520 - Xiabuxiabu

[ccplz]

Don't know if anyone trades Hong Kong, but thought this was an interesting name:

 

Thesis

- Fast casual hotpot chain based in China

- High quality business being mispriced due to temporary headwinds from overexpansion and stock trading at a illiquidity discount and general lack of attention (only trades 300k usd/day)

- Currently free float is only 20% of shares O/S; PE firm owns 32% and will exit following 2016 results which will be catalyst for rerating

 

Xiabuxiabu’s economics are among the very best in the restaurant industry:

 

- ROIC is consistently in the 35-50% range given high level of FCF generation, cash on b/s (currently cash makes up 25% of market cap) and minimal reinvestment needs

- ROE averages above 20%

- Consistently higher gross margins vs. competitors due to bargaining power as the scale player in the hotpot space and best-in-class distribution system and central kitchen

- Pricing power: ASP has increased YoY for the last 4 years despite an increasing number of restaurants opening in lower tier cities

 

The restaurant is rated highly on both English and Chinese websites – the rating for Xiabuxiabu on Dianping, a Chinese restaurant rating app averages 4.5/5, again comparable to Haidilao despite being significantly more affordable, and a cursory look on Tripadvisor shows that their restaurants have good reviews even with Western customers.

 

Market Potential: there are currently ~5,000 KFCs, ~2,000 Pizzahuts and ~2,000 Starbucks in China. The most popular local fast-food chain, Discos, has close to 3,000 restaurants. Both Chipotle and Panera Bread have around 2,000 restaurants in the USA.

 

The number of chained restaurants per 1000 people is significantly below both APAC and global averages:

 

http://i.imgur.com/orEQIMs.jpg

 

The company is currently operating ~550 stores.

 

Growth Initiatives

1. Xiabuxiabu 2.0: a more upscale/modern format of the original concept. 2.0 adds a bubble tea bar which is higher ASP/margin vs. soft drinks/bottled water. The 2.0 menu contains all the SKUs of the original menu at the same price point, but it also adds a number of new, higher ASP, higher margin products (in total 2.0 serves around 100 SKUs vs 80 SKUs for 1.0. Unit economics for 2.0 are vastly superior to 1.0: According to the company, ASP for 2.0 is more than 30% higher vs. the old stores (>65 RMB vs. ~50 RMB) due to better product mix, while turnover is 9% lower (3x vs. 3.3x) as people were staying in the stores longer than before. Based on the performance of stores that have already been converted, the revenue differential between the 1.0 format and 2.0 should be around 20%.

There is evidence that the new initiatives are working - Same store sales for Jan/Feb 2017 came in at around 5% yoy which is a drastic improvement from -4% in 2015 and +0.6% for first half 2016.

 

2. Coucou: a more upscale hotpot concept; ASP for Coucou is 130 RMB vs. 50 for Xiabuxiabu 1.0. The first store opened in Beijing’s Sanlitun district in June 2016. Anecdotally it seems the restaurant is very popular with Beijing locals; ratings and comments have been mostly excellent (see below), with average wait times exceeding 1 hour on Saturdays even 8 months after it opened. The restaurant is operational all-day: it serves Cantonese dim-sum and Taiwanese bubble tea during the period between lunch and dinner, as well as after 10PM. The co. targets annual revenue of 30-50m RMB per store (vs. Xiabuxiabu 1.0 annual revenue of 5-7m/store and Haidilao, a comparable popular hotpot concept at 30m/store). At year end there were 3 Coucou restaurants operational. The company is targeting 6 new Coucou openings for FY 2017, for a total of 9 restaurants by 2017 year end.

 

3. Condiments JV: the company is also investing 10m USD to start a branded condiments business in a 50:50 JV with Chairman Kuang Chi Ho. Kuang will be responsible for selling and distribution of condiments. Strategy / relationship between parent co and sub is similar to the strategy and relationship between hotpot chain Haidilao and public co. Yihai (HK: 1579), although less of subco’s revenue will come from Parentco (compared to Yihai, which is ~50%).

 

Key drivers of growth are: 1) new store openings, 2) improved economics of the 2.0 stores, 3) growth of Coucou and 4) potential of Condiments biz.

 

Valuation

There are very few publicly traded China based fast-food chains. Café De Coral, a HK peer, trades at 14x forward EV/EBITDA. Xiabuxiabu trades at a discount to Yum China (even with consensus numbers) despite being overall a higher quality business with more growth potential.

 

U.S. based peers with similar growth profiles generally trade at 30+x forward P/E multiple and 15-20x forward EBIT.

 

I base my valuation of the company on my forecast of normalized earnings, which takes into account the impact of 2.0 and Coucou on annualized earnings, as well as median EBITDA and earnings multiples of comparable companies in the FnB and consumer space.

These assumptions are meant to be illustrative - actual financials will differ from these forecasts depending on the exact timing of the rollout and the proportion of stores that are converted to 2.0.

 

Key Assumptions (by end of FY 2018, store # is average for the year, RMB in mn)

- 717 total stores, 448 stores converted to 2.0

- 2.0 Sales per Store: 5.56, 1.0 Sales per Store: 4.21

- Store-level OPM for 2.0: 22%; store level OPM for 1.0: 20%

- 6 Coucou Stores, revenue per store: 22

- Coucou OPM: 26%

- Overhead of 140, tax rate: 25%, net other items: 100

- Multiple assumption: 10x forward (2018) EBIT

 

These assumptions result in 8.9B RMB of enterprise value, to which I add 1.36b RMB of cash and investments. The result is an equity value of 10.307b RMB, or 10.92 HKD/share, which implies an upside of 102%.

 

Catalysts – improved liquidity following GA exit + 2016 Earnings

http://i.imgur.com/tSclkEu.jpg

 

Analysts were speculating that GA would sell a part of their stake before 2016 earnings were announced. The fact that they haven’t sold suggests that the results should be good.

 

[awindenberger]

Looks like they just released their 2016 results today: http://xiabuxiabu.todayir.com/attachment/2017032821020100002759627_en.pdf

 

Nice results for 2016 as you predicted. Their overall restaurant operating margin is already at 23%, higher than your assumptions.

 

Current PE ratio of about 16, with cash in the bank equal to 25% of current market cap. They expect to add another 100 restaurants in 2017, a 15% increase to the total base.

 

I must say, this company looks like it could have a massive growth runway, and is trading at a very reasonable price. I wish they had an ADR in the US.

[vegaseller]

There seems to be lots of interesting neglected businesses listed on HK these days. Ccplz, you seem to know a lot about the company, would you care to share some of your views on management?