• Koufu's 3Q19 core net profit growth of 19% y-o-y was in line with expectations, with 9M19 core net profit meeting 72.6% of our full-year forecast. Earnings was lifted by new outlets, growth in existing outlets as well as margin expansion.
• Outlook remains robust with two new food courts due to open in 2020 and a higher target of 29 bubble tea outlets by end-19.
• Maintain BUY and target price of S$0.95.
• Koufu is undervalued at 13.6x 2020F PE, vs peers’ average of 18.7x 2020F PE.

3q19 Results

3Q19 net profit of S$7.2m in line with estimates.

• KOUFU GROUP (SGX:VL6)’s 3Q19 core net profit grew 19% y-o-y (excluding one-off IPO expense in 3Q18), with 9M19 core net profit forming 72.6% of our full-year estimate. See Koufu Announcements.
• We deem the results to be in line as 4Q is typically a stronger quarter (4Q18 and 4Q17 formed 28.8% and 27.0% of full-year core net profit respectively).
• The strong earnings were driven mainly by higher revenue contribution from the outlet & mall management (+6.2% y-o-y) and F&B retail segments (+7.3% y-o-y) on the back of new outlets and same-store sales growth. In addition, core net margin expanded to 11.5% (+1.2ppt), in line with the improvement in food court performance which flows straight into bottom line due to the high operating leverage of the business.

New outlets to support steady growth.

• Koufu opened two new food courts at 116 Kallang Way and Millenia Walk in 3Q19, tracking our expectations of five new food courts in 2019. This brings the number of food courts operated by the group to 51 (Singapore: 49, Macao: 2).
• In addition, leases for an additional two new food courts (one each in Singapore and Macao) have been secured and they are expected to open in 2020. Thus, our estimate of three more food court openings in 2020 is achievable.
• For the F&B retail segment, the group expanded its full-service vegetarian restaurant - Elemen - with two new openings in 3Q19.
• Management shared that the Elemen business has been well received; impressively more e customers are non-vegetarians.

Surpassed initial target of 25 bubble tea outlets by end-19.

• Koufu opened five new R&B Tea outlets in Singapore in 3Q19. Plans are underway for further expansion as 10 new locations have been secured and are slated to open progressively from 4Q19 to 2020. Therefore, the group has set a new target of at least 29 R&B Tea and SuperTea outlets by end-19, from initially guided 25 outlets.
• We understand that the group is unlikely to expand the brand next year as aggressively as in this year in terms of number of outlets. However, the group is on the lookout for opportunities to expand the brand to Philippines and Thailand (potentially through JVs), in line with its strategy to expand overseas once the brand has established a strong foothold in Singapore.
• Based on data by GrabFood, the average monthly consumption per GrabFood user in Thailand and Philippines is 5-6 cups. Koufu is also expecting to open its first R&B Tea outlet in Malacca, Malaysia, in mid-Nov 19.

Stock Impact

Steady growth ahead.

• With full-year contribution from newly renovated Rasapura, new outlets ramping up and roll-out of R&B Tea outlets, we believe net profit is on track to meet our forecast 19% growth in 2019. Earnings momentum for 2020 will be driven by the full-year effect of five new food courts opened this year (we estimate three more food courts in 2020), steady growth of older outlets as well as increased contribution from the high-margin bubble tea business.
• While the food court business provides steady growth and makes up the bulk of earnings, we believe Koufu’s strategy of expanding into different F&B segments through its venture into Elemen restaurants and bubble tea business will provide incremental earnings in the long term.

Strong cash position.

• Koufu’s solid performance and cash generation ability has helped it build a significant net cash of S$91.6m as of 3Q19, equivalent to 21% of its market capitalisation, translating to an attractive ex-cash valuation of 10.7x 2020F PE.

Earnings Revision / Risk

• We maintain our earnings estimates.
• Risks include failure to renew leases, inability to secure new outlets, departure of key tenants and food stalls, changing consumer preferences, higher-than-expected competition, and execution risks on expansion plans.

Valuation / Recommendation

• Maintain BUY and PE-based target price of S$0.95, pegged at 16.8x 2020F PE (previously 18.1x 2019F PE), or a 10% discount to peers’ average 2020F PE of 16.8x as we roll valuation to 2020. See Koufu Share Price; Koufu Target Price.
• Koufu has the highest 2020F ROE, lowest gearing and is the most profitable among peers. At 13.6x 2020F PE, Koufu currently trades at a deep discount to peers.

Share Price Catalyst

• Sale of two central kitchens and special dividend.
• Better-than-expected contribution from food court management and R&B Tea.

Source: UOB Kay Hian Research - 6 Nov 2019