• JUMBO GROUP LIMITED (SGX:42R)'s 2Q19 earnings in line, growth driven by closure of nonperforming outlets in Singapore.
• Interim DPS of 0.5 Scts declared.
• Growth continues to be driven by margin improvement of Singapore operations.
• Maintain BUY, Target Price S$0.51.

Maintain BUY, S$0.51 Target Price

• We remain positive on Jumbo Group and maintain our BUY recommendation with a Target Price of S$0.51.
• Jumbo Group is on track to post higher margins from
  1. the closure of lower-margin stores and opening of higher-end and higher footfall restaurant outlets;
  2. higher franchise income following a slew of franchise outlets established in FY18; and
  3. absence of expenses incurred for its 30th anniversary celebrations in FY18.
• We also anticipate that performance of new stores would be strongly led by Jumbo Seafood ION, Jumbo Seafood Jewel, and Zui Yu Xuan Teochew Cuisine.
• Jumbo Group trades attractively at 17-19x (pre-exceptional) forward PE (equivalent to -1 SD of its mean PE) and offers a decent dividend yield of 3.6-4.2%.

Where We Differ

• Our FY19F earnings is slightly above consensus. This is largely due to our higher margin expectations from
  1. closure of low margin stores;
  2. addition of higher margin outlets;
  3. contribution of franchise revenue;
  4. lower HQ expenses as mentioned above.

Potential Catalyst

• Faster–than-expected outlet expansion, especially in China, and regional franchises are potential stock catalysts provided its cost structure does not deteriorate considerably. More franchise outlets should also deliver better growth once the number of outlets attains critical mass. The better performance of China outlets could also lift earnings.

Valuation

• We derive our Target Price of S$0.51 based on 23x blended FY19-20F PE, pegged to peer average.

Key Risks to Our View

• Apart from operational risks, we see the failure to deliver growth in China as a key risk to our earnings growth projection. Singapore’s business is stable while the bulk of the growth is driven by China.

What's New - Singapore Operations Driving Growth

2Q19 earnings in line, led by margin expansion of Singapore operations:

• Jumbo Group's 2Q19 earnings of S$5m (+17.6% y-o-y) was in line with expectations on the back of lower revenue (-1.2% y-o-y) of S$41.3m. Gross margin was higher at 64.6% (+1.3ppt y-o-y) while operating profit was S$5.2m (+7% y-o-y).
• The lower revenue and better margins were largely due to a decline in key operating expenses such as staff costs, lease expenses, store closures, and higher franchise income. The margin improvement and earnings growth were mainly driven by Singapore outlets.
• China operations also improved as JV income remained flat, with self-operated outlets posting lower losses as seen from lower positive minority interest contribution. Jumbo Group declared an interim DPS of 0.5 Scts, in line with expectations.

Operating margins higher, lifted by franchise contribution and lower operating costs:

• Jumbo Group's gross margin was 1.3ppt higher at 64.6% on higher franchise income from more outlets compared to FY18. Operating costs were further aided by relatively lower staff, lease and other operating expenses. Lower staff (-3.4% y-o-y, S$12.5m) and lease (-3.7% y-o-y, S$3.6m) expenses were largely from the closure of nonperforming outlets, while other expenses (-10.9% y-o-y, S$3.6m) benefitted from:
  1. lower professional costs from better pricing of professional services employed; and
  2. absence of 30th anniversary celebration expenses seen in FY18.
• The positive impact on store closures for this year will include Jumbo NSRCC, JCafe NSRCC, JPot Vivo City, and Ng Ah Sio Bak Kut Teh Tanjong Katong.

Earnings recovery taking shape as anticipated:

• The improvement in earnings in 2Q19 was a result of closing non-performing stores in Singapore. This led to lower revenue vs last year, but because these stores had higher costs and were yielding lower operating margins, the store closures had a positive impact on margins.
• In addition, there was higher franchise revenue which contributed to higher gross and operating profit as well. We anticipate that new stores - Jumbo Seafood ION, Jumbo Seafood Jewel, and Zui Yu Xuan Teochew Cuisine - would perform well and add to growth going forward, and we believe these outlets have locked in relatively attractive rental rates.

Maintain BUY and S$0.51 Target Price

• This set of results delivered net profit that was in line with our forecasts. Therefore, our earnings estimates of Jumbo Group remain largely unchanged.
• We continue to be positive on Jumbo Group on better margin momentum over the coming quarters. While Singapore operations is on the earnings recovery path, earlier than expected turnaround of earnings contribution in China would be another driver for the stock.
• The stock currently trades attractively at 17-19x (pre-exceptional) forward PE (equivalent to -1 SD of its mean PE) and offers a decent dividend yield of 3.6-4.2%. See Jumbo Group share price, Jumbo Group dividend history.
• Maintain BUY with Target Price based on 23x blended FY19-20F PE at S$0.51.

Source: DBS Research - 15 May 2019