$Japan Foods(5OI.SI)

https://alpacainvestments.blogspot.sg/2017/12/japan-foods-holding.html

Japan Foods Holding (JFH) has recently caught my attention, after I have started screening for stocks again. JFH operates a wide range of F&B outlets selling Japanese food. We may be familiar with the Ajisen Ramen brand, which accounts for the bulk of JFH's revenue (39.5%). JFH also operates brands including Menya Musashi and Keika Ramen. JFH has operations in Singapore, Malaysia, Vietnam, Hong Kong and China.
JFH has a four pronged strategy to grow its business - developing new concepts, cost control, overseas expansion and network expansion/consolidation.


1H 2018 Financial Results


For 1H 2018, JFH reported an earnings per share of 1.35 cents, compared to 1.53 cents a year earlier, a 11.8% fall. Revenue fell marginally from $33.5 million to $33.0 million.
As at 30 Sep 2017, JFH had $19.6 million in cash and cash equivalents. This makes up more than a quarter of JFH's market cap of $74 million. Furthermore, JFH has zero borrowings. A healthy balance sheet means that JFH has the financial strength to fund any expansion plans or acquisitions.

Increasing Gross Profit Margins

JFH frequently highlights their high gross profit margins, which have been increasing over the past 5 years, hitting a record high of 85% this year. However, if we were to look at their net profit margin, it would paint a different picture. JFH's net profit margins have been declining over the same period. I'll be looking deeper into the cost structure of JFH to better analyse these differing trends.
Here is the comparison between the expenses JFH incurred in FY 2013 compared to that of FY 2017:



Firstly, while JFH's revenue has increased from $61.3 million to $65.5 million, they still managed to reduce their cost of sales from $12.2 million to $9.9 million. Thus their gross profit margin increased from 80% to 85%. JFH's increasing gross profit margins signals that they have managed their costs of sale well. Cost of sale mainly consists of the cost of raw materials, which were probably kept low because of bulk purchases and economies of scale.
However, JFH's net profit margins fell over the same period, from 10.4% to 7.2%. As we observe from the comparison above, this is mainly due to selling and distribution expenses increasing, from $37.9 million to $46.5 million. Selling and distribution expense is the main component of JFH's expenses, and rose due to higher wage costs and higher depreciation expenses incurred. 
Naturally, the business would incur higher staff cost and depreciation expenses as it expands, as new outlets are set up. However, JFH's expenses have risen at a faster pace than its growth in revenue, which offsets its increasing gross profit margin, resulting in its net profit declining. Going forward, JFH is expected to continue facing such cost pressures due to a tight labour supply. We should pay attention to how JFH manages these cost components in the upcoming quarters.

Dividend Payout

JFH has the highest dividend yield among its peers, at 4.8% as of today's closing price of S$0.42. However, this is mainly due to JFH's dividend payout ratio leaning towards the high side. JFH's 5-year dividend payout history is shown above. Note that JFH used to payout higher dividends from 2013-2014, then cut its dividends after earnings fell. 
For FY 2017, JFH paid out 75% of its earnings as dividends to shareholders. For some comparison, Jumbo's payout ratio is around 60%. This is probably because Jumbo still needs to fund its expansions to penetrate new markets, while JFH already has an established network of F&B outlets across the region. For 1H 2018, earnings per share was 1.35 cents, which gives us a full-year pro forma EPS of 2.7 cents, indicating that JFH would probably be abe to maintain a healthy 75% payout ratio. Interim dividend had increased slightly from 0.75 to 0.8 cents.
JFH currently trades at a P/E ratio of 16x, which is reasonably priced compared to its peers. I won't say that JFH is undervalued, but given that F&B companies generally trade at slightly higher valuations, I believe JFH's current share price is still rather attractive.

Discounted Cash Flow Valuation

Personally, I'm not really a fan of using DCF to arrive at a valuation, because of how widely the valuation can fluctuate based on the inputs we decide to use. As they say, garbage in, garbage out. However, since a DCF is still an extremely common valuation metric, I'll still include my DCF-based estimates here.
As JFH is an established F&B chain, and with little expansion plans in the pipeline, the assumptions I used were a discount rate of 9% and a terminal growth rate of 2.5%. I used a 2.5% TGR, which is higher than Singapore's GDP growth rate, because JFH has still has operations in a number of emerging economies such as Vietnam and China. These countries should experience higher GDP growth rates than us. 18 of JFH's outlets are based overseas, while 49 in Singapore.




Starting with JFH's five year average free cash flow of $5.56 million, I arrive at a valuation of $0.51 per share for JFH, which represents a 21.4% upside from today's price of $0.42. Notice that if we were to tweak the parameters slightly, the valuation we would arrive at can differ substantially, as we get a range from $0.34 to $0.95. If we were to be more conservative, and apply a higher discount rate of 10% and assume a lower terminal growth rate of 2%, we would have JFH at fair value now. To me, a DCF is at most rough estimate of the company's value, and we'll have to evaluate both the quantitative and qualitative aspects of the business. 

High Insider Ownership

JFH's CEO, Mr Kenichi, and Non-Executive Vice Chariman Mr Eugene Wong hold a 70% and 5.47% interest respectively. That is a total of more than 75% held by key executives. I prefer companies with high management ownership, because this gives us a much stronger alignment of interest between the management and shareholders. However, a consequence of this high management ownership results a mere 19% of the outstanding shares being held by the public. Thus, JFH's trading volume is extremely low, or may not even be traded on some days. Investors may face liquidity risks if they have to cash out urgently.

Conclusion

While JFH is a small cap stock, I believe that it has a geographically diversified and stable business. If JFH is able to keep its costs in check, increase its operational efficiency and mitigate its declining net profit margins, JFH could see some earnings recovery. However, one aspect of JFH I dislike is that they operate too many brands, which results in JFH's brand equity lagging behind its peers.
Should JFH's share price fall below $0.40, with little change in fundamentals, I believe that it would present a good opportunity to purchase a solid, cash flow generating company. At that price, we would be receiving a dividend yield in excess of 5%. However, as I'm currently a shareholder of Jumbo, should I purchase JFH's shares, my portfolio would become slightly heavy on the F&B sector. 

Read: Jumbo at 52-week low

Note: As of writing, I do not have a position in Japan Foods.




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16 likes 29 comments
TUBInvesting

Crazy rise today! say yes to fundamental investing.

TUBInvesting

Reply to @kc2024 : Wait for the dividend. Hold it long term.

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layers

so far the commenters only 1 vested?

warster

Great analysis! Japan food has been on my watchlist for a bit because I feel the market might have underpriced it a bit, but the thing about the food industry is that it is very competitive, and I've always wondered where lies Japan food's competitive moat.

For eg. jumbo and breadtalk can always count on IE singapore to propagate their brands overseas. I've seen how IE singapore works and you'll be surprised how far they'll push the boat, if your brand is under their endorsement.

Also like you mention, the tight labour markets and inflationary pressure of raw food materials also contribute to the decreasing operating margins, and since their their biggest revenue generator (ajisen ramen) is largely seen as budget ramen chain, the demand is largely elastic, and so, they cannot afford to pass on the extra cost to the consumer, and not forgetting that they're also facing headwinds from other ramen chains such as ippudo etc which will again affect the revenue. And with fnb with high uncertainties (no economic moat), a dcf model could be quite inaccurate.

bgting

Reply to @warster : I believe operation efficiency plus economy of scale is a moat. Then the ability to raise prices is an important factor. If costs increase, everyone will have to raise prices to pass the costs on to consumers. (Inflation!) Not too sure how sensitive consumers are to prices though. If no one can raise price, margin will be squeezed. The lowest cost producer will be relatively better off.

bgting

Oh the contrary, I think the multiple brands is an advantage. Synergy is seen in the improving gross margin as the central kitchen efficiently does the preparation.

For example, from the Chairman's statement in the 2016 annual report :
"Of all our achievements in FY2016, I would say the most significant was the launch of our first non-Japanese concept “New ManLee Bak Kut Teh”. Established over 40 years ago, this was franchised from Kuala Lumpur, Malaysia.

Shareholders may ask why bak kut teh and why a deviation from Japanese food? My answer to that is that it makes perfect sense. This pork bone soup is a familiar favourite among Singaporeans because of its aromatic soup broth and tender pieces of meat. There are synergies because bak kut teh uses the same major ingredients as the pork bone broth that our central kitchen prepares for our ramen shops across the island. This means that we not only enjoy cost savings from bulk purchases but also can maximise our central kitchen capabilities to launch a new concept that has allowed us to venture into a new cuisine."

I'm not sure about chilli crabs and bak kut teh though. Haha ...

As most of the outlets are in shopping malls, restaurant businesses could be facing headwind as more space is allocated for F&B in the malls (something like 10% to 30%?) due to threat from e-commerce. Now consumers are spoilt for choice for food in malls.

Mulitple brands has the advantage of opening several outlets at each mall to capture market share. There should also be more room for rent negotiation with the landlord too. This is a reason why we often see Breadtalk, Toast Box, Din Tai Fung and related brands in the same malls.

Another advantage that Japan Foods has been doing is if a brand is not doing well at an outlet, it can revamp it with another brand. Perhaps this is also done purposely to refresh the offering at the location.

The locations that are poor and not profitable will be closed down. Opening of new outlets also incurs costs.This affected the results 2016.

bgting

Reply to @AlpacaInvestments : Having many brands is a strategy of FMCG companies. This is to occupy more shelf space so that whichever brand consumer buys, higher chance it's the company. But the trade off is cannibalization.

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TUBInvesting

I seldom see people talk about this counter. For F&B counter, people is always talking about Jumbo and now No Signboard. Thus, this is a good refreshing article.

Just sharing what I wrote previously on Japan Food in April.

http://tubinvesting.blogspot.sg/2017/04/i-...

Still vested.

AlpacaInvestments

Reply to @TUBInvesting : Haha interesting perspective! Would remember to try Akimitisu if I happen to pass by!

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Martin_Seah

thanks for the detailed discussion

jeremyowtaip

The return on equity (ROEs) for Japan Food Holdings have fallen for the past three years. Also, the dividend payout ratio has increased while net profits have fallen over the past few years as well. Based on this trend and also the various observations of challenges in their cost pressure you have shared, it seems that Japan Food Holdings is not able to grow at the lucrative high rates as it used to do anymore. That is why it is better for them to return a bigger part of their earnings to shareholders as dividends rather than invest in their own slowing growth which is what the management is doing in recent years as seen from the trend of their financials.

AlpacaInvestments

Reply to @jeremyowtaip : Hi Jeremy, thanks and have a great 2018 too! =)

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