0703.HK - Future Bright Holdings

[theasiareport]

From the footnotes:

 

"As at 30 June 2014, all the secured bank loans of

HK$340.2 million (31 December 2013: HK$346.8 million)

of the Group contained a covenant that Mr. Chan and his

associates had to hold not less than 37% (31 December

2013: 40%) equity interest holding of the Company.

 

The unsecured bank loans with maximum facility of

HK$75,000,000 (31 December 2013: HK$75,000,000) of

the Company contained a covenant that Mr. Chan and his

associates had to hold not less than 37% (31 December

2013: 40%) equity interest holding of the Company."

[yadayada]

Asiareport what are your thoughts on the company? Find any flaws in the previous points i made?

 

That covenant is probably in there so the CEO will keep an eye on quality control?

[whistlerbumps]

Does anyone have thoughts about the success of the Hengqin project?  It is a huge investment for the company (total cost HKD 1.1bln) vs. current EV of 0.9bln.  Definitely could be a material risk for FB if it does not succeed. 

[Guest chai]

Hengqin is too early to make a call, and from what I understand, it's really a long-term play (for next 10++years).

The bigger risk that I see in this company is really the Key Man risk and the associated political risk.

 

Ultimately this is a F&B business, which is notoriously competitive with no barriers of entry. The only edge the Company has is its exclusivity within the large casino complexes (which I believe are on 5-year lease contract).And I think it is fair to say that the key (if not only) reason why the Company manage to secure these leases are largely due to the founder CEO's connection/ network. The Co manages such a diverse range of cuisines and doesnt have any single strong brand, unlike Tsui Wah or a typical QSR...

I cannot see any reason why the casino operator would not lease the restaurants space to other players upon lease expiry if the CEO is no longer around - for whatever reason..

 

It also seems that the CEO is somewhat involved in local politics?

If he loses out in a political struggle - and I think it is fair to say that in China, it's really a game of throne - just look at Bo Xi Lai and his allies etc, will/can this Co survive in the longer term? Too many such "politically"- linked companies (with pristine balance sheet, strong growth prospect) in China that went down...

[whistlerbumps]

I agree... Here's the way I see it...

 

Positives- long-term Macau growth due to new hotel supply, Hengqin upside optionality, Optionality from industrial catering/souvenirs business

 

Negatives- Sustainability of current very high F&B margins, Hengqin development & execution risk, key man/political risk, regulatory/macau risk....

 

 

On a different note, has anyone had success speaking to IR at FB?  I have emailed them but haven't heard back and am curious as to whether they actually speak to investors. 

[yadayada]

I think valuation is more then compelling. If Hengqin is a failure, they dont get new catering and margins get squeezed 10-15% (which would mean an even higher pay increase), it should still  be worth more assuming a conservative valuation.

 

If they finish building their 50k sq ft building, and get 5k$ per square feet for it if they would sell, then that building should be worth 2.88$ per share alone (this is current market valuations of transactions in that area). The fact that they paid so little for that land is basicly a subsidy from the government. If it is a failure, it is still probably worth more then 1$ per share. Even with no new contracts and margin squeeze, the food business is probably worth 1.5$ per share (assuming 95m in  earnings with a 11x multiple, a 35% decline in earnings). The yellow building is worth about 75 cents. So in a worst case scenario where non of the upside happens, hengqin is a failure, and margins get squeezed, that should get you 3.25$ per share.. Let's put a big fat 25% discount even on that, and we get 2.5$ per share, or about 25% upside in the bear scenario.

 

Any of those things do work out, and shares should be trading at 6-7$ at the very least.

 

So I wouldn't say those things you mentioned are real risks. Id say actual downside risk from current valuation is

 

1. minority holders get screwed, giving a large discount on assets, in combination with:

2. food business declines and they get no new contract renewals.

[whistlerbumps]

Can you elaborate more on how you are valuing Hengqin?  Are you including the cash outflow from Future Bright for land acquisition and development?

 

With 50k sq mtrs at 5k per sq mtr, I see 250mln of value using your numbers.  However, they will have to spend 260mln to acquire the land and then ~850mln to develop the site for a total investment of 1.1bln (as they have disclosed).  Thus, if your 50k and 5k is right, then isn't Hengqin a significant loss (~-1.00 per share) for FB? 

 

Apologies in advance if I have misunderstood your analysis.

 

[yadayada]

oh Sorry my assumptions were USD. I converted to HKD, i guess that was kind of unclear. so 5kUSD per sq meter. Current property prices average about 25-30k yuan/sqm, that is about 30k hkd. Or a value of about 1.5bn hkd if property prices stay the same. I got the sq ft and meter mixed up in my last post too. So that is Sq meter not Sq feet.

 

1.1 billion hk$ will be put into the project. They got a mortgage and about 900m$ of cash now. They will generate likely another ~150-200m$ this year alone from operations. So if you take value 2-3 years out with same value per square meter, I get 2.16$HKD share for Hengqin alone. valueing the food business at 1 billion hkd (assuming earnings get a big squeeze), that is 1.44$, and about 0.75$ for Yellow house. That is 4.35$. And this is being pretty pessimistic about their food business, which i think is not really warranted.

 

If you read red's posts about it (and the comments) he explains it much better then I do.

[whistlerbumps]

OK.. so I see 50*38.75 HKD=1.9bln - 1.1bln cost = 840mln net value or 1.2 per share in that scenario.  Do you disagree?

[yadayada]

OK.. so I see 50*38.75 HKD=1.9bln - 1.1bln cost = 840mln net value or 1.2 per share in that scenario.  Do you disagree?

well they have 600m$ in net cash now. And im using value of 2 years in when everything is cleared up most likely and there is no confusion about the risks. So in my assumption there is no net cash position, and the value of the total project.

[whistlerbumps]

OK.. I was only considering Hengqin.

 

Re Cash, I am not sure how comfortable I am giving them 100% credit for the cash for a couple of reasons

 

1) the banks are requiring them to overcollaterize the loan with cash (at 12/31/13 207mln of bank deposits were being used to secure 200mln bank loan- note 22).  While I understand that some level of security is normal in this market, why is the level pledged bank deposits over 100%? 

 

2) Management decided to raise 260mln this summer despite having almost 300mln of net cash already on the balance sheet and a business that just generated 200mln of FCF.  Might some of this cash be required for ongoing operations (perhaps to be considered well capitalized by their F&B customers) and not available for projects like Hengqin? 

 

 

Appreciate the dialog and hope I am not annoying you too much with my questions/thoughts.  I agree there are some interesting elements here but there are definitely some risks that I am not comfortable with yet. 

 

 

 

 

[yadayada]

I dont know, maybe because they can pay lower interest then? I think what is likely, they will sell a % of the Hengqin project to a developer. So with the current net cash balance they will pay all the costs easily. So 2 years from now, they likely have a net cash position + 2/3 of a hengqin piece of real estate .

 

On the other hand, if earnings would double with succesful restaurant openings and 1-2 catering jobs, and real estate prices rise in hengqin if investment heats up there, the shares could be worth 10$. Let's say 1.7 bn$ for 70% of heng qin (assuming 6k USD /sqft). 350m$ in earnings = about 4 billion$. 500m$ for yellow house and 3-400m$ in net cash (or dividend payments). That is about 9.3$ per share. So seems like you get a huge margin of safety here. Huge upside with no risk (?) at current price. Gotta love the hong kong stock market!

 

If you read Red's analysis, he thinks earnings could go up to over 1 billion , in that case upside is probably closer to 20$. But let's wait and see before that happens.

[Guest chai]

Q4 result is out.. Gross Operating Profit for FY2014 is expected to be 249.2m vs 271.8m in FY2013...

 

"The Board wishes to inform the shareholders of the Company and potential investors that based on its management information currently available, the Group will record a considerable decrease in profit for the year ended 31 December 2014 as compared to the year ended 31 December 2013."

 

"The gross operating profit, being gross margin less direct operating expenses, of the Group for the Fourth Quarter was about HK$44.4 million, representing a decrease of approximately 39.8% as compared to the fourth quarter 2013 of HK$73.7 million. The gross operating profit margin for the Fourth Quarter was about 19.5%, a decrease in about 16.5% compared to the fourth quarter 2013 of 36.0%. Such decrease in gross operating margin in the Fourth Quarter was attributable mainly to the increase in direct operating expenses related to the newly opened restaurants at Huafa Mall, Zhuhai and the continuous loss incurred by the food souvenir business in that quarter."

 

"Management believe that in the coming first half of 2015, the Group’s operating environments would remain quite challenging, and the Group would be cautious to monitor the development of its food souvenir business and franchise restaurant business. "

[whistlerbumps]

I actually didn't think the Q4 result was that bad compared to my expectations.  Annualize Q4 GOP less property revenue is 150mln of GOP.  Remove admin expenses of ~106mln (TTM H1) generates 44mln of EBIT including the losses from the start up restaurants and food souvenir.  Haircut cash and investment property by 20% and  Hengin by 30% and its worth ~1.25 per share in a very conservative scenario. 

 

Upside comes from one of multiple options 1) F&B EBIT growth due to recovery/new restaurants, 2) Hengqin success, 3) Industrial Catering Growth, 4) Food souvenir growth (or at least stemming the losses).

 

Success of some of these options could easily drive the share price over HKD 5 vs 1.25 on the downside so the risk reward appears pretty attractive albeit volatile at HKD 2.  Thoughts?

 

PS- one option for the cash/debt question is currency related.  It could be that all the cash is RMB but the company wants HKD liquidity for dividends etc.  That could explain why they have borrowed with 100%+ collateralization.  Have not been able to confirm with the company yet.

[yadayada]

I think 1.25 downside is extremely conservative. That would assume their F&B business is wiped out overnight. If you add back one time advertising of 40m$, and some one time costs this year and assume that they get their souvenir business to breakeven that business still does 150m$+ in FCF.

 

I think the stock should be at 3.5$ at the very least. Let's see how it plays out in the next 2 years. Some big casino openings coming up.

[whistlerbumps]

Agree that its conservative as it assumes that they will continue to lose money in souvenirs/new restaurants at a similar level forever.  The counter point is that there may be more downside for their core restaurant profits if Macau continues to slow through H1 15 (which they suggested was possible in the PR).  Net-net my point was that even with very conservative analysis, the risk-reward seemed attractive.

[Laxputs]

I'm still very excited for the long term prospects of this company. Their footprint has now doubled from 133'179 sqft 2013 to 277'102 sq/ft 2014. Lots of that was 2h14 and it can take a year to ramp up a new restaurant.  That does not include the Food Souvenir shops they opened in 2014 that are currently loss making.

 

MOS: I see 1.10$/share is non-core assets (cash/equivalents and investment properties) that could be liquidated. I've assumed they need 25% of cash on hand for normal operations and they liquidate the Inv Prop at a 25% discount--so I'm being conservative. The remaining equity stub would be trading at 50 cents/share based on the current 1.60 share price.  Suppose a 6x multiple on 2012 net ordinary operating profits of .18/share and the new "core" equity should trade at 1.05/share. Add in the non-core liquidation and you have 2.16/share. To me this is the MOS, worst case scenario--35% above today's price. And their footprint is now over 2x the 2012 footprint.

 

When I add together a base case Food and Catering, Food Souvenir breakeven, Food Wholesale, Property Rental, Hengqin at acquisition cost I get 308$ Net Income.  10x on that is 4.80$/share. But likely Industrial Catering or Hengqin contribute more and the margins on their current operations I've assigned are too conservative. I think 8$/share is very reasonable over the next couple years.

 

I see large upside and protected downside. 16% holding.

[60North Investments]

I share the views of Laxputs. It's now trading at a p/e of 6.5 and ev/ebit of 4.5 if you deduct $130m paid for Hengqin in January. H2 was disappointing, same store sales were down 7%. They'll continue ramping up more restaurants, food courts and food souvenir shops in the coming years. In H2 alone they opened 135k sq.ft. of restaurant spaces, a massive increase as Laxputs said. Capex was $27m in 2013, versus $186m in 2014. Gross margin % was slightly up in 2014 to 73%, so they haven't at least discounted the foods.

 

I'm especially looking forward to the sales figures of food courts in 2015. They now have 21 of them, 19 new ones in H2. For the past three years, sales from food courts have been $60m, $62m and $65m, which I find a little puzzling. In 2014 they had 21 food courts, 2013 it was 2 and 2012 10. I'll be interested to watch whether those 19 new ones will be delivering decent sales in H1 or not.

 

Also, management stated that Hengqin's foundations will be laid in the end of 2015. The whole building process may take up to 3 years, and they will "in due course find appropriate partners to participate in this proposed investment".

[Laxputs]

On their balance sheet: "Investment Properties". Is that the building they are leasing out and Hengqin? Or just one? Others?

 

TIA

[Genyi]

For the past three years, sales from food courts have been $60m, $62m and $65m, which I find a little puzzling. In 2014 they had 21 food courts, 2013 it was 2 and 2012 10.

 

Those are food court counters, not whole food courts. Food court counters have a high variability in sales, depending on the quality/price of the food they sell, size, the location within the court, competition with nearby counters, etc. Yet, the lack of correlation you point out is a bit puzzling indeed.

 

For those who missed it, FB released a document on 16 march, which seems to be most of the coming 2014 annual report, but without the pretty pictures....

 

http://fb.etnet.com.hk/ca-calendar-e.html

[heisenberg]

i think my main issue with that stock is that their profit margin is going to get squeezed dramatically in 2015 compared to 2014.

Let me explain :

On one side the wages are going up :

when walking in Macau you can see that restaurants are struggling to hire employees ( jobs ads on their door )

unemployment rate is now 1.7% and new casinos are expected to open soon building up the pressure on wages ( already trending 5-10% up )

On the other side, revenues are going down as F&B are highly correlated to the casinos GGR which are dropping 30-40% yoy

 

Scissor effect for the margins in 2015...

 

Cash on balance sheet = be suspicious in Asia if it builds up with no plan to return it to shareholders

Prime real estate = some pure listed properties play are trading at 50% nav so apply a safe discount on it

Plus on the Hengqin land they bought at the top, they are likely to take a hit in mark-to-market on their book value. It is still the no man's land that I saw a few years ago, no life in sight except mosquitoes

 

Happy to kick off a real discussion and be proven wrong

 

[yadayada]

Allow me to explain why I think those are not really issues

 

1. wages are only a smallish part of their costs, even with dramatic increases, it would still only raise total costs by a few %. And even if costs go up a lot it doesn't matter as the company is so cheap. Besides unlike casinos they can attract foreigners, and connections to mainland China will improve over the next few years. If you take out one time costs (like ~50m one time marketing and some opening costs) they will make 180m-200m$ this year. Even if you squeeze that by 100m$, that is still cheap. If you look at personel costs, you would need to see a large drop in revenue, and a very large pay increase (large double digit %).

 

2. F&B is more correlated with amount of visitors (aside from the few high end restaurants they operate). And # of visitors rose by 8% in 2014, and seems to be steady so far in 2015. There were even complaints that the large number of visitors were hurting quality of living. Most of the drop in revenue to casinos was high rollers, and they dont make up a large part of income (because there are not that many of them) to F&B. And if anything Macau has reached a limit of the number of visitors they can take (due to space and overbooked hotels, which will be fixed).

 

3. cash on balance sheet, they do have real plans, they will invest it in their recently acquired plot in Hengqin over the next 2-3 years. And prospects on Hengqin look more on the positive side. They also got this land quite cheap due to basically a subsidy, so it will probably be worth more each year with the amount of investment this area has attracted so far. I think they have about 700m$ on the balance sheet right now, and likely most of that will be invested in their Hengqin project. I think they have this cash balance to get leverage for when they sell a % of this project to a developer.

 

4. A lot of property companies dont treat minority holders well, and dont pay out a whole lot of money. And they have weird structures and hoard cash without investing it, and have a lot of real estate in mainland China with shakier prospects. But FB has paid out 30% of earnings, and seems to treat shareholders better, so discount will be smaller. And there are no weird Matryoshka structures.

 

And I think long term prospects are really good. Penetration rate from mainland is really low compared to Las Vegas, Chinese love to gamble, and disposable income will grow in double digit % for some years to come. And Macau is only place to gamble, while Vegas has many competitors throughout the US.

 

If you look at tourism spending in China, GDP has doubled between 2008 - 2012, while tourism spending as a % of GDP went from 2.8 to 4.4%. So tourism spending almost quadruppled. So there is a sizabe amount of leverage here once GDP reaches a certain level. Even GDP only grows 20-30%, disposable income will rise much faster. Also the number of casino resorts per person in Asia is really really low compared to the United States. Plus new infrastructure and entertainment making Macau much more attractive and easy to reach.

 

And you can profit from that growth potential, buying the company for little over 5x 2013 earnings under NAV! So you dont even need growth to do well here imo.

[Guest chai]

2. F&B is more correlated with amount of visitors (aside from the few high end restaurants they operate). And # of visitors rose by 8% in 2014, and seems to be steady so far in 2015. There were even complaints that the large number of visitors were hurting quality of living. Most of the drop in revenue to casinos was high rollers, and they dont make up a large part of income (because there are not that many of them) to F&B. And if anything Macau has reached a limit of the number of visitors they can take (due to space and overbooked hotels, which will be fixed).

 

My impression is that almost 50% of their revenue still came from their high-end Japanese restaurant chains Edo - which if you do a google search, you will see a number of increasingly unfavourable review in particular of their service standard(from sites like TripAdvisor which I presume would be quite reliable) ...

The correlation between high roller and Future Bright's business is probably higher than many people realise..

 

Further - I am not sure how exactly a steady growth in tourist spending on Macau F&B would directly benefit Future Bright.. Yes they are opening more restaurants but given the high competitive characteristics of any F&B business (as  they start entering into mass markets) - it is hard to see how they can continue maintain their existing margin (which is primarily derived from the high-end restaurants located within casinos).. Bruce Greenwald summed it up well: a non-franchise growth has not value at all..

KSW_703_020215_71840.pdf

[yadayada]

I think part of japanese restaurants are other franchises as well, about half I think as of 2013.  Also it is not like their profit will dissapear now, simply margins are compressed.

 

Also their footprint doubled, and they had one time costs, and footprint of Japanese barely went up. Even if margins are cut, removing one time costs they will make close to 200m$ once new places start ramping up. And 150m$ if they add nothing and if food counters lose money. They will have a 500m$ building generating steady FCF, and their Hengqin stuff which could be worth well over 1bn$.

 

So apply a 8x multiple on 150m$ (just to be really really conservative, assumes all their new footprint breaks even and EDO does not recover) add 500m$ and add about 800bn$ remove 300m$ of debt, and you get a 2.2bn$ valuation, more then double. I dont think anyone is arguing that their core business is the best thing ever, but add in some steady new catering gigs and I think the company is very mispriced.

 

Also I dont think highroller gambling will stay low forever. I think it will recover at least partially at some point. I mean I dont care what happens this year, as long as what happens 2-3 years from now is positive.

 

And there is huge optionality, catering could add a whole lot, if traffic goes up in Macau area it must positively impact FB, if higherroller stuff recovers, etc. Food counters are a success. Even if only one of those things happen, upside gets boosted a lot. Net income could easily go to 4-500m$ in a few years.

 

So even with pretty pessimistic assumptions, and then putting a big discount on that you get upside here. Tsui wah is probably higher quality, but then your paying 20x earnings and several multiples over NAV vs 5x earnings here and below NAV.  It is priced like it is rapidly going out of business!

[whistlerbumps]

I will wade into this with my thoughts as well...

 

1) To me, the key issue is the F&B margins.  Here is how I calculate H2 14 F&B margins.  I take GOP of 85.9 - Admin of 61.8 - property revs of 14.6= 9.6mln.  To this, I add back 43.8mln of souvenir losses to get an implied F&B EBIT of 53mln, down from 99mln in H1 14.  The question for me, is how much of this margin degradation is due to start up costs of the new restaurants in Q4 14 vs. worsening restaurant performance.  If it is mainly due to the start up costs, then I think H2 15 and 2016 EBIT will start to show a significant rebound,  However, I agree I am worried about the weakening performance of the Japanese restaurants (still ~50% of sales) and the risk that prior margins were inflated due to an abnormally strong period in Macau VIP.

 

2) I am less worried about the valuation of Hengqin.  Research suggests that they got a very sweet deal on this land, most likely due to Chan Chak Mo's connections.  I think the bigger risk on Hengqin is really more the key man risk of what happens to the deal (and to the business at large) if CCM becomes persona non grata in Macau.  If they are able to develop as planned, I think that deal is likely a homerun.  I think this also removes a lot of the squandering of cash risk as they will need it for this potentially high return project.

 

3) I do worry that they will waste a bit of money in the food souvenir business.  Their losses have been worse than expected so far and they show no sign of slowing it down in my opinion.  I think its more of a short/mid term risk than a LT risk though as one would assume that CCM will cut his losses eventually given the way he has behaved.

 

4) Overall, I see this as a stock with decent downside protection and several options for upside (Henqin, F&B expansion/new Cotai casinos, F&B margin normalization, industrial catering expansion, food souvenir business actually works).  If any of them works, then you probably have 100% upside and if multiples work then you start to make a lot of money. 

 

However, if F&B earnings continue to weaken to 50mln annually from 100mln run rate and you put an 6x multiple on it and haircut cash, property and henqin by 25% (so its actually a negative value project due to required capex), then I think its worth HKD 1.

 

Thus you have ~30% downside and various shots on goal at 100% and more upside which seems like an attractive risk reward to me.