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This report should not be considered to be a recommendation by any individual affiliated with CFA Society Taiwan, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock. This report is published for educational purposes only by students competing in The CFA Institute National Taiwan University Research Challenge. Equity｜TWSE｜Consumer Products｜Consumer Staples 10 December 2018 Recommendation: Gourmet Master Co., LTD (2723 TT) SELL When the Bakery Café Bakes in Caffeine Fading We initiate coverage of Gourmet Master (GM) with a SELL rating and NT$190 target Target Price NT$190 price, implying a 20% downside based on 20x 2019E P/E. Our 2019E EPS is 17% Current Price (7 Dec.) NT$237 below the Street consensus. Downside -20% China (63% of total 2018E revenue): Pressures on revenue and operating margins The China revenue growth has decelerated to 3% in 2018E from c.7% in 2016/17. We Company Profile expect revenue to further dip by -1%/-2% in 2019/20E in view of fading upsides from NT$ 183.0 - 52-Weeks Price Range remodeling, online delivery competition, and China’s slower retail sales growth. We NT$ 397.6 forecast GM’s per store sales decline in China will enlarge to 7% in 2019-20E, vs. 4% Shares Outstanding 180M in 2017-18E. Furthermore, start-up coffee brands like Luckin Coffee emerges as new Market Cap. NT$ 42.7B threats to GM, as Luckin rapidly increases online visibility through heavy digital USD/TWD (7 Dec.) 30.84 channel investment. We forecast the company’s operating margin in China will thus Dividend Yield 2.3% decrease to 6% in 2019-20E, from c.10% in 2017-18E. 2018 P/E 24.8x The US (20%): Slower store expansion due to aggressive competitors Source: Bloomberg After stores increased from 40 to 55 in the US, GM’s US per store sales decreased by c.12% over 2017-18E. We expect GM’s per store sales in the US to keep declining Valuation Methodology Price (NT$) c.10% in 2019-20E due to elevating competition and cannibalization. Like GM, Paris P/E 190 Baguette (PB) is an Asian bakery café in the US that aims to triple their US exposure DCF 189 to 300+ stores by 2020E. We believe not only PB but further new entrants that Target price 190 replicate GM’s business strategy will end up eroding GM’s market and slowing the revenue growth almost half to 10% in 2020E, from 28% in 2018E. Source: Team estimates Taiwan (16%): Revenue to shrink amid fiercer competition Since store format upgrade has ended in 1Q18, and organic growth loses its Operating Margin and EPS Forecast momentum, we expect GM’s per store sales in Taiwan to decrease by 9%/8% YoY in 15.0% 13 2019-20E, from 11%/9% in 2017-18E. Among the fierce competition, GM posts the 11 fewest registered members despite ongoing expansion. Compared with Taiwan coffee 10.0% 9 industry sales growing at 4% CAGR from 2012-17, we believe GM’s revenue growth 5.0% will fall to c.6% in 2019-20E because of failure to boost retention rates, from c.4% in 7 2017-18E. 0.0% 5 Initiate with NT$190 P/E-derived TP and SELL rating We set GM’s one-year target price at NT$190, based on 20x 2019E EPS (at the lower OPM (%; LHS) EPS (NT$; RHS) end of P/E band), implying a 20% downside and cross-checked with DCF valuation. We Source: Company data, Team estimates believe 20x P/E is fair due to GM's earnings downtrend in 2019E. We project that OPM (peaked out in 3Q17 at 12.7%) would be 8.4%/7.0% in 2019/20E, and would result in Stock Price Movement a -2% earnings growth in 2019E. Although the share price has undergone huge 12,000 500 correction this year, we believe the worst has not come yet, as the market has not 10,000 400 priced in vanishing competitive advantage due to rising engagement by other players 8,000 300 and the absence of moat. 6,000 200 Gourmet Master’s Key Financials 4,000 2,000 100 Year 2017 2018E 2019E 2020E 2021E 2022E 2023E 0 0 Revenue (NT$mn) 23,018 24,278 24,659 24,628 24,465 24,338 24,229 Revenue YoY (%) 4.4 5.5 1.6 -0.1 -0.7 -0.5 -0.4 Gross profit margin (%) 59.3 58.6 58.0 58.3 58.4 58.5 58.6 Operating margin (%) 12.3 9.3 8.4 7.0 6.2 6.0 5.9 TWSE (LHS) Net income (NT$mn) 2,138 1,721 1,689 1,437 1,287 1,269 1,269 Gourmet Master TWSE (LHS) Net income YoY (%) 22.8 -19.5 -1.9 -15.0 -10.4 -1.4 0.0 Source: Bloomberg Earnings Per Share (NT$) 13.12 9.56 9.38 7.98 7.15 7.05 7.05 Dividend Per Share (NT$) 5.4 4.3 4.2 3.6 3.2 3.2 3.2 Dividend yield (%) 1.5 1.8 1.8 1.5 1.4 1.4 1.4 P/E (x) 18.1 24.8 25.3 29.7 33.2 33.6 33.6 Source: Company data, Team estimates National Taiwan University 1 Figure 1 Sales Breakdown by Region Business Description Company Overview Gourmet Master Co. Ltd. (GM), the holding company of 85°C Café, is a bakery café providing a variety of food products including bread, beverage, and cake. By regions, 63% of sales come from China, 20% from the US, 16% from Taiwan and 1% from Australia and Hong Kong (Figure 1). Expansion Track Overview and Current Expansion Plan GM started selling cakes and beverages in Taiwan, and through its franchise model, it has broadened its reach to 443 stores by 3Q18. In contrast, GM embraces the self- owned business model to manage food safety, for a consistent marketing strategy in Source: Company data China. GM positions itself as a bakery café to capture the rapidly growing Chinese market. GM has 607 self-owned stores in operation. After expanding in China, GM Figure 2 Product Mix by Region landed on the US as an Asian bakery specialist. Following China's operating experience, 100% 25% 80% 30% 30% GM expands its market with self-owned business model and runs 49 stores. Overall, beverage accounts for 55% revenue in Taiwan, bread for 55% revenue in the US, and 60% 20% 30% a more balanced product mix in China (Figure 2 and Figure 3). 40% 55% 55% 20% 40% Aside from the three major markets, GM also extended its footprint to Australia in 15% 0% 2007 and Hong Kong in 2012 by forming joint ventures with local enterprises. GM USA China Taiwan bought back 50% ownership from Café de Coral in 2014 and directly ran all stores in Bread Beverage Cake Hong Kong thereafter. Source: Company data Figure 3 Store Numbers by Region Recent Regional Strategies In the US, GM will open two new central kitchens in Northern California and Texas to 1,200 24 26 15 49 support its store expansion. It also makes inroads into delivery services through 12 13 40 900 9 25 14 17 443 partnership with DoorDash at select branches. 7 400 429 332 350 600 341 In China, GM will focus on 2nd generation store remodeling and slow its expansion 300 538 580 607 nd 410 489 502 pace. By 3Q18, the proportion of 2 generation stores reached 77%, and GM will refurbish the rest in following years. In addition, GM wants to target young females - 2013 2014 2015 2016 2017 9M18 through its new store format and plans to expand into inland China by opening new China Taiwan US Others stores in lower tier cities.