• Stay NEUTRAL with SGD0.45 Target Price from SGD0.48, 5% upside, with 5% FY20F (Mar) yield as we lower FY19F-20F earnings by 12%.
• The ongoing rationalisation of stores and moderating consumer discretionary spending amidst slowing economic growth has dragged profits lower in FY19. While Japan Foods Holding Ltd. (SGX:5OI) continues to improve operational efficiencies, expand regional presence, refresh its ageing brands and launch new franchise brands, intense competition and tight labour supply could keep near-term profits depressed.
• A net cash balance sheet, strong FCF generation and 5% yield should provide support to Japan Foods' share price.
• Sheng Siong Group (SGX:OV8) (SSG SP, BUY, Target Price: SGD1.25), a grocery retailer, is our preferred pick in the Consumer sector.

Further Reduction in Dependence on Foreign Labour

• In the 2019 budget announcement, Finance Minister Heng Swee Keat flagged F&B as a labour-intensive business, while announcing a reduction in foreign worker dependency ratio ceiling (DRC) for the services sector. The DRC, which limits the proportion of foreign workers in a firm, will fall to 35% from 40% in 2021.
• In an already tight labour market, further reduction in DRC will make it difficult for F&B players to grow their businesses. Moreover, the need to improve productivity and implement technological solutions will lead to higher costs.

Brand Portfolio Management and Weak Consumer Spending Have Dragged Revenue Lower for Its Key Brands

• Japan Foods continues to practice good restaurant portfolio management, by taking into account market demand and the individual restaurant’s profitability.
• In the last 12 months, it closed two Ajisen Ramen restaurants and has witnessed temporary closure of one restaurant for re-sizing of floor space. In FY18, this brand accounted for 40% of its total revenue. For other key brands, revenue declined y-o-y during 9M19 due to negative same-store sales growth.

There Are Still Some Bright Spots

• In Dec 2018, Japan Foods announced a 50:50 JV with Minor Singapore (Minor), which will allow it to bring Minor’s Thai restaurants to Japan, while enabling the latter to expand Japan Foods’ brands in Thailand and China.
• While we are yet to incorporate the earnings impact, we remain upbeat on the JV as it will make it possible for Japan Foods to leverage on operational strengths and industry experience of a strong partner and grow its business outside Singapore.

5% Yield Should Provide Price Support

• While near-term earnings growth is expected to remain weak, net cash balance of SGD22m (30% of its market cap) and quarterly FCF generation of SGD1m should support a yield of 5%.
• Strong earnings contribution from its new brands as well as from its JV with Minor could re-rate the stock.

Source: RHB Invest Research - 08 Mar 2019