We learnt from Oldtown’s analyst briefing yesterday that the company’s expansion plans are well on track. In this report, we also set out the findings of our survey of the company’s F&B and FMCG businesses in China’s Guangdong province, as well as reaffirm our positive view on its China venture, particularly the FMCG segment. We remain positive on the company’s prospects and value the stock at RM2.31, pegged to a 15x FY13 EPS but strongly believe that it could re-rate to 17x-18x forward earnings as soon as next year, powered by Oldtown’s growing overseas business.
Very good turnout indeed. Oldtown’s briefing yesterday was attended by more than 40 fund managers and analysts. The company was represented by Mr. Lee Siew Heng (Group Managing Director), Mr. Clarence D’Silva (COO for F&B) and Mr. Alex Chuah (COO for FMCG).
Kiosks a potential earnings catalyst. We were pleasantly surprised with the artist’s impression of Oldtown’s kiosk outlets although such a concept is not new. The company intends to launch its first kiosk this month or next in the high-traffic malls of KLCC and Mid Valley Megamall, targeting working adults aged 20 to 40 years. This business model can be adopted in countries where mall rental rates are high, such as Hong Kong, and can potentially fuel the company’s earnings as the payback period is estimated to be as fast as 12 to 18 months.
What we saw in Guangdong. We recently brought the company’s top management on a non-deal road show in Hong Kong and also took the opportunity to extend our visit to examine the progress of its FMCG and F&B businesses in Guangdong, China. In this report, we share with investors what we saw as well as our views on its business expansion there.
Maintain BUY. All in all, we reiterate a BUY recommendation on Oldtown, premised on the company’s consistent top- and bottom-line growth. The stock is valued at at RM2.31, pegged to 15x FY13 EPS but could re-rate to 17x-18x on forward earnings next year. Our forecast is that its overseas business will contribute more than 30% of group earnings compared with the current 24% portion, underpinned by its FMCG business.
OTHER HIGHLIGHTS
3QFY12’s earnings likely to be subdued. To recap, Oldtown’s 2QFY12 revenue grew 11% q-o-q owing to stronger sales in its FMCG division (+19.0% q-o-q). However, the company’s 3QFY12 earnings may be subdued since the period coincided with the Ramadan month, during which its F&B business typically experiences a seasonal slowdown compared to other quarters. We understand that its ‘Rendang Delight’ menu could not lift the per store average as much as management had targeted. All in, the company will probably register earnings amounting to about RM8m-RM9m for the upcoming quarter.
Kiosk business potentially the next big catalyst for 2013. Oldtown intends to launch its first kiosk this or next month in KLCC and Mid Valley targeting the working adults of 20 to 40 years old. The kiosks will focus on the take-away or walk-through market in the morning and during lunch hours. Given the company’s F&B experience, we guesstimate that the payback period could be as short as 12-18 months, assuming an average daily revenue of RM3,500-RM4,000. As the capex to set up such a kiosk is minimal (estimated at between RM200,000 and RM300,000), the costs involved in winding up such an outlet not impact the company all that much should the venture fail.
A possible launchpad into new markets. If this business model is success in Malaysia, it could also potentially be adopted in countries with high mall rental rates such as Hong Kong. This represents a major development as Oldtown’s central kitchen in Foshan in Guangdong is well-positioned to support the business by minimising logistics costs compared with exporting directly to Hong Kong. We like the concept as there is a very low possibility of it cannibalising the business from Oldtown’s café outlets, since both types of outlets serve different customer segments.
Halal certification a boost to growth The company’s efforts to obtain halal certification from JAKIM are on track to be completed by 4Q12. Once Oldtown receives full certification for its outlets, it could well beef up its same store sales growth (currently at 1%-2%), as its existing outlets could widen their reach by catering to Muslims, who make up more than 67% of the country’s population.
Halal certification a boost to growth The company’s efforts to obtain halal certification from JAKIM are on track to be completed by 4Q12. Once Oldtown receives full certification for its outlets, it could well beef up its same store sales growth (currently at 1%-2%), as its existing outlets could widen their reach by catering to Muslims, who make up more than 67% of the country’s population.
Drawing institutional investors. The proportion of institutional shareholders in Oldtown shares has increased tremendously over the past nine months. As shown in Figure 7, Oldtown International (its holding company) owns a 50.1% stake, followed by 19.7% by foreign funds, 14.7% by local funds and 15.5% by retail investors. We believe this is due to the rush to ride on the growth in coffee consumption in Malaysia and China.
Good response to road show. During our recent non-deal road show to Hong Kong, we showcased the company to more than 10 foreign investors. The company was represented by Managing Director Mr. Lee Siew Heng and COO for its F&B division Mr. Clarence D’Silva. The questions raised centered on the expansion plans for the group’s F&B division locally and regionally. Investors were also keen to find out about its overall F&B and FMCG expansion plans in China.
What we saw in China. We extended our stay after the Hong Kong road show and hopped over to Guangdong in China to conduct a survey on Oldtown’s FMCG and F&B business. In the following part of this report, we describe what we saw during our visits, as well as our views on its expansion progress there.
What we saw in China. We extended our stay after the Hong Kong road show and hopped over to Guangdong in China to conduct a survey on Oldtown’s FMCG and F&B business. In the following part of this report, we describe what we saw during our visits, as well as our views on its expansion progress there.
OLDTOWN’S FMCG BUSINESS IN GUANGDONG
The hype on hypermarket potential. To substantiate our positive view on the company’s FMCG business in China, we visited three hypermarkets - Jusco, Carrefour and Walmart – to gauge the shelf space taken up by Oldtown’s products in China, specifically in Shenzhen and Guangzhou in the Guangdong province.
Our conclusions:
i) The FMCG business in China’s hypermarkets seems very competitive, as we found more than 15 coffee brands on the shelves in those outlets visited.
ii) In terms of shelf space, Nescafe leads the pack by far, followed by Maxwell House. This is hardly surprising as both brands have been present in China for over 20 years. Nonetheless, Oldtown’s products were positioned at eye level despite it being a relatively newer brand. This indicates that its sales should be positive as hypermarkets tend to accord FMCG producers favorable display positions and shelf space (especially at the eye level) only if their sales are brisk.
iii) Oldtown prices its product at a premium to most brands, including Maxwell House and Nescafe.
The hype on hypermarket potential. To substantiate our positive view on the company’s FMCG business in China, we visited three hypermarkets - Jusco, Carrefour and Walmart – to gauge the shelf space taken up by Oldtown’s products in China, specifically in Shenzhen and Guangzhou in the Guangdong province.
Our conclusions:
i) The FMCG business in China’s hypermarkets seems very competitive, as we found more than 15 coffee brands on the shelves in those outlets visited.
ii) In terms of shelf space, Nescafe leads the pack by far, followed by Maxwell House. This is hardly surprising as both brands have been present in China for over 20 years. Nonetheless, Oldtown’s products were positioned at eye level despite it being a relatively newer brand. This indicates that its sales should be positive as hypermarkets tend to accord FMCG producers favorable display positions and shelf space (especially at the eye level) only if their sales are brisk.
iii) Oldtown prices its product at a premium to most brands, including Maxwell House and Nescafe.
The significance of shelf-space positions. As previously noted, Oldtown products enjoy prominent shelf space despite being a new brand in China, an important point since shelf space may well be the most precious real estate in the consumer-retail value chain. Regardless of how good the product design is, the shelf is the point where the consumer meets the retailer’s brand and product. We believe that Oldtown’s strategic eye-level shelf space may be a crucial factor for its growth in China via hypermarkets.
No presence in Shenzhen’s Walmart, to our surprise. Oldtown’s products are distributed in Walmart’s branches all over China, except in Guangdong as the province’s Walmart outlet is managed by a different party. Oldtown’s management is in the midst of negotiations to rectify this shortcoming.
A good start, but more needs to be done. Oldtown currently distributes its products in three regions in China: i) the northern region of Beijing and Tianjin, ii) the central region, in Shanghai, Jiangsu and Zhejiang, and iii) the southern region, being Guangdong. As shown in Figures 10 to 25, our positive view on the company’s FMCG business in China is reinforced by its accorded prominent shelf space and increased sales in the country (+68% y-o-y in 1HFY1). While we think that the company has had a good start in China, it still needs to ramp up its on-the-ground sampling activities to maintain the growth momentum. Its appointed distributors are expected to increase their stock of Oldtown’s coffee products next year when the company’s new factory is completed.
OLDTOWN’S F&B BUSINESS IN GUANGDONG
Prominent locations. The company opened its first China outlet in Nov 2011 in Guangzou’s UU Park shopping mall, located in a commercial district where the likes of Hyatt and PricewaterhouseCoopers are found. Its second outlet, located in the Yi Tong building, opened in March while its third outlet was launched in a prominent commercial area in Shenzhen last month.
Based on our surveys, we arrived at the following conclusions on Oldtown’s F&B business in China:
i) The customers at its cafés are largely consist of families and the younger generation.
ii) Its branding and outlet image in China is consistent with that in Malaysia.
iii) It does comparatively better business during lunch and dinner.
Four outlets by year-end. The management plans open about four new outlets in China by year-end. Currently, as all sauces and raw materials that the company uses for food and beverage are shipped from Malaysia, the management has been less aggressive so far this year in expanding its outlets. It prefers to aggressively roll out its outlets once its central kitchen in Foshan is ready for full operations by early 2013.
High acceptance level for its products in China. During the analyst briefing, we further discovered how well-accepted Oldtown products offered in its café outlets in China are. Its management clarified that the acceptance level is very high, with strong sales recorded for products like laksa and nasi lemak. They also added that the lunch and dinner segments are doing very well but more customer awareness is needed for its breakfast segment.
VALUATIONS AND COMPARISONS
PE re-rating in the cards. Oldtown is currently trading at a 2.8% discount to its local peers (in terms of FY13 PE ratio) and a steep 29.5% discount to its global peers (in terms of FY13 PE). The stock is currently valued at a 15x FY13 PE. However, we strongly believe that the stock could trade in the 17x-18x forward earnings range as early as next year, in line with its regional peers, as its oversea business register higher contributions by next year.
Maintain BUY. All in all, we reiterate our BUY recommendation on Oldtown, premised on its consistent top- and bottom-line growth. We value the stock at RM2.31, pegged to 15x FY13 EPS, but strongly believe that it could rerate to 17x-18x forward earnings next year as the earnings contribution of its overseas business rises to an estimated 30% versus 24% currently.
The potential upside to our view lie in:
i) Obtaining full halal certification from JAKIM to penetrate the Muslim market.
ii) Stronger-than-expected rollout of outlets.
iii) Better-than-expected volume and revenue growth in domestic and overseas operations for both the F&B and FMCG segments.
iv) Better-than-expected margins due to cheaper raw material prices.
The downside risks to our view are:
i) The inability to secure new store sites when the company needs them in tandem with its expansion plans.
ii) A slowdown in volume, weaker consumer spending and heightening competition.
iii) Lack of consistency in the quality of café outlet food and services.
APPENDIX 1 - CONSTRUCTION OF OLDTOWN’S NEW MALAYSIAN FACTORY IN IPOH, PERAK,
Construction to complete by 4Q12. Oldtown plans to centralise all its manufacturing facilities in the Tasek Industrial Estate to achieve optimum efficiency, allowing it to consolidate its administrative functions and logistics in a single location. The plant, when completed, will boost its production capacity for instant coffee mix and instant tea mix to some 27,729 tonnes per year. We are forecasting for the company to only boost annual capacity by 2x, or about 15,840 tonnes, next year to incorporate a gestation period before the plant becomes fully operational.
APPENDIX II: A BRIEF SUMMARY OF CHINA’S HYPERMARKET INDUSTRY
China - a retail breeding ground. In the past decade, the hypermarket culture has successfully wooed China with its low prices and one-stop shopping concept. In line with this, the Chinese grocery sector has had undergone rapid y-o-y expansion in line with the country’s GDP growth. As a result, international retailers are flocking to China to capitalise on this trend.
Hypermarkets vs supermarkets: Out with the old, in with the new. The key difference between hypermarkets and supermarkets is in product diversity. Supermarkets offer daily consumables and staples that are consumed as part of the daily diet, while hypermarkets stock all that is available in a single location, including furniture, electronics, computers, apparel, etc. From 2001 to 2007, supermarkets had lost almost 10% of their market share to hypermarkets. Thus, Oldtown could grow its consumer base by targeting distribution in hypermarkets instead of traditional supermarkets.
The hypermarket industry, being relatively new, is pretty competitive. Sun Art Group and Walmart Group are the two international groups who are the market leaders in China’s hypermarket sector, with 8.1% and 7.7% market shares respectively. However, local competitors such as CR Vanguard Group are also holding their ground, commanding 6.7% of the groceries’ market share.
Impact zones in second- and third-tier cities. First-tier cities have been the most impacted by hypermarket growth. However, there is ample opportunities in second- and third-tier cities as these areas are projected to see the most rapid growth in the upcoming years. Hypermarkets are progressively growing their market shares in these areas - 37.9% and 37.2% market share in Hangzhou and Shenzhen respectively in 2011. This said, Oldtown can capitalise on this by using hypermarkets as a vehicle to establish a presence and grow its consumer base in these second- and third-tier cities.
Source: OSK
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