaurants will benefit and the lower and middle segment of restaurants will suffer?
While there is a definite shift in consumption pattern for everyday food, Chinese should continue to eat out at restaurants like 1181 where family bonding happens and where businesses are conducted. In this environment, i would rather be investing in the regular sit down restaurants than quick service restaurants which should face more margin pressure.
Is there higher risk in operating restaurants in China?
Chinese government push to lift minimum wages, which meant that operating margin will continue to be pressured. While financial analyst in me would be worried, the business analyst in me views that Chinese restaurant like Tang Palace who could afford to pay should definitely pay their employee above minimum wages to retain high quality staffs. The higher wages could be offset by higher pricing.
The level of competition for restaurant business in China is extraordinary. If you launch a dining concept that is popular, expect a lookalike to be operating opposite your restaurant in 1 month time. It is easy to copy the type of food you are offering, but what is hard is the level of service. Increasingly, consumers will pay for the consistency of quality of food and the quality of service. 1181 having the virtue of operating for a very long time, across the whole of China have the capability to do so.
Restaurants are difficult business to operate. There are virtually no moat. The only "moat" is the quality of food and services. I can only look towards the Chairwoman and CEO for inspiration here. Chairwoman had helm the company since (2011 - 2019) and has done really well before transitioning to the role of the Chairperson. The current CEO is an ex-chef and looks about the right person to carry the group forward where the food needs to be differentiated.
Another emerging portion of their advantage is the "float" they are generating with the customers. Tons of customers had top up their pre-paid account to continue transacting at a discount with 1181 While these are low margin transaction, they are also low cost funds for 1181 to utilise to bankroll other part of their business. The e-commerce type of business is a complementary portion to their core restaurant business and it would be good to see this float continuing to grow.
The bet would be that the revenue will look a lot more like FY2018 than FY 2022. There is also a possibility to underwrite a rebound in revenue back to FY2017 margin level.
1181 will be a sell if the new CEO prove to be incapable to maintaining 1181 quality of food throughout China or if the e-commerce business instead of providing float became a “giant sucking sound”.
TASTE GOURMET 8371.HK:
Written on: 8th August 2023
2023 January: Taste Gourmet 8371.HK purchased at an average price of HKD 0.773 is a operator of multiple brand restaurants in Hong Kong. Their stated aim is to the next Meixin of Hong Kong. Usually, I would be worried if someone states their aim to be the Starbucks or something. But stating Meixin is another matter for most do not know who Meixin is.
In the short term, 8371 is executing to plan by signing more leases and creating more concepts during the pandemic. 8371 has continued to shift to more “effective” concepts such as having concepts that have better use of labour and have a higher spend per customers. This provided an overall lift in revenue, gross margin and net margin. Over the long term, there are options that some of their newly formed concepts in Hong Kong could be exported to China through their JV,
8371 is currently valued at HKD 636m, earning around HKD 68m on equity of HKD189m. The revenue for FY2024 should be much better judging from 1Q.
8371 would be a sell when the growth spiral out of control where outlet growth did not result in adequate revenue growth or that administrative and HQ cost starts to spiral up and take a life of its own.
Portfolio Update:
Written on: 14 August 2023
Ocean One (8476.HK) - HKD 0.80 [CLOSED]
2023 June: Ocean One (8476.HK) purchased at an average price of HKD 0.678 (+17.99%) was closed after the release of their latest 1Q result. There is a decrease in revenue, gross margin and net margin. As mentioned previously, this will be a sell if any of the above happens. I am shifting this pile of cash into the catering industry.
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