Potential injection of other F&B businesses. Berjaya Food (BFood) also holds the franchise rights and operates Kenny Rogers Roasters (KRR) in Malaysia, Indonesia and Cambodia via parent company Berjaya Corp (BCorp) (BC MK, NR), which has the global rights to the brand. The latter also holds the franchise rights in Malaysia for many recognisable food and beverage (F&B) brands such as Wendy’s,Krispy Kreme and Papa John’s Pizza. In our view, it is possible for BCorp to inject these other F&B brands into BFood in the future

 

BUY, with a TP of MYR4.00. Our TP (24.6x FY16 P/E) assumes the full dilution of its outstanding warrants. Full-year impact of Berjaya Starbucks Coffee Company SB’s (BStarbucks) consolidation would be felt in FY16. We believe a 10% premium multiple to that of its regional peers is justified as: i) it has a strong 3-year earnings CAGR of 47%, ii) Starbucks Coffee is a strong global brand, and iii) there are growth opportunities from the under-penetration of Starbucks Coffee outlets in Malaysia.

 

Risks: slowdown in consumer spending, currency fluctuation, fluctuation in prices of raw materials and competition.  See page 7 for key risks.

 

Table Of Contents

Investment Summary                   3
  
Valuation                                    4 
 
Key Risks                                    7 
  
Industry Overview                        8 
 
Investment Case                        12 
 
Financial Analysis                        17 
 
Company Background                  22 
 
Appendix                                   24 
 
Financial Exhibits                        25 
 
SWOT Analysis                           27 
 
Disclosure & Disclaimer                29

 

Investment Summary

Starbucks Coffee, the largest coffee outlet chain in Malaysia.  Starbucks Coffee has the largest presence in Malaysia with 175 outlets YTD, followed by its closest competitor,  Coffee Bean & Tea Leaf with less than half the number of the former’s outlets. It is the market leader in the segment with a 38% market share by number of similar outlets. For the past five years, its SSSG has grown by double digits. In FY14, its SSSG of 16% was the highest at  the global level. We believe that  Starbucks Coffee’s earnings are less susceptible to weak consumer spending patterns due to the strong customer loyalty for its products as well as its premium branding.  
 
Under penetration of  Starbucks Coffee outlet in Malaysia.  Malaysia had a Starbucks Coffee outlet penetration rate of six outlets per million people in 2Q14, which is fairly low compared with other developed Asian countries, where the outlet penetration rate is 8-19 outlets per million people. Given the expected rise in household income as well as increasing urbanisation, we believe there is room for 
Starbucks Coffee to further grow in Malaysia.  
 
Potential injection of other F&B businesses. BFood also holds the franchise rights and operates KRR in Malaysia, Indonesia and Cambodia through its parent company, Berjaya Corp, which holds the global rights to the brand. The latter also holds the franchise rights in Malaysia for many recognisable F&B brands like Wendy’s,  Krispy Kreme and  Papa John’s Pizza. In our view, there is potential for BCorp to inject these brands into BFood in the future. 
 
BStarbucks’ stellar performance is likely to continue.  For the past five financial years, BStarbucks’ earnings grew at strong double digits YoY on the back of the aggressive expansion of its outlets, double-digit SSSG as well as higher margins. Moving forward, we expect revenue CAGR of 19.7% over FY15-17F, driven by the expansion of outlets and incremental increase in sales per outlet. We expect its 
earnings CAGR of 20.3% over FY15-17F could be accompanied by margin improvements arising from its economies of scale.  
 
Initiate coverage with BUY.  BFood will likely be on a strong earnings growth trajectory stemming from its Starbucks Coffee arm, following the completion of the acquisition of the remaining 50% stake in BStarbucks. Our TP of MYR4.00 is derived by pegging a 24.6x P/E to its fully-diluted FY16 EPS. We believe its valuation premium is justified given its: i) strong 3-year expected earnings CAGR of 47.7%,    
ii)  Starbucks Coffee’s strong franchise value, and iii)  Starbucks Coffee being the largest coffee chain in Malaysia. 

 

Valuation

BUY with TP of MYR4.00.  We initiate coverage on BFood with a BUY recommendation and a TP of MYR4.00 (rounded)  which represents a 30.7% upside return. Our TP is derived by pegging the group’s fully-diluted FY16F earnings (assuming the full conversion of outstanding warrants) to a 24.6x P/E multiple which is 10% above the regional peer average (see Figure 5). We corroborate our findings 
with a DCF valuation (see Figure 6.) Although we expect the earnings growth of its KRR and Jollibean brands to be flat in the near to medium term, we think BFood will likely be on a strong earnings growth trajectory due to Starbucks Coffee, following the completion of the acquisition of the remaining 50% stake in BStarbucks.  

 

A premium of 10% over its ASEAN peers. Per Figure 5, the 24.6x P/E multiple we used implies a 10% premium to its regional peer average of 22.4x FY15 P/E. We believe BFood deserves a premium given its:  
i)  Strong 3-year expected earnings CAGR of 47.7% (in Figure 5 below the 3-year EPS CAGR column shows the historical rates; See page 18 on “Consolidation of BStarbucks to drive 47.7% 3-year earnings CAGR in FY14-17F”);  
ii)  Starbucks Coffee’s strong franchise value; and  
iii)  Starbucks Coffee being the largest coffee chain in Malaysia whereby in FY14, its SSSG was 16% - the highest at the  global level. The  ascribed 24.6x P/E implies an undemanding price-to-earnings growth (PEG) of 0.52x.

Corroborative valuation through DCF.  We used conservative estimates, a weighted average cost of capital (WACC) of 8.8% and a terminal growth rate of 2.5%, to derive a TP of MYR4.00 through a DCF method. Our DCF-derived TP implies FY15/FY16/FY17 P/Es of 45.4/24.6x/20.9x on a fully-diluted basis. In Figure 7 we show a sensitivity analysis.

 

P/E rose to its peak since listing. After it announced the acquisition of the remaining 50% of equity interest in BStarbucks from Starbucks Coffee International (SCI) on 23 July 2014, BFood’s share price gained 71.1% to date and P/E re-rated higher – almost touching +2SD from its historical trading range (see Figure 8). In our view, the market is willing to assign higher valuation multiples to BFood for having full control to develop and manage the Starbucks Coffee brand in Malaysia.

 

Key Risks

Slowdown in consumer spending. According to data on household consumption by the Malaysia Department of Statistics, Malaysians typically spend about one-third of their wages on food and non-alcoholic beverages. Hence, a slowdown in consumer spending would have an adverse impact on BFood sales.  Intense competition in the food and beverage (F&B) industry. The F&B industry in Malaysia is competitive with many new players emerging on a regular basis. The group’s competitors include a large and diverse group of restaurant chains as well as independent local operators. With increasing competition, BFood may face pricing pressure.

Currency fluctuations.  BFood has exposure to a few foreign currencies given its existing operations outside Malaysia such as Singapore, Indonesia, Brunei and Cambodia. All sales are transacted in the currencies of the respective countries of operations except Cambodia, where sales are transacted in USD. However, its most significant foreign currency exposure is to the USD since approximately 50% of 
BStarbucks’ purchases of drink ingredients, various supplies and equipment are denominated in USD. Based on our sensitivity analysis, every 10% deterioration in the MYR exchange rate vs the USD could negatively impact BFood’s PATAMI by approximately 7%.

 

Fluctuating rental rates.  Given that most of BFood’s restaurants and outlets are operated on rented properties, the group has significant exposure to the retail rental market. For FY14, its rental expenses represent ~20% of total operating costs. Meanwhile, for BStarbucks, rental expenses represent 43.1% of total operating costs. Hence, its earnings may be adversely affected by any substantial increase in rental expenses of its restaurants and outlets. Most of the group’s tenancy agreements are for an initial period of three years with an option to further extend for another two terms of three years each.  

Fluctuation in prices of raw materials. As BFood is involved in the F&B industry, 35-45% of its total COGS comprise raw material costs. Hence, a substantial increase in raw material prices would have an adverse impact on the group’s earnings in the event that it is unable to pass on the increase in costs to customers. BStarbucks is obligated to buy its supply of coffee beans and Frappuccino powder from SCI. Although we note that Arabica coffee bean prices have increased sharply since early 2014, we learned from management that prices for coffee have been locked in for FY15 as Starbucks Coffee Corp (SBUX US, NR) has locked in all of its coffee needs for 2014 and 60% of its needs for 2015. For FY16, we take into account in our forecasts potentially higher prices of Arabica coffee beans. 

 

Industry Overview

Starbucks Coffee to buck flat consumer spending pattern. We expect consumer spending in Malaysia to be flat in the near term, in view of the: i) rising cost of living, ii) rationalisation of government subsidies, and iii) upcoming implementation of the goods and services tax (GST). Although basic food items will generally be unaffected as demand is generally inelastic, we expect discretionary spending to decline. As such, we believe BFood’s KRR operation may be affected by lower patronage from its targeted customers/families, which are more susceptible to rising cost of living. However, in the case of  Starbucks Coffee, we believe its operation will likely be unaffected given that it is a premium brand with a different customer base which is less susceptible to the increase. 

Booming coffee culture in Malaysia.  Making traditional roasted local coffee is a cottage industry whereby coffee manufacturers supply coffee powder to local coffee shops and stalls directly. The remainder is sold to consumers via mini markets, convenience stores or sundry shops. Some manufacturers have ventured into 3-in-1 coffee packs, targeting households through retailers and supermarket chains. However, we note that people’s lifestyles have changed significantly over the years in tandem with economic growth. Malaysians have become more affluent, resulting in a change in taste, while consumption of F&B at western-style cafés has grown tremendously – particularly in big towns and cities. Malaysia’s coffee culture is also shifting from dining places to new hot spots where patrons – particularly among the Gen-Y and Gen-Z – are also able to hang out. The café is not only a place to consume coffee, but also a place to use technology in a cozy environment where customers could enjoy complementary food to go with their beverage.

Increasing urbanisation and change in lifestyle to boost the premium coffee chain industry. According to a 2014 market report by Euromonitor International, the Malaysian coffee industry is likely to see positive growth, driven by young consumers’ demand for convenient and fashionable products. The report added that increasing urbanisation in Malaysia and the changes in lifestyles due to the opening up of the economy would influence buyers’ decisions. The segment is likely to remain strong in the forecast period due to Malaysians’ changing preferences for beverages.

Malaysia is underpenetrated vs  other developed Asian countries.  As of 2Q14, Starbucks Coffee has a penetration rate of six outlets per million people in Malaysia, or nine outlets per million people out of the top three largest coffee chains in the country. This is fairly low compared  with other developed markets like Singapore, South Korea, Japan and Taiwan (see Figure 16). As people become more affluent, their lifestyles upgrade and household incomes rise. This, together with increasing urbanization, lead us to believe there is ample room for Starbucks Coffee to grow in 
Malaysia

Competitive F&B landscape. The Malaysian F&B industry is highly competitive. As consumers are spoilt for choice, the bar is raised for F&B companies fighting for a larger slice of the pie. The Malaysian F&B industry is divided into four broad categories, namely:  
i)  Full service restaurants (FSR);  
ii)  Quick-service restaurants (QSR);  
iii)  Small-to-medium independent F&B operators; and  
iv)  Cafés and bars.  
 
BFood positions itself as a FSR operator through its KRR restaurants and a café operator through its  Starbucks Coffee outlets. We have identified below the closest competitors of BFood in both its core operations, whereby these players have similar F&B offerings as KRR and Starbucks Coffee.

Source: RHB