Late last year, BreadTalk made the announcement that the company had won the franchising rights to operate Din Tai Fung in London. It was certainly good news for shareholders as their investment value in BreadTalk appreciated by 40% to $1.40 in less than six months after the news broke. Beforehand, there was a group of Din Tai Fung lovers who set-up a Facebook fan page to petition the Michelin-starred restaurant to open its outlets in Europe. They must be very happy to finally hear the news and enjoy the chain’s famous xiao long bao (steamed dumplings).
BreadTalk certainly thinks that London will be a good market for Din Tai Fung and if the first restaurant succeeds, they will then open more outlets. Besides London, BreadTalk has the rights to operate Din Tai Fung in the rest of England, Scotland, Wales and Northern Ireland as the franchising rights include the whole of the UK.
However, the questions most investors have now are:
- Is the market overreacting to the news?
- Can BreadTalk maintain the quality and service excellence of Din Tai Fung in London?
- Will the people who live in London like Din Tai Fung? Can they accept the brand?
- Most importantly, would the recent rally in share price continue moving forward?
The good news is most of these questions were answered during this year’s AGM.
Below are some of the key points I took away from BreadTalk’s 2017 AGM:
- FY2016 was a year of rationalisation for BreadTalk. Over the last five years, the company expanded its revenue at CAGR of 20% but this was achieved at the expense of its net profit margin. The management decided to slow their aggressive expansion and focus on improving its earnings. As a result, net profit margin improved to 1.85% from 1.22% in 2015. The margin would have been better if we exclude the one-time impairment of around $6 million due to the early closures of a number of underperforming stores. Despite the hit, long-term investors should be happy to know that BreadTalk’s operating cash flow and free cash flow for 2016 grew further to $85 million and $53 million respectively.
- BreadTalk aims to achieve a net profit margin of 8% by 2020. It is an internal target the company hopes to achieve in the next three years. This isn’t something new to us as the management has been talking about this ever since we started following the company in 2011. With the tough retail conditions and ever-increasing operating costs, it seems like a far-fetched goal considering that BreadTalk’s current net profit margin is at 1.85%. But only time will tell whether the company can execute and achieve this goal.
Moving forward, chairman George Quek elaborated that any expansion of new outlets or products will certainly take into account bottom-line margins, reversing from the company’s past course of action where it tended to put more emphasis on growing its top line and store count. BreadTalk’s second largest shareholder, Minor Food, also has deep experience in running the retail business and they have been very generous in sharing their knowledge with BreadTalk. Both companies are now learning from each other in applying the best practices to run their operations more efficiently. - BreadTalk’s food court segment widened its loss before tax to $7.4 million from a loss of $2.9 million in 2015. One shareholder was concerned with the food court operation as it has been a drag on the company’s net profit margin. CFO Chan Ying Jian pointed out that the amount included a one-time loss of $5 million due to the early closure of non-performing outlets. These outlets were in Tier 2 and Tier 3 cities in China where the food court concept doesn’t work well. Moving forward, BreadTalk will focus on first tier cities where food courts have caught on and see higher volume and faster table turnover. The management believes if they can continue to improve their site selection for food courts, it will boost the company’s bottom line as the food courts that are doing well actually earn higher net margins of 8% or higher.
- BreadTalk holds investment securities worth $90 million that are booked at cost. The same shareholder asked the board to elaborate on these investment securities. The CFO explained the investment securities are the company’s property investments. BreadTalk doesn’t directly own the underlying properties but through a special purpose vehicle that holds these properties – which is why they are classified as investment securities rather than investment properties.
Investment Properties Year of Investment Effective Interest CHIJMES 2011 29.0% Beijing Tong Zhou 1 2012 5.72% Beijing Tong Zhou 2 2013 5.86% 111 Somerset 2014 5.0% AXA Tower 2015 5.3%
According to Chan, 111 Somerset has since been divested in Jan 2017 and BreadTalk expects to record a gain of $9.3 million before transaction costs. The company also net a divestment gain of $8.5 million from 112 Katong Mall – a return on investment of more than 100%. CEO Oh Eng Lok explained that the company’s investment in properties support its core business as it allows BreadTalk to secure prime retail spaces over their competitors. But with interest rates expected to rise, he reassured shareholders that the management will be more careful in deploying the capital in the future. - BreadTalk owns strata offices in Shanghai worth $23 million. A representative from Aberdeen Asset Management asked for more detail about these 18 office units and the CFO explained that the offices are fully funded by equity and originally meant to support the team’s expansion in China. But as the company’s current premises is still sufficient, they decided to lease the 18 units at a 5% yield.
- The $75 million notes issued by BreadTalk is trading lower than its original coupon rate of 4.6%. The amount raised was used to pay down maturing loans and increase the proportion of fixed loans on the company’s balance sheet. According to bondsupermart, the traded yield for BreadTalk’s notes is around 3% and this will essentially help the company negotiate better rates from the bank.
- The management is disciplined on paring down the company’s debt level. A high level of debt on BreadTalk’s balance sheet has been a major concern for many investors and the CFO has addressed this issue by paring down the debt. As we can see from the chart below, net debt has fallen to $61 million in 2016. As a result, BreadTalk’s net gearing ratio has reduced to less than 0.5. The divestment of 111 Somerset will also pay down the loan backing the property.Having said that, he pointed out that the company will not be entirely debt-free as this will drag down its return on equity. At the same time, they want to have cash available to take advantage of securing good retail locations especially during this tough retail market where a lot of consolidation is taking place.
Moving forward, chairman George Quek elaborated that any expansion of new outlets or products will certainly take into account bottom-line margins, reversing from the company’s past course of action where it tended to put more emphasis on growing its top line and store count. BreadTalk’s second largest shareholder, Minor Food, also has deep experience in running the retail business and they have been very generous in sharing their knowledge with BreadTalk. Both companies are now learning from each other in applying the best practices to run their operations more efficiently.
Having said that, he pointed out that the company will not be entirely debt-free as this will drag down its return on equity. At the same time, they want to have cash available to take advantage of securing good retail locations especially during this tough retail market where a lot of consolidation is taking place.Before diving into the ordinary business of the meeting, George Quek gave a short speech. He hopes investors will be more patient with them for 2017 as BreadTalk tries to do improve its efficiencies on a operational level. Investors can probably expect to see better margins ahead as the management focuses on quality earnings rather than topline growth this year. He also invited shareholders to share their feedback to help the company operate better.
The fifth perspective
Personally, I thought 2016 was a good year with regards to the management slowing down the company’s growth in order to get things right on the ground. Over the past three years, I was concerned about the company’s singular focus toward expansion. As a customer, I sensed that BreadTalk’s product offerings and service quality had deteriorated across its bakery chains which I wrote about when the company garnered some unwanted publicity.
Since the discussion of this year’s AGM focused on net profit margins, my Fifth Person partner, Victor Chng, broke his silence toward the end of the Q&A session and said he hoped the company to not only concentrate on increasing its margin but to also pay attention to its food quality. Many F&B companies have gotten themselves into trouble when they skimp on the quality of their food to reduce costs on the basis of improving margins. Needless to say, I wholeheartedly agreed with Victor. All the best for 2017, BreadTalk!
P.S. At the meeting, George Quek cautioned us not to go near him as he developed conjunctivitis. We wish you a speedy recovery, Chairman!
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