We’ve all
been there. You mysteriously find yourself in Hong Kong’s Lan Kwai Fong area, 3am on a midweek morning wondering home when you stumble upon an open Tsui
Wah restaurant on Wellington Street with a great sigh of relief (swear it only
happened once to me, okay maybe twice…). Tsui Wah is an institution in Hong
Kong with its history dating back to the 1960s. It is a restaurant type that’s
locally known as a Cha Chaan Teng (loose translation is tea canteen), mostly
found in the Southern part of greater China (HK, Macau, Guandong etc),
combining the elements of Cantonese, Western and other Asian cuisines in a
casual setting. Highly recommend a look at their Top 10 dishes
(of the 170+). The Cha Chaan Teng market is highly fragmented with a lot of mom
and pop shops in HK but TW is the largest with a 3.2% share.
The company
went public in late 2012 to raise funds for expansion. At the end of
2012 it had 22 stores, generating sales of HK$760m. TW currently has 47
restaurants across HK (29), China (17) and Macau (1). In the last
financial year it generated sales of HK$1.5bn and EBITDA of HK$260m ($190 and
$33m respectively; inc. JVs). The operations are extremely efficient with
standardised and scalable chain of restaurants, central kitchens, speedy service and 8 restaurants
with round the clock opening times. To illustrate, the average revenue per store
is $4.5m (closer to $5m in HK and $4m China) vs $2-3m for global peers and
$1-1.5m for the avg chain Cha Chaan Teng in HK; avg. sales of around $1,100/Sq.
Ft.; 11-12 customer/seat turnover; ROIC on invested capital in high double
digits etc, you get the idea.
TW has a
very ambitious expansion plan for which they raised capital at the IPO (c.
HK$795m or $100m). Mgmt. plans to increase restaurant count to over 80 by 2017.
By 2015 they target to have 52 stores, implying 14 stores p.a. through 2017 (which
could prove to be aggressive) mostly in China. Each store costs around $1.15m
to build (with minimal maintenance capex), with average 1-2 months to breakeven
and 18 months payback. I’m modelling 4 and 7 store openings for HK and China
respectively p.a. by 2017 for a total count of 74 (39 in HK and 34 in China). Currently,
HK represents the bulk of the business, but China has been gaining share and
makes up c. 30% of sales.
The
economics between HK and China are somewhat different. HK has longer avg. opening
hours (19 vs 14 hours), higher turnover (11-12x vs 6x), which is compensated by
higher avg. check size in China (RMB180 vs HK$90 in HK) given higher menu
prices and targeting of higher income population, and higher square footage
(7-10,000 Sq. Ft. vs 3,000 Sq. Ft in HK on avg.). Two points to add here on the prices
and square footage: (i) TW increased avg. menu prices virtually every year and
its prices even in HK are at a premium to other similar type restaurants and
(ii) on the square footage mgmt. indicated that they plan on introducing
smaller stores in China as a new operating model.
Now I noted
above that the growth plan might be aggressive. TW’s key expansion target is China and within that Shanghai, which is one of the most competitive food and
restaurant markets as you can imagine. TW has gone from having one store in
2010 to 17 currently however this came to the detriment of sales per store. Casual
dining is exploding in China, however competition especially from chains such
as Xinwang or Charme is heating up (no pun intended), which is impacting
performance. The company is committed to not compete on price (it has the
highest avg. check size amongst the chains) but on core values and expected to
have a tough time with further expansion Shanghai. There is also an element of difference
in customer preference and taste between the Shanghai/Sichuan cuisine vs the
more tamed Cantonese. But Shanghai is not the only place in China with growth
potential. TW operates in Shenzhen or Wuhan, which it could tap for further
expansion. In addition to store count growth management is experimenting with
other source of growth such as deliveries in HK, though there would naturally
be some cannibalisation.
So this is
all wonderful but let’s see if it’s cheap. The current share price following
the HK market’s run up last week is HK$2.78, market cap of HK$4bn ($515m) and
EV of HK$3.4bn ($440m), trading at 13x EBITDA. I’m estimating that by 2017, TW
will have 74 stores (below guidance) with 39 in HK and 34 in China. I’m using
two methods to estimate revenues: (i) avg. Sq. Ft. x avg. sales/Sq. Ft and (ii)
avg. store count x revenue/restaurant. In the first instance the key
assumptions are: (a) 3,000 Sq. Ft. in HK and 8,500 Sq. Ft. in China (declining
to 6,500 Sq. Ft. by 2017 to account for mgmt.’s plan to introduce smaller
restaurants); (b) avg. sales/Sq. Ft. HK$13k and c. HK$4k, for HK and China
respectively. In the second method I’m assuming HK$36m and HK$32m revenue per
restaurant for HK and China respectively. Both methods get me to HK$2.3-2.4bn
revenue by 2017 and assuming a ramp-up to 17% EBITDA margins (below
historical average) I get to HK$400m EBITDA. This implies a multiple of around
8.5x, which I believe is quite low. Based on TW’s and peers historical EBITDA
range of at least 12x, the implied share price is HK$3.7 for a conservative 35%
upside. My estimates are fairly
conservative: (i) below guidance and consensus restaurant count growth, (ii)
below historical overall average sales/Sq. Ft. ($900 in my model vs $1,100
historically) and (iii) below historical EBITDA margins. In addition to the
cheap valuation, the company has a dividend payout policy of no less than 30%,
however this averaged 50% since the IPO. The forward yield is around 3%.
It would be
remiss not to mention the massive share price decline during 2014. The company
went public in 2012 at around HK$2.5 per share, eventually increasing to HK$5.6
by late 2013, dropping all the way down to HK$2.3 in mid March 2015. This was
due to a combination of events: (i) secondary share sale of controlling
shareholders to “increase liquidity in the market” at HK$5; (ii) resignation
and then appointment of a CEO (one of the co-founders); (iii) slower Chinese
expansion; (iv) slower SSSG in China and (v) increase in costs (especially rent
in HK), impacting margins. As noted above the Chinese competitive environment
is tougher, in addition growth can hurt margins in the early years as new
stores are not up to the scale of the existing ones. There is no short term remedy
for this but TW’s actions, such as increasing the number and efficiency of
the central kitchens will eventually help, as well as the ramp up of the new restaurants.
On the
governance issues, the secondary share sale caught investors by surprise. TW is
a controlled company with 5 key shareholders (also co-founders and directors)
owning 65% of the company currently, and they sold down 8% in January 2014 at
HK$5. The reason given was the standard
“increasing liquidity in the market” but it’s certainly not positive when core
shareholders are selling. The shares certainly ran ahead of themselves (over 2x
from the IPO price) so the shareholders probably saw it as an attractive time
to sell down. Then to compensate for the sale to a small extent in April 2014
as the price started to drop, core shareholders acquired 7m shares (0.5% of
total) at around HK$4. In addition, there are related party transactions to
consider where the company buys or leases properties from the directors.
The
potential risks with the investment are: (i) slowing growth and store opening guidance;
(ii) food safety issues – this has been increasing in China; (iii) increasing
costs – labour, raw materials or property related.
In closing,
I believe that TW is a high quality business, with a very unique brand, growth
story and capable management, whose share price got beaten up bad. I think it’s
worth taking a closer look at.
