• Koufu Group (SGX:VL6) is Singapore’s most profitable listed F&B company. We believe the market has overlooked its growth potential and highly defensive business model.
• Koufu Group’s strategy of growing its core food court business while expanding into other F&B segments marks the beginning of a F&B empire.
• Initiate coverage with BUY and PE-based target price of S$0.95.
• Koufu Group is deeply undervalued at the current 9.6x 2019F ex-cash PE and 3.9% dividend yield. Peers are trading at 20.1x 2019F PE.

Undervalued Due to Lack of Coverage and Short Listing Track Record

Initiate coverage with BUY and PE-based target price of S$0.95.

• This is based on 18.1x 2019F PE, pegged to a 10% discount to peers’ 2019F average. On the back of a growing food services industry, we like Koufu Group for its:
  1. defensive and highly cash-generative business model;
  2. strong balance sheet with net cash;
  3. solid market positioning of core branding;
  4. growth potential through its outlet management business and roll-out of tea beverage brands; and
  5. attractive ex-cash valuation of 9.6x 2019F PE.
• More analyst coverage and a longer listing track record should help improve price discovery and allow Koufu Group to rerate upward.

Deep discount from peers is unwarranted and should narrow.

• Singapore listed food services peers trade at an average of 20.1x 2019F PE. We apply a 10% discount to Koufu Group’s valuation to account for its short listing track record but do not rule out the possibility of bridging this valuation gap in the future as it begins to deliver. At 12.7x 2019F PE, Koufu Group currently trades at a substantial discount to peers.
• After taking into account IPO proceeds, Koufu Group will have net cash of S$91.2m, or 24.5% of its market capitalisation. On an ex-cash basis, Koufu Group trades at only 9.6x 2019F PE. We do not think Koufu Group deserves to be trading at such a substantial discount to peers, given its:
  1. 2019F ROE of 29.0% is the highest among peers;
  2. low gearing;
  3. net cash; and
  4. commitment to a minimum 50% dividend pay-out.
• Currently, Koufu Group also boasts the highest net profit among peers. Furthermore, we think Koufu Group’s growth through expansion of its core food court business and catering to millennials’ consumption preferences is more sustainable compared with companies which rely on back-end productivity and cost cuts to drive bottom-line growth.
• In a sanity check, Koufu Group’s closest peer, Kimly Limited (SGX:1D0), which owns and operates coffee shops in Singapore, is now trading at 12.0x 2019F PE. We think Koufu Group should trade at a premium to Kimly, given its larger profit base, higher ROE and straightforward ownership structure with clear control by a single largest shareholder. Furthermore, Kimly’s recent investigation by the Commercial Affairs Department (CAD) has also created an overhang on its valuation multiple.
• In addition, as Koufu Group embarks on an expansion programme that will transform it into a comprehensive regional F&B player.
• See Figure1 in attached PDF report for detailed peer comparisons.

Net profit to grow 11.8% in 2019.

• We expect net profit growth to be driven by a surge in revenue and an accompanying margin expansion based on efforts to expand the footprint of Koufu’s food courts in Singapore and Macau as well as incremental expansion of R&B Tea and Super Tea in the next three years.

Business Overview: One of the Most Established Players in the Industry

Established player with long operating history.

• With an operating history of at least 16 years since 2002, Koufu Group is one of the most established and largest operators and managers of food courts and coffee shops in Singapore. Currently, Koufu Group has 47 food courts and 15 coffee shops under management and complemented by 71 self-operated F&B stalls.
• Koufu Group also manages one food court and two self-operated F&B stalls in Macau.
• See attached PDF report for Koufu Group's corporate milestones. 

Solid portfolio of brands.

• Since its early days of peddling only the Koufu brand, Koufu Group has spread as far and as wide as possible by introducing new brands to cater to a wide range of customers. Today, Singapore’s food court dining scene will not be complete without Koufu as the group has risen to become one of the largest F&B players.
• Along the way, Koufu Group has also garnered countless accolades as a testament to its enduring value.
• See Figure27 in attached PDF report for Koufu's portfolio of brands. 

Investment Highlights

Established home-grown brand.

• Over the last decade, Koufu Group has expanded to become an established name in Singapore’s F&B scene with more than 60 outlets across the island and in Macau. While the group has developed a portfolio of brands, Koufu remains the flagship brand. The diversification in branding has allowed some of the food courts to be located in close proximity to one another, giving consumers a notion of variety.
• Koufu Group has a strong niche and strives to produce elements that are critical to differentiating services in a fairly competitive food services business by emphasising affordability and quality food. In addition, Koufu’s presence in tertiary educational institutions enables the group to build brand equity among the younger population. This had led to a stronger brand affiliation which in turn creates stickier tenants. As a result, Koufu Group’s outlet and mall management business has seen an occupancy rate of at least 93% in the last three financial years, providing the company a steady flow of income.
• As one of the largest operators of food courts and coffee shops, we note Koufu Group’s extensive footprint represents a virtuous network of brand presence mixed with cost advantages through scale.
• Taken together, Koufu’s brand affiliation and island-wide network represent a wide economic moat.

Solid cash cow business.

• Koufu Group’s focus on offering competitively priced dining options suited to local consumption habits has led to strong y-o-y growth in net profits in 2015-17. In addition to an F&B retail model that transacts in cash terms, the group also collects sales proceeds on behalf of stall operators in food courts and coffee shops under their management. Consequently, the business is cash-generative in nature.
• While Koufu Group does not have a fixed dividend policy, management intends to recommend and distribute dividends of at least 50% of profits for 2018 and 2019. We think this is sustainable, given Koufu Group’s strong cash flow generation. Based on our 2019 net profit forecast, this will translate to a potential dividend yield of 3.9%.

Expanding outlets...

• Koufu Group will focus on expanding in Singapore and Macau. In 2019, we expect Koufu Group to open five new food courts which will bring the total number to 52. In the long run, we think an addition of 2-3 food courts every year is sustainable due to the fragmented markets that Koufu Group operates in.
• For Singapore, it has set its sight on strategic locations in hospitals, educational institutions, commercial malls and new housing estates. In Macau, it will work with local real estate players to secure new sites.
• Adding new outlets will lead to an associated rise in self-operated F&B stalls. Our conservative estimate pegs the ratio of new self-operated F&B stalls to new outlets at 1:1. We estimate capex per new outlet at S$1.7m-2.0m, which is on the higher end of historical capex requirement per outlet (excluding Rasapura).
• Despite its expansion plans, management intends to run a tight outfit and periodically rationalise its portfolio of outlets, weeding out non-performing ones. This strategy will ensure operating margins are sustainable going forward.

…against the backdrop of NTUC Enterprise’s acquisition of Kopitiam.

• NTUC Enterprise Co-operative Ltd (NTUC Enterprise) had proposed to acquire Kopitiam Investment Pte Ltd (Kopitiam) in late-18. The combined footprint of NTUC Foodfare Co-operative Ltd (Foodfare) could yield an island-wide network of 111 outlets, creating the largest industry player by number of outlets. We think this acquisition will not adversely impact the industry landscape and may represent an opportunity for other established players such as Koufu.
• We do not think NTUC Enterprise’s overarching social mission to provide affordable food is in conflict with its profit-oriented business model, and NTUC Enterprise will seek to strike a balance between public and business interests. Consequently, across-the-board reduction in Kopitiam food prices is unlikely. Instead, Kopitiam’s penchant for aggressive site bidding will need to be aligned. This will rein in Kopitiam’s competitive bidding streak and reduce probabilities of runaway tender site bids that we witnessed in the Sengkang Square debacle.
• In addition, maintaining two separate operations for entities within the same industry is excessive over the long term and NTUC Enterprise may explore ways to reap synergies and economies of scale. This could be achieved through deeper integration of Foodfare and Kopitiam back-end operations and rationalising the chain of outlets held by the two entities.
• With the largest combined number of outlets and possible integration of back-end operations, Kopitiam and Foodfare may not dip into the tender unit market in the short term. In the event where Kopitiam and Foodfare may tender for new outlets, we expect both to exercise financial discipline with the resultant knock-on effect of more reasonable tender prices and healthier margins for industry players.
• We also draw comfort from the Competition and Consumer Commission of Singapore’s (CCCS) findings of there being at least five other established competing operators remaining post-merger in all catchment areas, which implies that there is no single precinct that is monopolised by the combined entity.
• On balance, Koufu Group will not experience undue margin pressure as a result of low food or rental prices and should continue to see expansion opportunities within the food court segment akin to what we are witnessing in the supermarket space where Sheng Siong continues to compete effectively against NTUC Fairprice. Food courts and coffee shop related operations will continue to form the bulwark of Koufu Group’s profits and management’s intent to grow this steady business in Singapore and Macau will provide a solid platform of growth for Koufu Group.

Advancing into the millennial realm.

• On top of the hawker fares that Koufu Group offers, the group is taking steps to appeal to millennials’ taste buds by setting up food courts in tertiary institutions and venturing into F&B offerings such as tea beverages which are highly popular with a younger crowd.
• The R&B Tea brand is Koufu Group’s first foray into the tea business, with the first outlet in Marina Square in 2017.
• Super Tea (S) Pte Ltd is a 60% partnership with Suzhou Nine Dragon Ball Catering Trade Management Co Ltd (苏州九龙珠餐饮管理有限公司), a Taiwanese bubble tea company. The partnership accords Koufu Group exclusive licences to the R&B Tea (R&B) and Supertea (ST) brands for markets such as Macau and the Southeast Asia region excluding Cambodia and Vietnam. Excluding the regions under Koufu Group’s exclusive licences, there are more than 800 R&B Tea and Supertea outlets in Asia.
• The initial positive market reception prompted R&B Tea’s further expansion and an introduction of Supertea – a contemporary concept store selling tea beverages and bread. The distinctive flavour of its Brown Sugar Boba Milk Tea and word-of-mouth marketing culminated in Marina Bay Sands’ R&B Tea outlet achieving 1,200 cups sold in a day.
• Currently, Koufu Group operates 12 R&B Tea and Supertea kiosks. Backed by strong demand and optimism over its ability to remain relevant to trending tastes, management is guiding for an eventual roll-out of 50 R&B Tea and Supertea kiosks across Singapore.
• R&B Tea’s market positioning will be unlike that of incumbents Koi The Singapore and LiHO where it will seek to constantly refresh its tea beverage product range. We understand that this strategy was pursued to ensure the coexistence of various big name brands within the same vicinity while allowing R&B Tea to grow its market share through enlarging the industry’s pie. Koufu Group’s existing tenancies may also be carved out to house R&B Tea to aid its rapid roll-out.
• In addition to R&B Tea, Koufu Group has ventured into Elemen full-service restaurants. The restaurants serve natural meatless cuisine at higher price points. Currently, Koufu Group has three Elemen restaurants and is expecting to open another outlet at Paya Lebar Quarter in 2Q19. The expansion into different F&B segments will allow Koufu Group to expand its customer base and capture new markets. We also note that a “house of brands”, each with its own strength, image and loyal following, can have more staying and growing power than a “branded house”.

Disposal of two central kitchens should unlock value and open doors for a special dividend.

• Koufu Group operates two central kitchens - one for non-Halal and one for Halal food preparation at 18 and 20 Woodland Terrace respectively.
• In light of the upcoming launch of the integrated facility, management had indicated on several occasions its intention to sell these two properties. Based on the average market selling price of S$269psf, we expect the properties to fetch a combined S$10m, which could lead to Koufu Group announcing higher dividends.
• We estimate the sale could generate an S$8m gains. This had not been factored into our earnings forecasts as we await certainty over completion of the sale.

Integrated facility is a top-line contributor.

• With construction slated to begin in 4Q18 and targeted completion by 2H20, Koufu Group’s new integrated facility will drive and support its growth. The 20,000sqm integrated facility will include a larger central kitchen and a centralised dishwashing facility, and bring about improvement in productivity and operational efficiency. In addition, the centralised dishwashing facility could potentially free up more lettable space and boost leasing revenue.
• Management’s plans to maximise the use of the integrated facility by leasing out floor space to food-court tenants as central kitchens as well as setting up a food court to maximise revenue generated from the building. A training centre to provide training and upskilling of employees is also in the works, in line with government initiatives to boost the services sector’s productivity. Taken together, management expects the integrated facility to be a net positive contributor to Koufu Group’s bottom line.

Unaffected by tightening foreign manpower policy.

• The government is tightening the foreign workforce quota through the reduction of Dependency Ratio Ceiling (DRC) and S Pass sub-DRC. The first phase of reduction from 1 Jan 20 will see DRC for the services sector reduced to 38% from the current 40% while sub-DRC will drop to 13% from the current 15%. On 1 Jan 21, the DRC for the services sector will fall further to 35% and sub-DRC will be cut to 10%.
• Management had shared that its current DRC is below the requirement in 2021 and is thus not affected by the tightening in the DRC.

Industry: Steady Growth Ahead

• See attached PDF report for detailed analysis. 

Financial Outlook: Good Mix of Cash Cows and High Growth

Revenue CAGR of 8.5% CAGR in 2018-21.

• We expect revenue from outlet and mall management and F&B retail to grow at CAGR of 8.5% in 2018-21, driven by expansion of outlet network as well as rapid roll-out of R&B Tea and Supertea. We forecast group revenue of S$241.1m, S$264.4m and S$286.0m in 2019-21 respectively.
• Koufu Group has a proven track record in identifying key market trends and riding it. We expect this trend to persist. The group’s move into food courts was well-timed and Koufu Group has reaped the benefits through steady headline growth. This story appears to be repeating with the popularity of its tea beverage brands and focus on healthier food options.
• While food court operations represent a well-established base for steady growth in cash flows and investor returns, we think a well-executed expansion of R&B Tea and Supertea will provide an additional leap to F&B retail’s growth prospects.

Net profit CAGR of 11.4%.

• Koufu Group is expected to enjoy profit growth driven by new outlets coming on stream in 2019, incremental expansion of its food court network and the ramp-up of R&B Tea and Supertea. Investors can also look forward to margin expansion driven by the high net margins of Koufu Group’s tea beverage business. However, we account for depreciation of the integrated facility beginning 2H20 but keep our forecasts on revenue contribution conservative at S$389,000 and S$1.6m in 2020-21 respectively.
• We forecast net profits at S$29.2m, S$31.5m and S$33.8m in 2019-21 respectively.

Strong earnings to sustain dividends.

• Despite a strong pipeline of new openings and the launch of the integrated facility in 2020, Koufu Group should still be able to build up strong cash flows through the steady ramp-up of new outlets and existing outlets.
• We expect robust operating cash flow of S$36.1m, S$42.6m and S$50.0m in 2019-21 respectively which should sustain dividends of at least 2.6 S cents, based on a 50% dividend payout ratio.

Management

Mr Pang Lim, CEO and Executive Chairman.

• Mr Pang is one of the founding shareholders of Koufu Group and has more than 27 years of experience in the F&B and food service management industry. Mr Pang is responsible for the overall management and operations of the group, setting and executing the strategic directions and expansion plans for the growth and development of the group, including sourcing for investment opportunities to promote the growth of the group’s business.

Mdm Ng Hoon Tien, Executive Director.

• Mdm Ng is one of the founding shareholders of Koufu Group and has more than 15 years of experience in the F&B and food service management industry. Mdm Ng is responsible for overseeing the operations of the Group. Mdm. Ng also assists the Executive Chairman and CEO in the formulation and implementation of Koufu Group’s business strategies and the F&B operations of the group.

Risk Factors

• Failure to renew leases.
• Inability to secure new outlets.
• Departure of key tenants and food stalls. 
• Changing consumer preferences.
• Higher-than-expected competition. 
• Execution risks on expansion plans. 

Source: UOB Kay Hian Research - 08 Mar 2019