• Keep NEUTRAL and SGD0.40 Target Price, 9% downside.
• JAPAN FOODS HOLDING LTD. (SGX:5OI) is experiencing rising costs pressures from a rapid increase in store count, and the introduction of new brands in Singapore. While moderating consumer discretionary spending and availability of labour remain a near-term challenge, contributions from new brands and its growing regional presence should help it deliver 4% growth in FY20F.
• A net cash position, strong FCF generation, and +4% yield should provide Japan Foods' share price support.

New Brands Continued to Record Strong Growth

• Japan Foods’ key brands, namely Ajisen Ramen, Menya Musashi and Osaka Ohsho, which account for 70% of its revenue, have witnessed y-o-y decline in revenue. As per 1QFY20 (Mar) results, revenue contribution from these three brands fell to 60%.
• However, the latest results seem to suggest that this weakness from key brands was more than offset by higher revenue contribution from new brands, namely Konjiki Hototogisu and Shitamachi Tendon Akimitsu, which registered 60% growth in revenue during 1QFY20.

Rising Costs From Rapid Expansion in Restaurants in Singapore

• In last 12 months,Japan Foods has seen a net addition of seven restaurants in Singapore. Almost all of this expansion came from new brands that were launched during last year.
• While the new brands have contributed positively to revenue, it has also led to an increase in expenses, especially related to new restaurant openings and operating costs for an expanded restaurant network.
• Earnings have also had a marginal negative impact from the adoption of the Singapore Financial Reporting Standards 16 (SFRS16), which relates to lease accounting.

Building Overseas Presence

• After announcing plans to re-enter the Indonesian market, which was then followed up with the announcement of a JV with Minor Singapore to expand Japan Foods’ presence in Thailand, the company recently entered into an agreement with Ajisen China (538 HK) to form a JV that will enable Japan Foods to bring its Konjiki Hototogisu brand to Hong Kong. Japan Foods acquired a 30% stake in the JV for SGD20,400 and shareholder loan of SGD262,000.
• We believe Japan Foods is on the right track to focus on growth overseas, as the domestic market continues to face rising cost pressure and slowing economic growth.

Low Ex-cash Valuation and +4% Yield Should Provide Price Support

• With its net cash balance accounting for 30% of its market cap, Japan Foods’ ex-cash P/E is at a discount to listed restaurant peers in Singapore. In addition, an average annual FCF generation of > SGD3m should support the > 4% yield during FY20F-22F.
• Higher-than-estimated profit contribution from its new brands, and earlier-than-estimated profit contribution from its JVs are likely to re-rate the stock.

Source: RHB Invest Research - 22 Aug 2019