INVESTMENT MERIT

We call a “Trading Buy” on BJFOOD with a fair value of RM2.15. We are upbeat with the breaking even of KRR, postdisposal of its Indonesian unit in FY18, which previously dragged group earnings with operating losses of RM9m/year on overheads overrun. Furthermore, Starbucks continues to expand its base, banking on drive-through outlets. Declining coffee prices could eventually translate positively to margins.

Cutting the chicken fat. In Nov 2017, the group disposed its entire 51.0% stake in PT Boga Lestari Sentosa, Indonesia, which developed the Kenny Rogers Roasters (KRR) chain there. The segment suffered poor customer take-up while over-expansion led to overhead costs overrun, resulting in an average operating loss of c.RM9.0m between FY15-FY17. A one-off restructuring exercise expense of RM15.4m was incurred in FY18 to facilitate the disposal. Adding to the trimming of less-profitable locations, from 93 stores in FY15 to 77 stores in 3Q19, the brand is seeing a sustainable turnaround from its leaner structure, having already broken even at the operating level in 3Q19. New concepts (i.e. KRR Express grab-and-go stores, walk-through diners) and offerings (i.e. fried chicken, nasi lemak) are the steps taken to reinvigorate customer demand.

Serving more cups. The Starbucks coffee chain contributes to c.80% of group sales, predominantly operating in Malaysia with an estimated 282 stores and 4 stores in Brunei as of 3Q19. More strategic openings are in the pipe-line, at high-traffic locations such as new public transport hubs and stations as well as drive-throughs (currently at 42 stores) at highway rest stops. The brand previously faced cost pressures impacted by high commodity prices and strengthening of foreign currencies. We expect these factors to ease following their respective recovery in the near term.

Cheaper beans to brew. Coffee beans make up the largest of the group’s raw material commodity, attributed to the high sales portion from Starbucks. Recent Arabica and Robusta price trends demonstrated a CYTD decline of c.10% (Source: Bloomberg). We gathered that the group sources its beans from Starbucks Corp., US (SBUX) for quality control, but are also priced at slightly above market rates. Hence, there could be a lag in improvement of input costs, which means that the benefit could only be seen in the medium term.

Earnings forted by more stores. We anticipate near-term prospects to be led by store base growth, with 25 new Starbucks stores and 3 new KRR stores per year. For Starbucks, same-store-sales growth (SSSG) could improve to 3% in FY19/FY20 (from 2% in FY18) from its effective penetration into newer locations. KRR’s SSSG could ease to 1% (from 6%), but this is attributed by the consolidation of its restaurant business. Meanwhile Jollibean Foods, Singapore could persist to record thinning losses as it restructures its staff count and store base. Overall, we anticipate FY19/FY20 to register revenue of RM688.8m (+8%)/RM762.3m (+11%) with PATAMI of RM32.3m (+95%)/RM39.3m (+22%), led by: (i) growth in the group’s storefront and store sales, (ii) leaner operating cost environment, and (iii) cheaper input prices.

We call “Trading Buy” with a FV of RM2.15. Our TP is derived from a 20.0x FY20E PER, being the stock’s 2-year Fwd. PER average, a period post-PT Boga’s disposal. The valuation is at a slight premium to OLDTOWN’s implied 19.0x Fwd. PER privatisation valuation, granted by its: (i) strong international brand equity, and (ii) wider outlet base. We also gathered that consensus valued SBUX at c.25.0x Fwd. PER. This puts our BJFOOD valuation at a 20% discount, which we think is still reasonable. While SBUX commands a higher ROE of c.40% (vs c.10%) and stronger average net margins of 13% (vs. 5%), BJFOOD could offer better dividend returns at c.4% (vs. c.2%).

Source: Kenanga Research - 16 May 2019