Ajisen China

We valued Japan Foods Holdings (JFH) (see this post), which is running restaurants with Ajisen Ramen brand and other Japanese food brands in Singapore, few weeks ago. Now, we are looking at the sister company in China. But these two Companies are two separate legal entities with no cross holdings. They are both franchisee of Ajisen Ramen brand from Japan and run their business in different countries.

Ajisen (China) Holdings operates restaurant chains with Ajisen Ramen brand in China. As at end of 2015, it runs a total of 673 restaurants, out of which 38 are located in Hong Kong. About 95% of the revenue comes from the restaurants operation and 5% from manufacturing and sales of noodles and related products.

Ajisen China vs Japan Foods

While these two may be considered sister companies running Ajisen brand, the comparison is not really apple to apple. More than 90% of Ajisen China’s revenue comes from Ajisen brand, while less than 50% of JFH’s revenue comes from Ajisen brand. The former has 5% revenue from manufacturing noodles; the latter has none but has diversified Japanese food brands. Let’s compare them as restaurant chains operators, regardless of brands.

Year 2015 Ajisen China Japan Foods Difference
Outlets 673 46 14.6x
Revenue HKD 3,129 SGD 62.6 8.7x
EBIT HKD 368 SGD 4.6 13.8x
EBIT margin 11.7% 7.3% 4.4%
ROA 4.9% 12.4% -7.5%
ROE 6.9% 15.5% -8.6%
ROE (excld net cash) 15.6% 32.3% -16.7%

Based on exchange rate SGD-HKD 5.77.

Note that over the past 3 years, the revenues for both were flat: Ajisen China’s at HKD 3.1 – 3.3 billion and JFH’s at SGD 61 – 63 million. Nice for comparison when there is no growth for both. However, Ajisen China’s margins were stable at 11 – 13% over the past 3 years, while JFH’s margin dropped from ~13% in FY13-14 to 7.3% in FY15. So, the table above compares the Companies when the former has stable margin and the latter is facing falling margin.

Ajisen China’s scale is so much larger than JFH’s. Ajisen China is 14x the size of JFH in terms of the number of outlets, with nearly 9x the revenue. The playing field is also very different with Ajisen China operating in 120 cities with hundreds of millions of population and diverse cultures vs JFH’s 1 city (Singapore) with 5.5 millions of population. Ajisen Ramen can continue to expand its business to several other Tier-2 and Tier-3 cities within China, but JFH is limited to Singapore only unless it starts expanding to other cities in South East Asia, which have very diverse cultures, tastes and currencies.

In terms of returns on investment, JFH’s ROE of 15.5% (while experiencing falling margin) is far superior to Ajisen China’s ROE of 6.9%. As both hold substantial net cash, let’s compare the ROE excluding the net cash. Again, JFH’s ROE (excluding net cash) of 32.3% is 2x Ajisen China’s 15.6%. In other words, at current rate, if both companies open a new outlet, JHF is going to earn back the capital at twice the rate of Ajisen China.

Ajisen China’s IPO and Growth

Two years before its IPO in March 2007, Ajisen China’s ROE was 60 – 80%, impressive to attract many investors and very rational to keep opening new outlets. Right after IPO, it raised so much cash that the ROE immediately dropped to 20%, and since then, it only deteriorated. The nearly HKD 2 billion of cash was not efficiently (very poorly) invested, resulting an overall low ROE of 7% at the moment.

The EBIT margin has dropped from 20 – 30% in FY06-FY10 to 11 – 12% now, reflecting a much competitive environment. Note from the table below that the breakdown of costs into S&A and Other do not accurately reflect the actual cost breakdown. I took these figures directly from Morningstar.com without adjusting them.

Profitability 10Y - 2015

Source: Morningstar.com

The growth of the Company two years prior to IPO and four years after IPO had been tremendous. The number of outlets more than doubled from 56 in FY05 to 120 in FY06. After IPO in March 2007, the number of outlets grew to 662 in FY11. That’s nearly 12x the size in FY05. The GFC in 2008 – 2009 took place and hurt the business substantially, but the operating margins remained very good at around 20%. What happened next is more concerning. The table turnover per day continued to fall for both HK and China businesses, meaning there are fewer and fewer customers visiting the restaurants. There was a steady increase in per capita spending, likely reflecting rising menu price following the inflation. But, that could only partly offset the fall in customer visits, hence, the revenue per day fell.

Operational Stats - 2015

Since FY11, the management took appropriate action to slow down the opening of new outlets, but couldn’t prevent the falling margin. The margin seem to have stabilized over the past 3 years, but now they are facing the problem of falling revenue.

Financials 10Y - 2015

Source: Morningstar.com

 

As a consequence, the share price took a big hit, falling from the peak of 17 to 3.27 now. Current price of 3.27 is less than half the price of 7.10 when it went IPO. So, while the revenue has grown 5 folds and the net profit more than doubled since IPO, more than half of the market value has been destroyed. What happened???

Price Chart - 2015 Apr 29

In 2007, Ajisen China was ranked first among the top 50 fastest-growing Asian enterprises of the year (awarded by Business Week). Its IPO was also named “2007 Best Mid-Cap Equity Deal” by Finance Asia. In 2008, Forbes placed it in “Asia’s 200 Best Under A Billion” list. For such a high profile, high growth company, the valuation during IPO went to sky high. At IPO, the company was valued at around HKD 7 billions. The net profit in 2006 was HKD 113m. That makes TTM P/E of ~62x.

The share price didn’t disappoint after IPO. It rose nearly 100% in the following 9 months before facing the GFC heads-on. After GFC, the market continued its bullish view on the Company’s prospect, as demonstrated in the high valuation multiples of P/E 36.1x for FY10. However, subsequent tougher competition and falling margins bring the valuation to more reasonable range. In the process, shareholders, who bought during the peak of optimism, lost more than 80% of their money. The shareholders, who bought during IPO, still lost more than half of their money.

Valuation Multiples 10Y - 2015

Valuation

I built a simple valuation model using DCF for Ajisen China. In my base case, it’s valued at 3.66bn or share price 3.36. Compared to current price of 3.27, I think it’s fairly valued.

I assumed that in FY16, the revenue fell by 6% and EBIT margin dropped to 11%. I also assumed the growth to be 2.5% for subsequent years, WACC of 11.5% and EBIT to remain at 11%.

My main worry is that the operating margin of 11% is not sustainable as the F&B competition gets tougher and tougher in China. Margin compression occurs across the sectors in China. If the operating margin drops to 7.8% (happened in FY12), then the value estimate of the Company will drop to ~ 2.9 billions HKD (bad case).

If the Company does better than expected, improving its margin slightly and continuing its moderate expansion, it could be worth 4.5 billions (good case). Given its low ROE now, it does not make sense grow aggressively.  So, the room to improve is on the margin, which seems to be what the Management is focusing on.

Considering all the factors, I will stick to my base case (3.36) in valuing this Company instead of using the bad case or good case. As there is no margin of safety, I will call a HOLD. Will relook if the price drops to a more attractive level or the business prospect shows encouraging improvement.

Huge Net Cash

At my valuation of 3.36, this implies TTM P/E of ~16.1x, which seems high for a Company that has slow growth (or even falling growth). This is misled by the huge cash it is holding. The net cash represents approximately half of the market value. Excluding this huge net cash, the adjusted P/E is ~8x, which looks quite cheap for a Company with decent margin, good free cash flow and average ROE (excluding net cash).

The Management should actually return the excess cash to the shareholders as it’s more than enough for expansion for next few years. If a new outlet needs HKD 3m investment, 100 new outlets need 300m. With cash of nearly 2 billions, they could open more than 600 new outlets! At current ROE and tough competition, I guess they will open at most 250 new outlets in the next 3-4 years (will also close many non-performing outlets for sure), requiring capex of around HKD 1 billion. The current dividend yield of ~5% is good and can be well supported by the operating cash flow, with the retained earnings used for expansion.

The excess cash could be returned to shareholders via share repurchased. To my surprise and also delight, the Company plans to initiate stock buyback program in the next AGM. The Management has done a good job at growing the business over the years, a decent job at maintaining the margin in a competitive environment, and a poor job at managing its cash holdings. I hope all these years, they have learned to be more rational with managing its cash holdings. This stock buyback is a good first step.

 

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