China / Hong Kong Company Guide Haidilao International Holding Ltd Version 1 | Bloomberg: 6862 HK Equity | Reuters: 6862.HK Refer to important disclosures at the end of this report DBS Group Research . Equity 1 Aug 2019 HOLD (Initiating Coverage) Priced in a blue sky Last Traded Price ( 31 Jul 2019):HK$30.50 (HSI : 27,778) • One of China’s leading and fastest growing hotpot player Price Target 12-mth:HK$28.70 (5.9% downside) with strong servicing reputation on going above and Analyst beyond for its customers Alison FOK+852 36684170, [email protected] Mavis HUI+852 36684188, [email protected] • Expect near-term positives priced in, now trading at 46x Alice HUI CFA+852 36684182, [email protected] FY20F PE; we expect downside risk on FY20F earnings on margin dilution as a result of fast expansion Price Relative • Initiate coverage with HOLD and TP of HK$28.7 One of the fastest-growing hotpot restaurant chains in China with inflated valuations. Haidilao is one of the fastest-growing and leading hotpot cuisine restaurant chains in China. We forecast the group to achieve an earnings CAGR of 34.5% in 2019-21F, on the back of a sales turnover CAGR of 36% supported by its ambitious store- expansion strategy, positive SSSG and above-industry table turnover ratio. We estimate the group’s net store openings at +210/+200/+195 in FY19-21, with stronger focus on tier 2 cities. Contrary to peers, Haidilao presents itself as a premium service provider rather than sale Forecasts and Valuation FY Dec (HK$m) 2018A 2019F 2020F 2021F of products, supported by attractive employee profit-sharing and Turnover 16,969 26,225 36,628 48,362 incentive schemes. Bouyed by the inclusion into the Southbound index EBITDA 2,944 4,400 5,818 7,851 in Dec’18, Haidilao has now delivered a share price return in excess of Pre-tax Profit 2,347 3,454 4,541 6,247 78% YTD, and is the most expensive HK-listed restaurant play at 46x Net Profit 1,732 2,517 3,309 4,553 Net Pft (Pre Ex) (core profit) 1,646 2,517 3,309 4,553 FY20F PE. While we are positive on the Group’s outlook ahead, we Net Profit Gth (Pre-ex) (%) 68.5 45.4 31.5 37.6 believe near-term positives may have been priced in and there is EPS (HK$) 0.35 0.50 0.66 0.91 limited room for upside revision. Core EPS (HK$) 0.33 0.50 0.66 0.91 EPS Gth (%) 68.5 45.4 31.5 37.6 Where we differ: We are 7% below market consensus earnings in Core EPS Gth (%) 60.2 52.9 31.5 37.6 FY20F, as we expect fast store expansion can result in margin dilution. Diluted EPS (HK$) 0.33 0.50 0.66 0.91 We forecast a net margin contraction of 0.2ppt in FY19-21F on labour DPS (HK$) 0.11 0.14 0.19 0.24 BV Per Share (HK$) 1.73 2.06 2.48 3.06 and raw material pressures, versus consensus expansion of 0.3ppt. PE (X) 87.9 60.4 46.0 33.4 Other critical factors: Connected party transactions have amounted CorePE (X) 92.4 60.4 46.0 33.4 up to 38.4% of FY18 sales, which could be a concern in the medium P/Cash Flow (X) 63.0 41.5 36.8 28.3 P/Free CF (X) nm 117.1 81.1 48.1 run. Separately, in Mar’19, Haidilao acquired Youdingyou, with the EV/EBITDA (X) 50.4 33.6 25.3 18.5 Chairman’s brother as one of the key shareholders for Rmb204m, Net Div Yield (%) 0.3 0.5 0.6 0.8 equivalent to 1.96x P/NAV. The Company intends to leverage on P/Book Value (X) 17.6 14.8 12.3 10.0 Haidilao’s management capabilities to deliver a QSR formatted brand. Net Debt/Equity (X) CASH CASH CASH CASH ROAE(%) 35.7 26.6 29.3 33.0 Valuation: Earnings Rev (%): New New New Our TP of HK$28.7 is based on 1.1x FY20F PEG, a 20% premium to Consensus EPS (HK$) 0.50 0.71 0.90 XiabuXiabu, or equivalent to 43.4x FY20F PE. We initiate coverage Other Broker Recs: B:12 S: 1 H:5 on the stock with a HOLD call. Source of all data on this page: Company, DBS Bank (Hong Kong) Limited Key Risks to Our View: (“DBS HK”), Thomson Reuters Better than expected same-store sales growth and store expansion, coupled with margin expansion, and potential success in the development of a secondary brand At A Glance Issued Capital (m shrs) 5,300 Mkt Cap (HK$m/US$m) 161,650 / 20,650 Major Shareholders (%) Zhang (Yong) & Shu (Ping) 57.6 Shi (Yonghong) & Li (Haiyan) 16.4 Free Float (%) 15.0 3m Avg. Daily Val. (US$m) 12.93 ICB Industry: Consumer Services / Travel & Leisure ed-TH / sa- CS /DL Company Guide Haidilao International Holding Ltd Table of Contents SWOT Analysis 3 Company overview 4 Valuation and recommendation 7 Critical Factors 8 Financial summary and forecast 9 Appendix: Industry overview 12 Page 2 Company Guide Haidilao International Holding Ltd SWOT Analysis Strengths Weaknesses • Haidilao is one of the largest hotpot cuisine brands in China • Haidilao’s total operating costs as a percentage of with a total of 466 outlets as of December 2018, and is sales is lower than peers, thanks to its high table highly regarded for its impeccable services. turnover at >5x and above-industry same-store-sales growth (SSSG) generation (6-14%) in FY16-18. • Haidilao adopts a directly operated business model, which However, equipped with an aggressive store enables better quality control due to a complex operating expansion plan, Haidilao could face some execution environment in China. At the same time, Haidilao is well risks ahead. known to be generous in its compensation system to its employees all the way to the bottom, which supports a • Haidilao’s five largest suppliers, accounting for 38.4% higher-than-industry retention rate. For example, restaurant of total FY18 cost of purchases, are related to a managers can choose either to take up 0.4-2.8% of total number of connected parties. Besides carrying off- profits of their own managed stores, and/or a portion of balance sheet risk, the complexity of Haidilao’s their mentees (first and second generations) profits to business structure could also deter any means of third- encourage building internal talent. party M&As in the future. • Haidilao’s labour cost as a percentage of sales is high relative to peers. As Haidilao may not want to compromise on its service quality, the group could face more labour cost pressures ahead. • With the fast-growing pace of the delivery sector (projected to grow at a CAGR of 17.9% in 2017-22E [Source: F&S]), hotpot cuisine may lose out to other cuisines in the long run due to difficulties in replicating a similar order for delivery vs in-house dining. Opportunities Threats • The expansion in China’s catering industry should benefit • Slowdown in economic activities (e.g. trade war) will the company. According to Frost & Sullivan, China’s have a direct impact on eating-out spending catering market is expected to grow at a CAGR of 10% in 2018-22E. • The competitive landscape in the catering sector will remain challenging • Well positioned to benefit from a shift in consumption • Food safety concerns could be more difficult to upgrade towards eating out and delivery market. contain as the company expands its scale further. To • Haidilao’s brand name is synonymous with service capability boost customer confidence, Haidilao has installed live rather than purely just hotpot cuisine. This provides ample CCTV cameras available on the electric ordering pad opportunity for the group to cultivate or acquire new for customers to view the kitchens themselves. brands, such as Youdingyou (優鼎優), to drive the long- • The Haidilao trademark does not belong to the listco, term diversification of its portfolio. but to its controlling stakeholders. Source: DBS HK Page 3 Company Guide Haidilao International Holding Ltd Company overview Timeline Founded in 1994 and listed in 2018, Haidilao was established Year Description in Jianyang, Sichuan province. Today, Haidilao is a globally 1994 First hotpot restaurant in Jianyang, Sichuan Province leading and fast-growing Chinese cuisine restaurant brand opening focusing on hotpot cuisine. The group has a perpetual, 1999 Haidilao expanded network outside of Sichuan to royalty-free and exclusive licence to use the Haidilao brand, Xi'an, Shaanxi Province 2002 Expand restaurant network to Zhengzhou, Henan granted by the founders’ private listco, Sichuan Haidilao. 2004 Expand restaurant network to Beijing 2006 Expand restaurant network to Shanghai In September 2018, Haidilao successfully launched its public 2007 Received HACCP quality management system offering at a higher-end pricing at HK$17.8 per share, with certification the issuance of 424.53m new shares, and raised net proceeds 2008 Awarded title of Chinese Famous Hot Pot by China of HK$7,299.3m. The cornerstone investors included Hillhouse Cuisine Association Capital, Greenwoods Asset Management, MSIM, Snow Lake 2010 Introduced self-operated hot pot delivery Capital and Ward Ferry which invested a total of US$375m, 2011 Haidilao is recognised as a well known trademark in and accounted for 3.1% of the company’s share capital. Note China by the State Adminstration for Industry & that co-founders Ms. Shu and Ms. Li hold approximately Commerce.