• Koufu Group's 1Q19 earnings in line, driven by foodcourt management revenue and better operating margins.
• At 16.3x forward PE, valuation is no longer at a discount to peers as growth prospects are priced in.
• Take a pause after 20% return since initiation; downgrade to HOLD on limited upside to S$0.80 Target Price.

Downgrade to HOLD, Target Price Maintained at S$0.80

• We recommend investors to take a pause after our BUY recommendation on KOUFU GROUP LIMITED (SGX:VL6) since our initiation at S$0.66 in August last year (see report: Koufu Group Ltd - DBS Research 2018-08-27: Mouthful Of Fortune). The stock has returned 20% since then, with valuation re-rating from 13x to 16.3x affirming our investment thesis.
• Our earnings forecasts remain unchanged as Koufu Group remains on track to meet our estimates, supported by Marina Bay Sands Foodcourt’s full 12 months of operation this year. The current valuation of 16.3x FY19F PE is in line with peer average, with growth prospects priced in.

Where We Differ

• We are now neutral on the stock as valuation has re-rated and is no longer at a discount to peers. However, fundamentals remain sound, with strong cashflow generation capability, defensive earnings, net cash balance sheet, and strong return on average equity (ROAE).

Potential Catalyst

• This will stem from realisation of economies of scale over the long term and special dividends from sale of its existing central kitchen property before moving into the new integrated facility.
• Longer term drivers include the setting up of an integrated facility aimed at delivering economies of scale, and overseas growth from Macau.

Key Risks to Our View

• Key earnings risks include failure to renew leases, inability to secure new outlets, departure of key tenants and food stalls, customers downtrading to hawker centres and coffee shops, competition from foodcourts that offer more attractive propositions (environment, pricing, food quality etc.) to customers.

What's New - Time to Take a Pause

Koufu's 1Q19 earnings in line:

• Koufu Group's 1Q19 revenue of S$57.8m (+4.9% y-o-y) and core earnings of S$7.2m (+17% y-o-y) were in line with our estimates. Revenue was driven by Outlet and Mall Management segment which grew 9.2% y-o-y to S$29.7m while F&B retail segment was largely flat at S$28.1m.
• Net expansion of outlets. The total number of outlets as at end-1Q19 was 166, increasing by 10 outlets (net basis) from 4Q18. There were two additional foodcourts, two self-operated F&B stalls (from The Woodgrove and Buangkok Square) and six additional F&B kiosks (at 100 AM mall, Tampines MRT, Parkway Parade, Yew Tee Point, Buangkok Square and Macau University).

Better operating margins as costs remained stable:

• Operating margins improved to 16.2% (+2.8ppts) as both cost of sales and operating expenses held steady. The increase in revenue had largely flowed straight to operating profit. Operating costs were largely flat at S$39.6m, with other income increasing to S$1.8m (+25% y-o-y) from reimbursement of renovation fees charged to stall operators of the new outlets, offset by higher staff costs of S$10.3m (+5.6% y-o-y), led by new outlets.
• Growth driven by Marina Bay Sands Foodcourt and new outlets: We see growth for FY19F coming from the full 12- month contribution of two (net basis) new foodcourts that opened in FY18, and Marina Bay Sands Foodcourt, which underwent temporary closure from April 2018 to July 2018.
• More outlets on the way. Going forward, Koufu Group will add three new food courts at 164 Kallang Way (FY19), LeQuest (FY20) and Macau (FY19), one coffee shop at Blk 289C Compassvale Crescent (FY19), one Elemen restaurant, and five more R&B Tea outlets.
• Koufu Group is also currently negotiating with overseas JV partners to bring R&B Tea to Indonesia, Malaysia, Australia and the Philippines, and Elemen restaurant to Indonesia. These could form another revenue and earnings stream going forward if successful.

Overall growth still muted as we expect some drag from new outlets:

• 1Q19 continued to see a net increase in the number of outlets. There would be some drag on growth from startup costs as new outlets are added. Going forward, we see a steady net rollout of new outlets, led by expansion of Supertea and R&B Tea kiosks. There are now 16 kiosks, up from 4 outlets at end-FY17.
• This quarter’s addition of 6 outlets shows management’s intention on growing the Supertea and R&B Tea brands in Singapore and Macau. It targets at least 20 Supertea and R&B outlets by end of FY19.
• While the strong rollout of outlets will boost revenue and gross margins, we believe a breakeven period of 6-9 months is required before these new outlets turn profitable. Our earnings forecast is therefore conservative as we believe any increase in outlet contribution will be dragged by start-up costs and the 6-9 month breakeven period.

Downgrade to HOLD Following Re-rating, Target Price Unchanged at S$0.80

• Our earnings estimates and Target Price of S$0.80 based on 17x FY19F PE are both unchanged since results are largely in line. The stock has returned 20% since our initiation, with valuation re-rating from 13x to 16.3x FY19F PE, which is now in line with SGX listed F&B peers (ex-BreadTalk Group). We excluded BreadTalk Group (SGX:CTN) from the peer average, as BreadTalk Group’s PE multiple includes contribution from investment properties, which results in a higher PE multiple. On an ex-property basis, BreadTalk Group trades at about 19x core PE, which also brings our average PE for the peer group to 17.7x.
• With Koufu’s higher share price, dividend yield has since retraced from 3.8% to 3% as well. While valuation is no longer at a discount to peers, Koufu Group’s fundamentals remain sound.
• Koufu Group still has strong cashflow generation capability, defensive earnings, net cash balance sheet, and strong return on average equity (ROAE). However, Koufu Group's share price upside is limited at this juncture due to valuation, and we advocate investors to take profit. Given the limited upside, we downgrade the stock to HOLD.
• We will review our call when valuations turn more palatable or when catalysts driving earnings upgrades or special dividends materialise.

Source: DBS Research - 7 May 2019