23 April 2012
OldTown to deliver growth and yields in the long run
Investor interest in café operator, OldTown Bhd (RM1.46) has perked up in recent days. This could be due to a variety of factors, including the company’s relatively defensive business profile, upbeat prospects for earnings growth and yields as well as fairly modest valuations.
The company’s normalised net profit (after adjusting for one-off and other items) grew an estimated 15% last year, and we believe a similar double-digit earnings growth rate is sustainable for the foreseeable future. That compares well against the stock’s prevailing valuations.
The stock is trading at roughly 11.2 times our estimated earnings for 2012 and 9.6 times for 2013. In addition, shareholders will earn dividend yields estimated at 4.5% to 5.2% for the two years. While its shares may consolidate in the near term, following a good run-up, OldTown should see more upside in the long run.
Double-digit earnings improvement is expected from both the company’s key business units — the café operation and beverage manufacturing.
Plans to open 30 to 40 new cafés
OldTown added 21 outlets to its café chain in 2011, bringing the total to 196, including those in Singapore, Indonesia and China. This was slightly off the pace of an annual net add of 33 outlets on average in the previous three years, and is likely due in part to the company’s restructuring and listing exercise in mid-2011. However, OldTown fully intends to pick up the pace going forward.
For the current year, the company plans to add 20 to 30 new outlets locally, about half of which will be opened under its franchise scheme, which allows it to expand quickly and gain market share without overtaxing the balance sheet.
At the same time, the company is in the process of applying for halal certification for all 183 cafés in the country, hopefully before the end of this year.
It has secured certification for some 25 outlets to date. The food processing centres and beverage manufacturing are already certified. If successful, this will significantly expand its target market, which at the moment is predominantly Chinese.
For overseas expansion, two or three new outlets are planned for Singapore and and five to eight in Indonesia. A second outlet in Guangzhou, China, opened in March 2012.
Recall that OldTown signed up a master franchisee for the Guangzhou and Macau provinces last year. The target is to open some 36 cafes by 2015. A new food processing centre in Guangzhou, in which OldTown has a 19% stake, is planned by end-2012. In addition, the company is exploring the possibility of appointing licensees for other provinces in China to further expand its footprint. Licensing, like the local franchise model, limits the company’s investment risk.
In all, we are likely to see 30 to 40 new outlets per year, locally and overseas, going forward. The new outlets and organic growth — same store growth is estimated to average some 2% to 3% — are expected to underpin a 15% to 20% annual earnings growth.
Beverage manufacturing has a huge target market
The café chain accounted for roughly 62% of OldTown’s total revenue in 2011, with the balance coming from the beverage manufacturing arm. The latter is also expected to grow in tandem for the foreseeable future.
OldTown is estimated to have over 42% market share in the instant white coffee mix segment domestically. While it will likely continue to fare well, the higher growth potential should come from exports, which currently account for half of the company’s beverage manufacturing revenue.
The OldTown brand of instant coffee mixes has done particularly well in Hong Kong, where it is ranked second in terms of market share, and Singapore.
Building on its success, OldTown has pushed into the mainland Chinese market, where the potential demand is much larger. Initial sales figures have been encouraging. Its products are sold through three distributors via major retailers such as Walmart, Jusco and Carrefour in coastal cities including Beijing, Shanghai and Guangdong.
The company has also set its sights on two other coffee drinking countries in the region, South Korea and Vietnam. Statistics suggest that per capita coffee consumption in South Korea is five times the average for the Asia-Pacific region and double that of Malaysia, and growing, driven by the younger generation of consumers. Vietnam is one of the world’s largest exporters of coffee beans but consumption has been lagging and therefore presents good growth potential.
With a much larger addressable market, OldTown believes the beverage manufacturing business can maintain growth at a high double-digit clip. Sales grew at an average compound growth rate of nearly 34% per year in the past three years.
The manufacturing facility for coffee and milk tea mixes was running at roughly 83% utilisation at end-2011 and is expected to hit maximum capacity this year. To cater for the expected growth, OldTown is in the process of building a new factory in Ipoh, which will double the existing capacity once it is up and running, slated for 3Q12. Capital expenditure is estimated at some RM48.7 million, for infrastructure and machinery. The facility can be expanded further to up to five times the current level by adding more production lines at fairly marginal cost.
Modest valuations should translate into further gains
We estimate net profit at RM43.2 million this year, up 18% from our estimate of normalised earnings of RM36.6 million in 2011, and further expand to RM50.4 million in 2013. That implies the stock is trading at a price-earnings ratio of roughly 11.2 times 2012 and 9.6 times 2013 — fairly modest compared with the prevailing consumer sector’s average valuations.
Based on the company’s minimum 50% net profit payout ratio, dividends per share are estimated at 6.5 sen and 7.6 sen per share for the two years. That translates into pretty attractive net yields of 4.5% to 5.2% at the current share price.
Certainly there are risks, even though the sector is generally viewed as relatively resilient. Consumer spending is expected to remain quite robust. However, it could weaken if the global economic growth outlook deteriorates significantly or if inflation eats into disposable incomes.
The rapid expansion in OldTown’s café operations also raises difficulty in terms of quality control. Deterioration in food quality or poor service at even a few outlets could hurt the brand name and sales across the whole chain. Furthermore, competition in both the café chain and beverage manufacturing is intense and consumer preferences can be very fickle.
On balance though, we suspect that OldTown should continue to perform fairly well over the next two to three years. Its balance sheet is strong with net cash totalling RM72.6 million as at end-2011.
Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.