All required disclosure and analyst certification appear on the last two pages of this report. Additional information is available upon request. Redistribution or reproduction is prohibited without written permission PP7766/03/2013 (032116) 20 April 2012 The white coffee champion… We initiate coverage on Oldtown with a Buy recommendation and a target price of RM1.69 based on its 12-month forward P/E of 13x. We like Oldtown based on, (1) strong 3-year earnings CAGR of 25.8% driven by its aggressive expansion plan, especially its FMCG segment, (2) extremely scarce investment alternatives to ride on the rising coffee consumption in China, and (3) tremendous earnings potential from the untapped coffee market in China. Furthermore, Oldtown is also a good yield play, offering attractive FY12- FY14 yields of 4.0%-6.6%! …that could ride on the rising coffee consumption in China Oldtown is a strong regional café operator and an established beverage (mainly white coffee) manufacturer in Malaysia. The group floated its shares on Bursa Malaysia on 13 July 2011 to raise RM79.2m to fund its ambitious regional expansion plan, underpinned by its 5-fold increase in its beverage manufacturing capacity! Given its strong brand name and market leadership in the white coffee segment, we view Oldtown as one of the key beneficiaries to rising coffee consumption in China. According to the International Coffee Organization (ICO), China’s coffee consumption is only 35g per capita as compared to 300g per capita in Asia. Over the past 2 years, we have seen the proliferation of coffee drinking culture in China as the country’s coffee import grew by 38.3% and 41.9% in 2010 and 2011 respectively. In FY12, Oldtown plans to expand its café chain aggressively by opening 35-50 new outlets in four of its key markets, i.e. Malaysia (20-30), Singapore (2-3), Indonesia (5-8) and China (36 by FY15, translating to 9 p.a.). This translates to 18-25% growth from its 196 café outlets in FY11. However, given the slow progress in 1Q12 (6 outlets added), we take a conservative stance by only assuming 26 new outlets to be opened p.a. over the next 3 FY. Based on our estimates, this could generate 8.0% and 11.6% revenue growth for its F&B business in FY12 and FY13 respectively. As for the fast moving consumable goods (FMCG) segment, we are even more positive as a 5-fold capacity expansion plan would be completed in 4Q12. Currently, the existing plant which has an annual capacity of 9.2m tonnes is running at 90-95% utilisation rate. The group aims to achieve an overall utilisation rate of 30% for its enlarged capacity of 45.8m tonnes in FY13, this translates to a strong volume growth of 17.3% and 66.7% in FY12 and FY13 respectively. 3-year earnings CAGR of 25.8% As such, we project the group’s earnings to grow by a 3-year CAGR of 25.8%. In addition, we anticipate its net margin to improve from 11.6% in FY11 to 13.1% in FY14 due to the better economies of scales as the group grow bigger. Our forecasts are 8.8% lower than Bloomberg consensus forecasts in FY12, but 8.8% higher than Bloomberg consensus forecasts in FY13. In contrarian to the consensus view, we believe Oldtown’s earnings growth would only take off strongly in FY13, once its new manufacturing plant start commissioning in Jan/Feb 2013. Valuation and recommendation We initiate coverage on Oldtown with a BUY recommendation and target price of RM1.69, based on its 12-month forward P/E of 13x. Furthermore, Oldtown is also a good yield play, offering attractive FY12-FY14 yields of 4.0%-6.6%, based on the company’s dividend policy of 50% payout ratio. Key risks include (1) threat of the new entrants who could imitate Oldtown's recipe and restaurant concept at a much competitive price, (2) higher costs pressure due to labour wages, rent and coffee bean, and (3) global economic slowdown which could hurt the F&B industry as a whole. Oldtown Berhad Buy Consumer Bloomberg Ticker: OTB MK | Bursa Code: 5201 Initiating Coverage Analyst Ian Wan [email protected]+603 2717 6694 12-month upside potential Target price 1.69 Current price (as at 19 Apr) 1.51 Capital upside (%) 11.9 Net dividends (%) 4.0 Total return (%) 15.9 Key stock information Syariah-compliant? No Market cap (RM m) 498.3 Issued shares (m) 330 Free float (%) 36.4 52-week high / low (RM) 1.51 / 0.89 3-mth avg volume (‘000) 1,235.9 3-mth avg turnover (RM m) 1.6 Share price performance 1M 3M 6M Absolute (%) 18.0 17.1 38.5 Relative (%) 16.0 10.9 26.6 Share price chart Major shareholders % Oldtown International 53.1 Neobalano Carpus 7.2
Transcript
All required disclosure and analyst certification appear on the last two pages of this report. Additional information is available upon request. Redistribution or reproduction is prohibited without written permission
PP7766/03/2013 (032116)
20 April 2012
The white coffee champion… We initiate coverage on Oldtown with a Buy recommendation and a target price of RM1.69 based on its 12-month forward P/E of 13x. We like Oldtown based on, (1) strong 3-year earnings CAGR of 25.8% driven by its aggressive expansion plan, especially its FMCG segment, (2) extremely scarce investment alternatives to ride on the rising coffee consumption in China, and (3) tremendous earnings potential from the untapped coffee market in China. Furthermore, Oldtown is also a good yield play, offering attractive FY12-FY14 yields of 4.0%-6.6%! …that could ride on the rising coffee consumption in China Oldtown is a strong regional café operator and an established beverage (mainly white
coffee) manufacturer in Malaysia. The group floated its shares on Bursa Malaysia on 13 July 2011 to raise RM79.2m to fund its ambitious regional expansion plan, underpinned by its 5-fold increase in its beverage manufacturing capacity!
Given its strong brand name and market leadership in the white coffee segment, we view Oldtown as one of the key beneficiaries to rising coffee consumption in China. According to the International Coffee Organization (ICO), China’s coffee consumption is only 35g per capita as compared to 300g per capita in Asia. Over the past 2 years, we have seen the proliferation of coffee drinking culture in China as the country’s coffee import grew by 38.3% and 41.9% in 2010 and 2011 respectively.
In FY12, Oldtown plans to expand its café chain aggressively by opening 35-50 new outlets in four of its key markets, i.e. Malaysia (20-30), Singapore (2-3), Indonesia (5-8) and China (36 by FY15, translating to 9 p.a.). This translates to 18-25% growth from its 196 café outlets in FY11. However, given the slow progress in 1Q12 (6 outlets added), we take a conservative stance by only assuming 26 new outlets to be opened p.a. over the next 3 FY. Based on our estimates, this could generate 8.0% and 11.6% revenue growth for its F&B business in FY12 and FY13 respectively.
As for the fast moving consumable goods (FMCG) segment, we are even more positive as a 5-fold capacity expansion plan would be completed in 4Q12. Currently, the existing plant which has an annual capacity of 9.2m tonnes is running at 90-95% utilisation rate. The group aims to achieve an overall utilisation rate of 30% for its enlarged capacity of 45.8m tonnes in FY13, this translates to a strong volume growth of 17.3% and 66.7% in FY12 and FY13 respectively.
3-year earnings CAGR of 25.8% As such, we project the group’s earnings to grow by a 3-year CAGR of 25.8%. In addition,
we anticipate its net margin to improve from 11.6% in FY11 to 13.1% in FY14 due to the better economies of scales as the group grow bigger.
Our forecasts are 8.8% lower than Bloomberg consensus forecasts in FY12, but 8.8% higher than Bloomberg consensus forecasts in FY13. In contrarian to the consensus view, we believe Oldtown’s earnings growth would only take off strongly in FY13, once its new manufacturing plant start commissioning in Jan/Feb 2013.
Valuation and recommendation We initiate coverage on Oldtown with a BUY recommendation and target price of
RM1.69, based on its 12-month forward P/E of 13x. Furthermore, Oldtown is also a good yield play, offering attractive FY12-FY14 yields of 4.0%-6.6%, based on the company’s dividend policy of 50% payout ratio.
Key risks include (1) threat of the new entrants who could imitate Oldtown's recipe and restaurant concept at a much competitive price, (2) higher costs pressure due to labour wages, rent and coffee bean, and (3) global economic slowdown which could hurt the F&B industry as a whole.
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Initiating Coverage | Oldtown | 20 April 2012
3
A WHITE COFFEE CHAMPION… Introduction Oldtown is a regional café chain operator and an established beverages manufacturer in Malaysia. As at 31 Dec 2011, the group operates 196 café outlets in the Asia region, of which 183 in Malaysia, 8 in Singapore, 4 in Indonesia, and 1 in China. These comprise of 96 franchised outlets, 79 fully-owned outlets, 18 partially-owned outlets and 3 licensed outlets. All of the group’s café outlets are supported by 3 centralised food processing centres, which located in Ipoh (2) and Subang (1), Malaysia. In FY11, the group generates 68% and 32% of its revenue from food and beverages (F&B) segment and fast moving consumable goods (FMCG) segment respectively.
Figure 5 : Oldtown’s café outlets by country as at FY11 Figure 6 : Oldtown’s café outlets by type as at FY11
Source: Company data, Alliance Research Source: Company data, Alliance Research
The Oldtown’s story begins in 1999, when its co-founders and executive directors, Goh Chin Mun and Tan Say Yap, formulated their own blend of 3-in-1 instant white coffee and commercialised the coffee product under the “OLDTOWN” brand name. Drawing on good customer response, Oldtown commenced its first export of its coffee to Singapore in 2000. In 2001, Oldtown incorporated White Café Marketing (WCM) as its marketing arm as it starts to penetrate into the Hong Kong market by expanding its product line to include different variations of instant coffee mix. WCM obtained a Halal certification from the Islamic Religious Department of Perak for the group’s beverages in 2002. This enables the group to penetrate into the rural areas in Malaysia including East Malaysia via major hypermarkets and supermarkets. Thereafter, the group launches more product lines such as instant milk tea mix, instant chocolate beverages and roasted coffee powder with wider export market coverage of up to 14 countries, including USA, UK, Taiwan and Indonesia. 6 years after the introduction of its white coffee, the group taken a strategic move to capitalise on its brand name by expanding vertically into the food services industry via a chain of café outlets based on the concept of traditional coffee shop in Ipoh, which offers variety of local foods and beverages. This vertical expansion takes off successfully and helps the group to build a strong brand name within the Malaysia F&B industry. On 13 July 2011, Oldtown floated its shares on Main Market of Bursa Malaysia and raised RM79.2m to fund its set-up of 5 new café outlets, relocation of 7 fully-owned café outlets and construction of a new beverage manufacturing and food processing plant in Ipoh. The set-up and the relocation of the café outlets have now been completed while the new manufacturing plant which is being built on a 9-acre land in Tasek Industrial Estate in Kinta, Perak is expected to be completed in 3 phases. The first phase will involve building a premise for the manufacturing of instant coffee mix and instant milk tea mix while the second phase would involve building an office block. Development plan for the third phase of construction has yet to be determined. Once the first phase is completed by 4Q12, Oldtown’s beverage manufacturing capacity would be increased by 5-fold!
Malaysia, 183
Singapore, 8Indonesia, 4
China, 1
Fully-owned40%
Partially-owned9%
Franchised49%
Licensed2%
A regional café chain operator and an established beverages
manufacturer in Malaysia
Story begins in 1999…
Obtained Halal certification for its beverages in 2002
Capitalised on its brand name by expanding vertically into F&B
segment in 2005
Raised RM79.2m via IPO on Bursa to fund its regional expansion in
2011
Initiating Coverage | Oldtown | 20 April 2012
4
Ambitious regional expansion plan… Malaysia is by far the largest market for Oldtown, which accounts for 76% of its revenue in FY11. Going forward, we believe Oldtown could continue to grow its domestic business as we believe the saturation point is still far away, although the group has already opened 183 outlets as at 31 Dec 2011. Taking the cue from KFC, Oldtown believes its café chain in Malaysia could potentially reach 300-500 outlets over the long term. To achieve this target, the group plans to launch the first Oldtown’s kiosk by 3Q12, which targets to serve the office crowd with beverage and some easy-prepared food in high traffic places such as train stations and office buildings.
Figure 7 : Oldtown’s revenue breakdown by segment Figure 8 : Oldtown’s revenue breakdown by geographical area
Source: Company data, Alliance Research Source: Company data, Alliance Research
We view this move positively as we believe the expansion via the kiosk concept would not only yield higher ROE for the group given its low set-up cost, but also help the group to tap into the market which is not served by its existing café outlets. Hence, any successful launch of its kiosk concept could be seen as a re-rating catalyst for the group in the future. In fact, Oldtown’s management has proven its strong implementation and execution track record by opening 183 café outlets in over 7 years, translating to more than 2 outlets opened per month. Over the near term (FY12), Oldtown targets to add another 20-30 new café outlets in Malaysia based on the fully-owned (50%) and franchised (50%) concept. According to the management, this could generate additional revenue of about RM15-20m in FY12, translating to 5-7% of total revenue growth from FY11. However, given the slow progress in 1Q12 (only 3 outlets added), we take a conservative stance by projecting only 14 new outlets to be opened in FY12, followed by 10 new outlets p.a. in FY13 and FY14 respectively. Based on our estimates, this could generate 4-6% earnings growth for FY12 and FY13 respectively, assuming the new outlets achieve half of its average revenue per outlet during the first year of operation due to non-full year effect. Presently, Oldtown’s average revenue per outlet stands at about RM900k p.a. According to the management, the average spending per customer (ASC) in the local outlets was about RM9.50. Going forward, the group plans to further penetrate into the Malaysia Halal food market by applying for full certification of JAKIM Halal for all of its café outlets by 3Q12. Once the group procure the full Halal certificate for all its café outlets, we expect its customer turnover to improve significantly. Furthermore, we also see potential upside on the ASC as management plans to induce higher customer spending per single lunch segment by introducing new set lunches in the near future. This could be an upside surprise to our forecast as we are currently conservatively assuming unchanged revenue per outlet over the next 3 FY, except the 5% price adjustment for all its F&B products in Oct 2011.
Operation of own café outlets (F&B),
33%
Product sales to franchises (F&B),
24%
Franchising related fees (F&B), 5%
Coffee beverages (FMCG), 35%
Instant milk tea mix (FMCG), 3%
Malaysia, 76.3%
HK, 9.4%
Singapore, 8.7%
Taiwan, 1.0%
US, 0.9%Others, 3.6%
Still plenty of rooms to grow its Malaysia café chain from 183
outlets to 300-500 outlets
Oldtown’s kiosk could be a new earnings driver in future
Over the near term (FY12), the group plans to add 20-30 new
outlets in Malaysia
More upside potential from customer turnover and ASC from
halal certification and new set lunches
Initiating Coverage | Oldtown | 20 April 2012
5
Figure 9 : Oldtown’s average revenue per outlet Figure 10 : Oldtown’s key sales statistic in February 2012
Source: Company data, Alliance Research Source: Company data, Alliance Research
Oldtown also plans to expand its café chain network in its international market. Currently, Singapore and Indonesia are the second and third largest markets for its café chain operation with 8 outlets and 4 outlets respectively. Going forward, the group plans to add another 2-3 fully-owned outlets in Singapore and 5-8 sub-licensed outlets in Indonesia. Based on our estimates, if the group continue to expand its Singapore and Indonesia’s café chain by 2 and 5 outlets p.a., it could potentially contribute about 1-4% extra profit for the group over the next 3 FY.
Figure 11 : Oldtown Singapore’s new design Figure 12 : Oldtown Indonesia café outlets
Source: Company data Source: Company data
While Oldtown continues to expand its café chain in Malaysia, Singapore and Indonesia, we believe the key earnings growth for the group would be coming from the China market over the next 3 years. Over the years, mainland Chinese has always been perceived as non-coffee drinkers, but rather tea-drinkers. This was evidenced by the country’s low coffee consumption of just 35g per capita, as compared to 4200g, 3710g, and 300g of coffee consumption per capita in USA, Europe and Asia respectively. According to International Coffee Organization (ICO), Europe and USA together consume more than 85% of the world coffee supply in 2011.
Figure 13 : Coffee consumption per capita by country/ region
Source: ICO, Alliance Research
638.5
872.4 888.5 948.8 962.5
903.9 36.6%
1.8%
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FY07
FY08
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FY11
- Pro
-form
a
FY11
-Rep
orte
d
RM '000
Singapore China Indonesia MalaysiaAverage sales per transaction (RM) 42.5 37.3 24.3 19.9 Average spending per customer (RM) 20.5 17.8 12.0 9.5
Total # of transaction 41,797 2,418 20,187 1,050,401 Total # of customers 86,536 5,054 40,719 2,197,751 # of customers per transaction 2.1 2.1 2.0 2.1
Total # of outlets 8 1 5 184Average # of customers per outlet (monthly) 10,817 5,054 8,144 11,944 Customer turnover per hour * 23.3 10.9 17.6 25.7
* Assuming 16 operating hours per day.
3,710
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Europe US South Korea Malaysia Vietnam Asia China
Gramme per capita
Singapore and Indonesia expansion could yield extra 1-4% profit to the
group over the next 3 FY
But still, China would be the main driver in future…
Initiating Coverage | Oldtown | 20 April 2012
6
However, over the past 2 years, we have started to witness the proliferation of coffee-drinking culture in China as the country’s coffee import grew strongly by 38.3% and 41.9% in 2010 and 2011 respectively. We believe this was mainly driven by the country’s fast-growing middle-class, who had increasingly be adapting to the American/European coffee-drinking lifestyle due to rising affluence. Given the promising outlook on the China coffee market, Starbucks announced its aggressive expansion plan in 2011, to triple its China outlets from 470 to 1,500 by 2015, translating to a 4-year CAGR of 34%!
Figure 14 : Coffee imported by China
Source: Bloomberg (China Custom), Alliance Research To ride on the rising trend of coffee consumption in China, Oldtown had started to penetrate into the huge untapped coffee market in China by launching its first café outlet in Guangzhou city in Nov 2011. The China venture is based on a 10-year master-license agreement with one strong local partner which allow it to operate OLDTOWN WHITE COFFEE café chain in Guangdong and Macau, China. Guangdong is one of the richest provinces in China with a population of 96m, which is 3.4x bigger than Malaysia’s population. Guangdong generates the highest GDP in China and contributes approximately 12% of the China national economic output. In 2010, the province’s GDP per capita grew by 10% y-o-y, reaching RMB 41,166 p.a.
Figure 15 : Guangdong GDP per capita
Source: Bloomberg, Alliance Research Drawing on good customers’ response on its first outlet, Oldtown opened its second café outlet in Guangzhou city on 2 March 2012. Based on our channel check via the Chinese “Twitter”, Weibo, there are more than 3,300 comments posted on OLDTOWN WHITE COFFEE as at 17 April 2012, of which 90% are positive! In fact, we aren’t surprised by the overwhelming response from the Chinese consumers, given that many of them have actually known and tried Oldtown’s white coffee in Hong Kong before, which accounts for 40% of its export revenue in 2011. Anecdotally, we have also heard that many Chinese tourists like to buy Oldtown’s white coffee as a souvenir when they visit Malaysia.
-4.3%
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metric tonnesCoffee Imported by China yoy growth
15,03017,213
19,707
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33,15137,589
41,166
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yuanGuangdong GDP per capita yoy growth
…as we have started to witness the
proliferation of coffee-drinking culture in the country
Hence, Oldtown started its China venture in Nov 2011
So far, the responses from Chinese consumers are overwhelming
Initiating Coverage | Oldtown | 20 April 2012
7
Figure 16 : Oldtown’s first 2 café outlets in Guangdong, China
Source: Company data Going forward, Oldtown plans to expand its café chain in China from 2 outlets to 36 outlets by 2015, translating to 9 new outlets p.a. However, given the slow progress in 1Q12, we project only 5 additional new outlets to be opened in FY12, including the second outlet opened in March 2012. Based on our estimates, this could contribute 1-2% earnings growth in FY12 and FY13. Furthermore, the group also plans to set up and start operating a new food processing centre in Guangzhou by the end of 2012, to support its further penetration into the rest of China market. Currently, Oldtown is still looking for the potential new licensees to expand its café chain in other provinces in China. Together with the café chain expansion in the other 3 countries, F&B business could generate additional 6% and 10% earnings to the group in FY12 and FY13 respectively, based on our estimates. Meanwhile, on the FMCG segment, we expect earnings to grow stronger than the F&B segment, given its 5-fold capacity expansion in FY12. Presently, Oldtown has a total of 18 distributors to cover 12 FMCG markets in the world. The group’s beverage products could be reached in more than 11k retail outlets in 3 of its key markets, of which 7768 are in Malaysia, 2,870 in Hong Kong, and 752 in Singapore. In China, the group has appointed 3 distributors, which have strong distribution network of about 1,000 retail outlets in the country. This enables the group to expand its reach in the China retail market, once its manufacturing plant is up and running by Jan/Feb 2013.
Figure 17 : Oldtown’s number of distributors by country Figure 18 : Key retail outlets that carry Oldtown’s products
Source: Company data, Alliance Research Source: Company data, Alliance Research
Based on management guidance, the group’s utilisation rate of its existing beverage manufacturing capacity is likely to reach 90-95% in FY12, improving sharply from the 76% and 64% achieved in FY11 and FY10 respectively. With the new plant coming on stream in FY13, the management aims to achieve an overall utilisation rate of 30% for its enlarged capacity (45.8m tonnes) via the penetration into Beijing, Tianjin, Shanghai, Jiangsu, Zhejiang and Guangdong provinces.
Targets to reach 36 outlets in China by 2015
FMCG would be the key earnings driver from FY13 onwards
Management targets to achieve 90-
95% and 30% utilisation rate for existing and new manufacturing
capacity
Initiating Coverage | Oldtown | 20 April 2012
8
Furthermore, it also plans to venture into South Korea and Vietnam’s FMCG market in FY12, which could potentially yield higher take-up rate for its new capacity. According to ICO, coffee consumption per capita in South Korea is about 1,800g, which is the second highest in Asia, after Japan (3,300g per capita). Therefore, we are bullish on Oldtown’s FMCG earnings growth over the next 3 years, especially in the China market. Based on our estimates, FMCG sales volume is set to grow by 17.3%, 66.7% and 26.7% in FY12, FY13 and FY14 respectively. As a result, the revenue contribution from the FMCG segment is projected to make up 40%, 50% and 53% of its total revenue in FY12, FY13 and FY14 respectively.
Figure 19 : Oldtown’s revenue breakdown by segment Figure 20 : Oldtown’s FMCG sales volume growth vs utilisation rate
Source: Company data, Alliance Research Source: Company data, Alliance Research
Figure 21: Oldtown’s SWOT analysis
Source: Alliance Research
60% 67% 67% 65% 62% 60%50% 47%
40% 33% 33% 35% 38% 40%50% 53%
0%10%20%30%40%50%60%70%80%90%
100%
FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F
Operation of Café Chain Manufacturing of Beverages
63%77%
90%
30% 38%20.9% 17.3%
66.7%
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Utilisation rate (LHS) Sales volume growth (RHS)
Strengths Weaknesses- A market leader with strong brand name in the white coffee segment. - Low barriers of entry for the F&B business.- Extensive distribution network in the region.
Opportunities Threats- Huge untapped China market. - Threat of the new entrants who are able to immitate OldTown's
restaurant concept and foods at a much competitive price.- 5-fold capacity expansion to underpin its ambitious regional expansionplan.
- Volatile raw material costs such as coffee bean might hurt itsprofitabil ity.
- Earnings potential in untapped Halal market in Malaysia.
Plans to venture into South Korea and Vietnam’s FMCG market too
FMCG business would overtake F&B business as the largest contributor
by FY14
Initiating Coverage | Oldtown | 20 April 2012
9
Risks F&B industry is always a highly competitive industry as barriers of entry are low due to low start-up cost and high tendency of change in consumer preference. Furthermore, consistency of food quality and service standard are not easy to maintain as the group expand its café chain aggressively. We see this as one of the key risks to Oldtown, especially if there is any successful imitation of its product’s recipes and restaurants concepts with a more competitive pricing. However, we believe this could be partly mitigated by its strong brand name and registration of its trademarks to protect against any infringement of its trademarks in the industry. On top of that, we are also concern of the high volatility of Oldtown’s profit margin (gross profit margin of 32-38% since FY07), although it is an industry norm within the F&B industry. The high volatility of profit margin is partly due to its commoditized raw material such as flour, sugar and coffee bean. Any unexpected events such as the changes in climate, government regulations and coffee diseases could result in a sudden surge in its key raw material costs. Apart from that, labour cost and rental cost increase could also hurt its margin, given that both of the costs make up about 30% of its COGS.
Figure 22 : FOA index vs Oldtown’s gross profit margin Figure 23 : ICO indicative coffee bean price
Source: Bloomberg, company data, Alliance Research Source: ICO, Alliance Research Last but not least, we see global economic slowdown as a risk to the group if the Eurozone sovereign debt crisis deepens. Having said that, we currently do not factor in a recession scenario in our forecasts as we believe domestic consumption in Malaysia is quite resilient as it consistently grew by more than 6% with the exception of 2009 due to global financial crisis. In fact, Oldtown managed to achieve 1.8% growth for its average revenue per outlet in FY09 despite the global financial crisis. Hence, we believe the domestic F&B industry could be rather resilient, unless there is a severe global economic recession.
33.3%
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Threat of new entrants who could successfully imitate Oldtown’s
recipes and restaurant concepts
Coffee bean, labour and rental cost increase could hurt its margin
Global economic slowdown could adversely affect the F&B industry
Initiating Coverage | Oldtown | 20 April 2012
10
FINANCIAL HIGHLIGHTS 3-year earnings CAGR of 25.8%
Oldtown reported a 3-year CAGR of 28.9% and 29.0% for its revenue and core profit respectively from FY09 to FY11, driven by its strong café chain expansion from 107 outlets to 196 outlets, translating to 3-year CAGR of 22%. Going forward, we project the group’s earnings to grow by a 3-year CAGR of 25.8%, underpinned by its strong volume growth in FMCG (3-year CAGR of 35.3%) segment as well as continuous café chain expansion of 26 new outlets p.a. We expect Oldtown’s net margin to improve slightly from 11.6% in FY11 to 13.1% in FY14 due to its better economies of scales as the group grows bigger. Our forecasts are 8.8% lower than Bloomberg consensus forecasts in FY12, but 8.8% higher than Bloomberg consensus forecasts in FY13. In contrarian to the consensus view, we believe Oldtown’s earnings growth would only take off strongly in FY13, once its new manufacturing plant start commissioning in Jan/Feb 2013.
Overall avg revenue/café outlet (RM k/yr)- (h = f x a) 948.8 903.9 861.7 860.8 856.6 Growth % 6.8% -4.7% -4.7% -0.1% -0.5%Avg revenue/ fully or partially-owned outlet 1,072.7 964.4 1,001.0 1,001.0 1,001.0 Growth % -10.1% 3.8% 0.0% 0.0%Avg revenue/ franchised or l icensed outlet (estimate) 1,760.8 1,610.0 1,610.0 1,610.0 1,610.0 Growth % -8.6% 0.0% 0.0% 0.0%
* f- Given the comprehensive workings, we only disclose the outcome, however, the drop in overall revenue/café outlet was
mainly due to higher contribution from franchised/ licensed outlets.
Strong growth underpinned by 40%volume growth in FMCG
business
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Strong balance sheet with net cash of RM0.21 per share Oldtown has a strong balance sheet with net cash of RM0.21 per share as at 31 Dec 2011. This enables the group to expand its F&B business aggressively over the next 3 years. Capex normalised in FY13 We estimate Oldtown to spend RM43m and RM8m for capex in FY12 and FY13 respectively as the group is currently building its beverage manufacturing plant which costs RM34m. We anticipate the group to incur about RM8-9m for its F&B business over the next 2 years as we project the group to open 8-9 fully-owned café outlets p.a. Based on our understanding, the set-up cost for a new outlet is about RM700k, depending on the size of it.
VALUATION AND RECOMMENDATION In conclusion, we initiate coverage on Oldtown with a Buy recommendation and target price of RM1.69, based on its 12-month forward P/E of 13x. We believe Oldtown is fair to be valued at 13x, given that (1) the regional F&B peers are on average trading at a 12-month forward PER of 13.8x, (2) Oldtown has the strongest 3-year earnings CAGR of 25.8%, translating to only 0.5x PEG,
and (3) Oldtown appears to be the best proxy to ride on the rising coffee consumption in China.
Last but not least, Oldtown offers the best FY12-FY14 yields of 4.0-6.6%, based on its dividend policy of 50% payout ratio.
Strong balance sheet with net cash making up 13.9% of its market cap
Initiate coverage with a Buy recommendation and TP of RM1.69
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APPENDIX I Industry analysis Malaysian F&B industry is a growing but competitive industry. According to 2010 Population and Housing Census of Malaysia (Census 2010), Malaysia has a young population with a median age of 27.6 years or 57.2% of the population is younger than 30 years old. This so-called Generation Y (Gen-Y) population is considered the fastest growing segment of the country workforce and the majority of them are deemed to have a high propensity to spend, including F&B expenditure as compared to previous generations. As such, we believe the F&B industry could be one of the biggest beneficiaries of the country’s young population.
Figure 26 : Malaysian population breakdown
Source: Census 2010, Alliance Research The barriers of entry for F&B industry are considered low given the low start-up costs. However, we view customer service and branding as the most critical success factors within the F&B industry as increasingly affluent Malaysian consumers are less price-sensitive now, but more focus on brands, product quality (both of food/coffee quality and restaurant’s ambience) and customer service. By building a strong brand via a differentiation strategy within the F&B industry, it could act as barriers to entry to the new entrants. Generally speaking, consumers’ spending behaviour is greatly affected by their disposable income, which depends on general economic condition in the near term. As consumers are increasingly discerning with heightened consumer rights awareness, bargaining power of consumer in the F&B industry is high due to low switching costs. Again, we believe the only way to mitigate the risk of high bargaining power of consumer is to build brand loyalty among customers via consistent good product quality and customer service. On the other hand, we view the bargaining power of suppliers in the F&B industry as moderate due to the trading nature of its commoditized raw materials such as flour, coffee bean and sugar, which depend on global supply and demand dynamics. Oldtown sources 80% of its coffee requirement from overseas, such as Brazil and Indonesia on a 6-12 months contract basis. Together with its typical inventory level of 6-9 months, this enables the group to plan its costs pass through more efficiently. Coffee industry is a growing industry in Asia. The primary substitute products posing a potential threat to coffee are caffeinated soft drinks produced by Pepsi and Coca-Cola. However, there exist significant difference in tastes, hence, consumers were unlikely to directly substitute coffee for caffeinated soft drinks or vice versa. As a result, it actually presented the industry with little threat of substitution.
0-14, 27.6%
15-19, 10.0%
20-29, 19.6%
30-39, 14.3%
40-49, 11.9%
50-54, 4.8%
55-64, 6.7% > 65, 5.0%
A growing but competitive market
Low barriers of entry
High bargaining power of buyers
Moderate bargaining power of suppliers
Low threat of substitute product
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Presently, Malaysia has about 14 café chain operators with the top five making up 78% of the total number of café outlets in the country. While on the FMCG segment, Oldtown is the third largest coffee retailer with 9.5% market share in 2011. Within the white coffee segment, Oldtown is the clear market leader with 42.3% market share, leading the second and third largest player, Super Group and Chek Hup who are estimated to have about 20% and less than 10% market share respectively, based on management guidance. As for the Hong Kong and Singapore coffee mix markets, Oldtown ranked is number 2 with increasing market share over the past 3 years, challenging the market leader, Nescafe which has about 29% market share in Hong Kong. Going forward, we expect the rivalry competition within the café/coffee industry to increase as we anticipate the major players strive to capture larger market share.
Figure 27 : Café chain operators in Malaysia Figure 28 : Oldtown’s FMCG market share breakdown by country
Source: Company data Source: Company data In conclusion, the industry is highly competitive with one positive and three negative scores in Porter’s Five Forces Analysis, while the bargaining power of suppliers is considered moderate.
# of outlets %Secret Recipe 212 24.2%Old Town White Coffee 183 20.9%Starbucks Coffee 125 14.3%Subway Sandwiches 95 10.9%Pappa Rich 63 7.2%Coffee Bean & Tea Leaf 52 5.9%Station 1 Leisure Café 41 4.7%Hailam Kopitiam 27 3.1%San Francisco Coffee 23 2.6%Dome Café 16 1.8%Gloria Jean's Coffee 13 1.5%Killiney Kopitiam 10 1.1%Kluang Station 8 0.9%Georgetown White Coffee 7 0.8%Total 875 100.0%
High rivalry competition
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APPENDIX II External auditors The current external auditors of Oldtown are Deloitte, which have not expressed a qualified opinion on the company’s financial statements. Board of directors Oldtown has a strong and experienced management team. The group practices good corporate governance by splitting the roles of the chairman of the board and managing director. The board consists of eight members, of which three are independent directors. 1) Datuk Dr Ahmed Tasir bin Lope Pihie, 60
Independent non-executive chairman, since 2009 Qualification > Bachelor in Agriculture Science (University Malaya), MSc in Seed Technology (University of Edinburgh, Scotland), PhD in Science and Technology Policy (University of Manchester, UK) Experience > He was the CEO of Malaysia Industry-Government Group for high technology from 1993-2008. He presently serves as the Chairman of Nagaya Global Bhd and Strand Aerospace Malaysia Sdn Bhd.
2) Lee Siew Heng, 45
Group Managing Director, since 2007 Qualification > Completion of secondary education Experience > He had accumulated more than 20 years of experience in the manufacturing and retailing industry with 9 years in the coffee beverage industry.
3) Goh Chin Mun, 40
Executive Director, since 2007 Qualification > Completion of secondary education Experience > He started his career in 1983 with Nam Heong Coffee Shop in Ipoh. Subsequently, he co-founded White Café (WC) where he was appointed the Product Research and Development Director and was then responsible for the formulation of the blend of white coffee that is produced by the group.
4) Tan Say Yap , 36
Executive Director, since 2009 Qualification > Diploma in Hotel Business Management (Syuen Hotel and Catering Management Institute) Experience > He co-founded and established WC in 1999. From 2005 to 2009, he was appointed the Business Development Director of Kopitiam Asia Pacific as is responsible for the café outlet operation during that period.
5) Clarence D’Silva A/L Leon D’Silva, 50
Executive Director & COO of F&B segment, since 2009 Qualification > Bachelor in Business Administration (California Technical College, US) Experience > He started his career in 1983 with Kentucky Fried Chicken as a management trainee. In 1989, he left to take up employment with Carl’s Jr. Asia Development Corporation and was eventually promoted to the position of General Manager of the brand in Thailand. In 2003, he joined Yoshinoya Food System as the Chief Operating Officer (COO). Clarence joined Oldtown in 2009 as the COO of Oldtown’s F&B segment.
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Board of directors (continued)
6) Chuah Seong Meng, 36
Executive Director and COO of FMCG segment, since 2009 Qualification > BBus. majoring in Marketing (University of Tasmania, Australia), Certified Marketer (Chartered Institute of Marketing, UK) Experience > He joined WCM as a Marketing Manager in 1999 and was eventually promoted to Group Marketing Manager in 2007. He currently oversees the business operations of the group’s FMCG business.
7) Chin Lai Yong, 43 Non-independent non-executive director, since 2009 Qualification > Diploma in Cost Accounting (London Chamber of Commerce and Industry) Experience > In 1998, she participated as an investor in the fashion retailing business before joining WCM as an administration officer from 2003 to July 2009.
8) Mark Wing Kong, 52
Independent non-executive director, since 2009 Qualification > CA with Malaysian Institute of Certified Public Accountant (MICPA) Experience > He was general manager of Corporate Finance department in Arab-Malaysian Merchant Bank Bhd. He left the company to join LB Aluminium Bhd in 1997 where he is currently the CEO.
9) Dr. Leong Chik Weng, 48 Independent non-executive director, since 2009 Qualification > BSc in Chemical Engineering (West Virginia University, US), PhD in Chemical Engineering (University of Massachusetts, US) Experience > He joined Raychem Corporation Menlo Park from 1989 to 1996. His last position at Raychem was Technical Director. He is currently the CEO of e-Lock Corporation Sdn Bhd.
Note: Chin Lai Yong is the sister-in-law of Lee Siew Heng.
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APPENDIX III Business Model
Figure 29 : Oldtown’s F&B business process flow
Source: Prospectus
White coffee background White Coffee originated from Ipoh, Malaysia and is known for its robust aroma and its creamier and richer taste. It is basically produced from the same species of coffee beans that black coffee used, i.e. Robusta or Arabica coffee. However, Old Town White Coffee is a blended of 3 types of coffee beans i.e. Robusta, Arabica and Liberica, of which 70% of the coffee bean used is Robusta. The main difference between white and black coffee is basically the way the coffee beans are roasted. To produce a traditional ‘black’ coffee, coffee beans are roasted with sugar and margarine. While ‘white’ coffee beans are only roasted with margarine. Without sugar, the roast is not as dark and hence termed as ‘white’ coffee. Coffee beans introduction Arabica coffee is a pricier and more superior specie as compared to Robusta coffee. It produces the rich flavour and body found in a good cup of coffee. Arabica coffee is difficult to grow, and prone to disease. Hence, requires more hand cultivation and result in lower yield harvests per acre. Robusta specie is a hardy, high yielding plant which is resistant to numerous pests. Most of the large coffee companies in the world will blend a small amount of Arabica coffee beans with a larger portion of Robusta coffee beans. Liberica is a specie of coffee that originated from Liberia, West Africa since 1843. Today, most of the liberica coffee trees are grown in Malaysia, Indonesia and Philippines with some in West Africa, and India. However, only nearly 1% of Liberica coffee is traded in coffee trading around the world. This beautiful long-living plant is strong, lush, with fruits and seeds proportion double to those of Arabica and more immune to parasites attacks.
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Oldtown Financial Summary
Balance Sheet Income StatementFY 31 Dec (RM m) 2010P* 2011A 2012F 2013F 2014F FY 31 Dec (RM m) 2010P 2011A 2012F 2013F 2014F
* FY10 is a pro-forma account which includes the contribution from the 8 subsidiaries which are not owned by Oldtown from Jan to May 2011.
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DISCLOSURE Stock rating definitions Strong buy - High conviction buy with expected 12-month total return (including dividends) of 30% or more Buy - Expected 12-month total return of 15% or more Neutral - Expected 12-month total return between -15% and 15% Sell - Expected 12-month total return of -15% or less Trading buy - Expected 3-month total return of 15% or more arising from positive newsflow. However, upside may not be sustainable Sector rating definitions Overweight - Industry expected to outperform the market over the next 12 months Neutral - Industry expected to perform in-line with the market over the next 12 months Underweight - Industry expected to underperform the market over the next 12 months Commonly used abbreviations Adex = advertising expenditure EPS = earnings per share PBT = profit before tax bn = billion EV = enterprise value P/B = price / book ratio BV = book value FCF = free cash flow P/E = price / earnings ratio CF = cash flow FV = fair value PEG = P/E ratio to growth ratio CAGR = compounded annual growth rate FY = financial year q-o-q = quarter-on-quarter Capex = capital expenditure m = million RM = Ringgit CY = calendar year M-o-m = month-on-month ROA = return on assets Div yld = dividend yield NAV = net assets value ROE = return on equity DCF = discounted cash flow NM = not meaningful TP = target price DDM = dividend discount model NTA = net tangible assets trn = trillion DPS = dividend per share NR = not rated WACC = weighted average cost of capital EBIT = earnings before interest & tax p.a. = per annum y-o-y = year-on-year EBITDA = EBIT before depreciation and amortisation PAT = profit after tax YTD = year-to-date
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