22 December 2017 Food & Beverage Cafe de Coral Deutsche Bank Markets Research Rating Company Date Hold Cafe de Coral 22 December 2017 Results Asia Hong Kong Reuters Bloomberg Exchange Ticker Price at 20 Dec 2017 (HKD) 20.70 Consumer 0341.HK 341 HK HSI 0341 Price target - 12mth (HKD) 24.50 Food & Beverage 52-week range (HKD) 27.40 - 20.65 HANG SENG INDEX 28,848 2HFY18 outlook Valuation & Risks Anne Ling Focus on sales growth so as to lower the cost ratio We met management for an update after the 1HFY18 results on 27 Nov. As Research Analyst mentioned in the media (there was no analyst meeting), management views the +852-2203 6177 staff cost hike as the key challenge for the company and industry. Top-line growth John Chou can combat this cost pressure. With new stores achieving maturity and spread- Research Analyst out festive seasons in 2HFY18, we believe the cost ratio will stay under control. +852-2203 6196 Overall market recovery less favorable for resilient play Key changes We fine-tune our 2018/19/20 NP by 4/3/3% to reflect the weaker-than-expected Sales (FYE) 8,471 to 8,466 -0.1% 1HFY18 performance. We maintain our Hold recommendation and target price ↓ Op prof margin 7.1 to 6.9 ↓ -3.7% at HK$24.5, as we believe the shares are fairly valued. Overall, we see the HK (FYE) market experiencing a recovery in 2017; this is likely to continue in 2018. Fast food Net profit (FYE) 505.8 to 487.0 ↓ -3.7% chains are regarded as resilient play in a mature market (no penetration growth Source: Deutsche Bank and consumers might start to trade up from fast food, especially for dinner). That Price/price relative said, CDC has a strong FCF model with a high dividend payout. 40 Valuation and risks 30 We derive our DCF-based TP using Deutsche Bank’s COE of 7.5% (a 2.7% risk-free 20 rate and a 4.9% ERP for the HK market) and a terminal growth rate of 1%, in line 10 with our forecasts for other HK consumer stocks. We continue to use a beta of 1. Jan '16 Jul '16 Jan '17 Jul '17 Key downside risks: 1) an SSSg slowdown; 2) central kitchens fail to improve profit Cafe de Coral HANG SENG INDEX (Rebased) margin; 3) a new round of minimum wage increases in HK, which management Performance (%) 1m 3m 12m could fail to pass on; and 4) China continuing to be a drag on earnings. Key upside Absolute -9.0 -15.5 -18.5 risks: 1) store efficiency resulting in operating leverage; 2) faster-than-expected HANG SENG INDEX -0.1 3.9 34.5 store openings in HK; and 3) a China operation recovery. Source: Deutsche Bank Key indicators (FY1) Forecasts and ratios ROE (%) 15.6 Year End Mar 31 2016A 2017A 2018E 2019E 2020E Net debt/equity (%) -23.9 Sales (HKDm) 7,567.2 7,895.3 8,466.1 9,222.3 9,914.3 Book value/share (HKD) 5.38 EBITDA (HKDm) 918.1 915.8 926.8 1,022.3 1,107.9 Price/book (x) 3.8 Reported NPAT (HKDm) 518.0 503.8 487.0 554.7 609.6 Net interest cover (x) – Reported EPS FD(HKD) 0.90 0.87 0.81 0.92 1.01 Operating profit margin (%) 6.9 DB EPS FD (HKD) 0.90 0.87 0.81 0.92 1.01 Source: Deutsche Bank DB EPS growth (%) -12.2 -3.3 -6.5 13.9 9.9 PER (x) 28.7 29.5 25.6 22.4 20.4 EV/EBITDA (x) 13.9 14.2 10.4 9.3 8.5 DPS (net) (HKD) 1.16 0.81 0.81 0.81 0.73 Yield (net) (%) 4.5 3.2 3.9 3.9 3.5 Source: Deutsche Bank estimates, company data Deutsche Bank AG/Hong Kong Distributed on: 22/12/2017 04:45:08 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. 7T2se3r0Ot6kwoPa 22 December 2017 Food & Beverage Cafe de Coral 2HFY18 outlook The key is to drive top-line growth so as to lower the staff cost ratio – the main challenge in HK Hong Kong. Management hopes that SSS will improve in 2HFY18 to more than 3%, as: 1) the festive seasons (2017/18’s Christmas and CNY) are more spread out, and 2) base is lower (SSS in FY17 was +4%, with 1H at +5% and 2H at +4%). There will be less store openings in HK, compared to 19 stores (net) in 1HFY18. However, overall sales growth will be helped by the new store growth in 1H apart from the SSSg. Management expects stable food cost. On the opex side, rental cost ratio is likely to be similar as in the previous period. The key issue is the staff cost ratio, which rose to 31.8% in 1HFY18 (from 31.7% in 1HFY17 and 31.1% in FY17). Three reasons for staff cost increase are: 1) more new stores opened in 1H, 2) salaries were increased to retain staff/stabilize the team, and 3) the impact of minimum wage. With new stores ramping up sales, the staff cost ratio should not be as high as for the full year. China. SSS was strong at 15% in 1HFY18, due to: 1) a better menu mix, and 2) increased number of stores engaged in online delivery (still less than 50% of the stores have such service). We expect this momentum will continue. On the back of a strong SSSg, it plans to accelerate store openings in 2HFY18. For reference, it closed 3 stores (net) in 1HFY18. In late Oct, it closed the last 2 stores in East China. It will focus on South China, moving forward. 1HFY18 results review Cafe de Coral reported an NP decline of 11% to HKD206m on a 6% rise in sales, to HKD4.1bn. Sales was in line while NP was 5% lower than DBe, mainly due to: 1) higher-than-expected opex, as the company invested more into its HK QSR business to improve its staff retention rate; and 2) higher-than-expected impairment cost, which stood at HK$21m (incurred in HK) vs HK$ 8m (incurred in China) in 1HFY17. The board proposed an interim dividend of HKD 18cents per share, same as last year. By country, HK saw sales grow by 5.7% but segment profit declined 6%, mainly due to increased staff cost. Its core brand, CDC, achieved 3% SSSg (half ASP and half traffic) during this period. Super Super Congee and Noodles saw SSS increase by 1% with two new stores opened. China segment profit increased 28% to HKD76.4m on a 7% rise in sales, mainly due to strong SSSg pickup (half ASP and half traffic) and operating leverage. After restructuring the management and localizing the menu, the company saw SSS increase 15% in southern China. It will open more new stores in some strategic locations to scale up the business. Page 2 Deutsche Bank AG/Hong Kong 22 December 2017 Food & Beverage Cafe de Coral Overall, it net increased 16 new stores and operated 474 stores by the end of Sep 2017. Its capex in 1HFY18 increased 30.3% to HKD232m. Figure 1: DB forecast changes YE Mar DB estimates (New) DB estimates (Old) Market forecast VS old DB estimates VS market forecast HKDm Sales Net profit Sales Net profit Sales Net profit Sales Net profit Sales Net profit 2018F 8,466 487.0 8,380 505.8 8,420 507 1.0% -3.7% 0.5% -3.9% 2019F 9,222 554.7 9,018 574.4 9,045 577 2.3% -3.4% 2.0% -3.8% 2020F 9,914 609.6 9,651 630.5 9,690 630 2.7% -3.3% 2.3% -3.2% Source: Deutsche Bank estimates, Bloomberg Finance LP, last updated on 21 Dec 2017 Figure 2: P&L Breakdown Half year YE Mar HKDm 2016 2017 2018E 2019E 2020E 1HFY17 2HFY17 1HFY18 2HFY18E Revenue 7,567 7,895 8,466 9,222 9,914 3,886 4,010 4,128 4,338 - Hong Kong 6,448.1 6,916.5 7,473.1 8,148.5 8,754.2 3,374.6 3,541.9 3,579.8 3,893.3 - China 1,119.1 978.7 993.0 1,073.8 1,160.1 511.0 467.7 548.3 444.7 YoY growth % 1.4% 4.3% 7.2% 8.9% 7.5% 4.3% 4.4% 6.2% 8.2% - Hong Kong 5.3% 7.3% 8.0% 9.0% 7.4% 8.3% 6.3% 6.1% 9.9% - China -9.2% -12.5% 1.5% 8.1% 8.0% -16.3% -8.0% 7.3% -4.9% COGS (2,360) (2,420) (2,585) (2,803) (3,000) (1,189) (1,231) (1,178) (1,408) YoY growth % -1.8% 2.5% 6.8% 8.4% 7.0% 2.1% 2.9% -1.0% 14.4% Gross profit 5,207 5,475 5,881 6,419 6,915 2,696 2,779 2,950 2,930 YoY growth % 3.0% 5.2% 7.4% 9.2% 7.7% 13.2% -8.2% -5.4% -0.6% GP margin 68.8% 69.3% 69.5% 69.6% 69.7% 69.4% 69.3% 71.5% 67.6% Other income and gains 0.716 -23.148 2.246 2.246 2.246 1.5 (24.7) (12.3) 14.5 SG&A cost (4,592) (4,849) (5,300) (5,756) (6,186) (2,421) (2,428) (2,696) (2,604) Staff cost (2,193.1) (2,455.9) (2,653.4) (2,890.4) (3,122.3) (1,230.6) (1,225.3) (1,314.4) (1,339.1) Rental cost (866.9) (930.1) (918.6) (1,000.6) (1,075.7) (453.3) (476.8) (506.1) (412.5) Depreciation (302.7) (312.7) (343.9) (356.9) (376.9) (151.1) (157.9) (167.9) (176.1) Others (926.9) (837.7) (1,040.4) (1,151.1) (1,234.2) (736.8) (726.3) (875.7) (852.5) YoY growth % 3.8% 5.6% 9.3% 8.6% 7.5% 4.3% 6.9% 11.4% 7.2% As % of sales -60.7% -61.4% -62.6% -62.4% -62.4% -62.3% -60.6% -65.3% -60.0% EBIT 615 603 583 665 731 277 326 242 341 YoY growth % -10.9% -2.0% -3.3% 14.2% 9.9% 12.5% -11.6% -12.7% 4.6% EBIT margin 8.1% 7.6% 6.9% 7.2% 7.4% 7.1% 8.1% 5.9% 7.9% Net interest cost 12.7 9.6 9.6 9.4 10.6 4.3 5.3 6.4 3.2 Exception items - - - - - - - - - Share of results of associates 0.0 - - - - - - - - Profit before taxation 628 613 593 675 742 281 331 248 344 Taxation (110.2) (108.8) (105.5) (120.1) (132.0) (49.5) (59.4) (42.4) (63.1) Effective tax rate -17.5% -17.8% -17.8% -17.8% -17.8% -17.6% -17.9% -17.1% -18.3% Minority interest 0.1 (0.0) (0.0) (0.0) (0.0) (0.1) 0.1 (0.4) 0.4 Net Profit 518 504 487 555 610 232 272 206 281 YoY growth % -11.7% -2.7% -3.3% 13.9% 9.9% 11.8% -12.4% -11.3% 3.5% NP margin 6.8% 6.4% 5.8% 6.0% 6.1% 6.0% 6.8% 5.0% 6.5% Source: Deutsche Bank estimates, company data Deutsche Bank AG/Hong Kong Page 3 22 December 2017 Food & Beverage Cafe de Coral Figure 3: Comparison of HK's key fast food and fast casual dining companies CDC Fairwood Tsui Wah Hong Kong Macro (comment from Macro environment has improved, but it mgmt) has not benefited its industry Na Na Pricing policy No price hike but will increase ASP through Not more than 2% for the full year.