October 16, 2020

Better Performance From Heartland Outlets

Post-Circuit Breaker Management shared that footfall and sales at Koufu’s outlets in the heartlands have recovered, but downtown and tertiary education outlets continue to be hampered by low footfall. Future growth drivers are contribution from Deli Asia, new outlets, gradual resumption of activities and potential incremental earnings from its master franchise agreement. Given the slower-than-expected recovery at downtown areas and in tourist arrivals, we lower our earnings by 4-10% for 2020-22F. Maintain BUY with 6% lower target price of S$0.73.

WHAT’S NEW

• Gradual recovery for outlets in heartland areas while tertiary education and office areas remain challenging. Management shared that footfall in heartland areas (50-60% of sales) has seen significant improvements post resumption of dine-in services. As such, sales from its outlets in these areas have reached close to pre-COVID-19 levels. Similarly, its full-service restaurant brand Elemen – that was in a breakeven position in 2019 – has seen an encouraging increase in sales in recent months, exceeding pre-COVID-19 levels.

• On the flip side, despite a gradual improvement as the government relaxes work-at-office restrictions, food courts located near offices and downtown areas continue to experience weak sales due to work-from-home measures. Similarly, its food courts in tertiary educations (approximately 10% of total outlets) have been impacted as classes move online. Its outlet at Marina Bay Sands (MBS) continues to be the hardest hit due to travel restrictions. Overall, we understand that the overall occupancy rate at its outlets in Singapore has dipped to around 88% vs 90-94% before, but management shared that the group is actively sourcing for replacements and have secured some new tenants.

• Macau update. With the easing of border restrictions between Mainland China and Macau since Aug 20, Macau saw 227k visitors in Aug 20, a substantial improvement over Jul 20 (74k) but still down 93.7% yoy. The group has recently opened a new outlet at Nova City, Macau (the lease was secured in 2019) which could lead to a slight drag on earnings from the rental expense and depreciation of right-on-use asset in 4Q20. On a more positive note, the group has consistently received rental waivers on a monthly basis since the beginning of 2020 for its Cotai Central outlet. This has helped to ensure the sustainability of stall tenants and the occupancy rate of the outlet.

• Growth drivers in 2021 include contribution from Deli Asia, new outlets and gradual resumption of activities in Singapore. The acquisition of Deli Asia was completed in Jul 20 and we estimate S$2.3m of earnings contribution in 2021, or 9.8% of net profit. We highlight that Deli Asia’s sales has grown in 2020 in spite of the circuit breaker measures. Aherefore, apart from being an earnings contributor, Deli Asia adds resiliency to the group’s portfolio, in our view. In addition, we think outlets near offices and tertiary educations should gradually recover in 2021 as business activities resume and local COVID-19 cases come under control.

STOCK IMPACT

• Government grants to partially mitigate earnings impact in 2H20. To recap, Koufu received S$5.5m worth of grants in 1H20. For 2H20, we estimate further cash grants of S$5m, mainly relating to the Jobs Support Scheme (JSS) should help to partially mitigate earnings impact of harder hit outlets. In addition, the Singapore government announced in Aug 20 that the JSS scheme will be extended for up to seven months, with payouts in March and Jun 21. The food services sector will receive wage support of 30% for seven months. With that, we estimate Koufu will receive cash grants of S$2m in 2021, or approximately 8.5% of 2021F earnings.

• Master franchise agreement in Philippines could provide incremental earnings. On 24 Aug 20, Koufu announced its maiden entry into the Philippines by bringing its Supertea and R&B Tea brands through a master franchise agreement with Shakey’s Pizza which has been awarded the sub-franchisee rights for a seven-year term. The agreement allows the group to collect franchise fees, royalties and marketing fees. Management shared that a co-branding strategy will be adopted in the initial stage/first year before Shakey subsequently expands standalone R&B Tea outlets.

• As part of the co-branding strategy, R&B Tea drinks are sold at 25 Shakey’s outlets and five PERI-PERI stores. This could expand as Shakey’s owns and operates 200 outlets in the country. The selling price is comparable to its outlets in Singapore at PHP110-140 (approximately S$3-4) and management shared that thus far, sales generated by its cobranding strategy has met expectations. We highlight that Philippines tops the list of average monthly bubble tea consumption per Grab Food user amongst ASEAN countries (refer to RHS table). While it is a small component of the group’s business, the business could provide incremental earnings over the longer term, in our view. Furthermore, the master franchise agreement allows the group to tap into a new market without capex exposure, thus limiting downside risk.

• Strong net cash position. Koufu’s cash generation ability has helped it build a significant net cash of S$72m as at end-1H20, equivalent to c.20% of its market capitalisation, providing the group with a large enough cash buffer to weather tough times.

EARNINGS REVISION/RISK

• We lower our 2020-22 net profit forecasts by 10.0%, 6.4% and 4.4% respectively. This comes mainly as we reduce our 2020 revenue by 5.4% on the back of slower-thanexpected recovery in outlets in downtown areas and the potential drag on earnings from the opening of the Nova City outlet in Macau. For 2021-22, we lower our revenue forecast by 6.4% and 3.7% due to the slower-than-expected recovery in tourist arrivals. VALUATION/RECOMMENDATION

• Maintain BUY with a lower target price of S$0.73 (previously: S$0.78), pegged at 17.2x 2021F PE or approximately 15% discount to peers’ average.

SHARE PRICE CATALYST

• Easing of travel restrictions in Singapore and Macau.

• Sale of two central kitchens and special dividend.

BUY by UOB Kay Hian Research.  Share price closed at $0.655.