BreadTalk Group Limited (“BTG”) is facing a series of operational challenges amid the coronavirus outbreak. Newly set up overseas outlets have not made a meaningful contribution to earnings, and the virus situation has posed a setback to the group’s business expansion activities. Recently, BTG launched a new food concept division to grow its brand portfolio and acquired Food Junction Group (“FJG”) to increase market share in the food atrium segment.

The group’s weak financial performance resulted in a breach of bond covenants as it did not maintain the required level of consolidated tangible net worth. To streamline the business and provide greater management flexibility, BTG’s founder led a privatisation offer for his company, potentially triggering a delisting put option to bondholders of BREAD 4.000% 17Jan2023 Corp (SGD).

In this article, we will examine BreadTalk’s latest financial results and evaluate the possible options for bondholders. Investors may also refer to our related article – “The BreadTalk 4% 2023 notes are priced just right” for a detailed view on BTG’s credit profile.

Recent management changes

On 31 Jan 20, the group announced that Mr Chan Ying Jian had resigned as the Group Chief Financial Officer (“CFO”) and Group Chief Investment Officer (“CIO”) with effect from 15 Mar 20. Mr Chan was appointed as the Group CFO in June 2015 and Group CIO last October. He was responsible for the corporate finance, treasury, shared services and risk management functions across the group’s business. As Group CFO, he was also in charge of planning and executing the group’s corporate strategies.

We also noted that in August 2019, former CEO Mr Chu Heng Hwee announced his resignation citing personal and health reasons. Mr Chu had a rather short stint at the company as he was appointed in July 2017. During his tenure, he led several of BTG’s overseas expansions, such as the opening of bakery chains in China, Indonesia and Thailand.

We do not see any immediate and significant credit impacts arising from BTG’s management shifts. The last major project involving Mr Chan prior to his resignation was the FJG acquisition. On 26 Feb 20, BreadTalk announced the appointment of a new Group CFO, Mr Chong Chow Pin.

The FJG acquisition: more challenges ahead?

In September last year, BTG announced the acquisition of a 100% stake in FJG, a private company that operated 12 food courts in Singapore and 4 in Malaysia (one of which opened in 2020 at Mid Valley Southkey, Johor Bahru).

While the acquisition will boost BreadTalk’s market share among food court operators, the Competition & Consumer Commission of Singapore has, via an approval statement, said that BTG’s market share among food court operators will remain below 20%. This means that BTG will still face steep competition with other established food vendors like Kopitiam and Koufu, on top of a fragmented F&B sector filled with many other boutique players.

In hindsight, the acquisition cost of S$80.0m was relatively large compared to the company’s net assets of S$147.1m (as at 3Q19). As 60% of the acquisition was funded by debt, BTG’s net gearing was undoubtedly pushed higher. We are credit negative on this transaction.

FY19 results

BTG reported revenue of S$664.9m in FY19, up 9% YoY from S$609.8m in the previous year led by sales growth across all divisions. However, it reported a loss after tax of S$5.2m primarily due to weaker performance from its bakery and 4orth divisions as well as operating losses from China and Hongkong. Group profitability declined slightly as gross profit margin dropped to 55.6% from 56.3% in FY18.

The bakery division made a loss (before tax) of S$13.5m during the year primarily due to a one-off S$6.1m impairment of pre-mature outlet closures and inventory obsolescence. More importantly, its China and Hong Kong bakeries as well as Indonesia ToastBox business saw a widening of operating losses in the year. Other regions also delivered poor performances. The Thailand Bakery segment reported losses and there was a decline of profitability in its Singapore bakeries.

The food atrium division saw a 5.3% YoY increase in revenue to S$165.3m, in part due to S$7.8m of contributions from the consolidation of FJG, which has commenced consolidation from 1 Nov 19. After including S$0.2m from FJG, profit before tax (“PBT”) for the division dropped 19.3% YoY to S$13.5m. With a sub-division PBT margin of just 2.6% from FJG (derived from the PBT of S$0.2m and S$7.8m revenue), the addition of the Food Junction Group did not seem to lift division profitability at this juncture. Overall, the division saw weaker profitability with PBT margin down from 10.7% in FY18 to 8.2% in FY19.

The restaurant division, which operates its anchor brand Din Tai Fung, saw revenue rising 15.0% YoY to S$175.2m as a result of the addition of 6 outlets. It entered into the UK market after opening its first Din Tai Fung restaurant in London during Dec 18. While the UK restaurant operation has yet to turn profitable, the division was nevertheless in the green achieving S$23.4m of profit before tax, up 0.2% from a year ago.

Finally, the 4orth division, a food concept segment comprising several F&B brands like Nayuki, TaiGai and So Ramen delivered revenue of S$32.5m in FY19. Revenue was significantly higher from S$14.2m in the previous year as the division expanded operations into China and Thailand with a total of 25 outlets (FY18: 12 outlets). That being said, these business initiatives may take time to get off the ground even though some of the brands have an established history prior to joining 4orth. The segment reported a loss of S$10.8m primarily due to start-up costs for new outlets and sub-par performance from existing outlets.

BTG incurred S$22.1m (FY18: S$9.2m) of interest expenses during the year, contributed by S$8.8m of interest related to borrowings and S$13.3m on lease expenses which the group is required to recognise on its financial statements due to the mandatory adoption of new accounting rules. BTG reported EBITDA of S$208.9m, which covers around 9.5x of its interest expenses, or ~6.3x excluding the effect of the new accounting rules.

Credit considerations: technical breach of bond covenants

In tandem with the loss which adversely impacted the company’s accumulated profit, the group technically breached its financial covenant stipulated within its S$100m outstanding BREAD 4.000% 17Jan2023 Corp (SGD). BTG’s consolidated tangible net worth decreased to S$53.3m (including the effects from new accounting rules), which was below the minimum requirement of S$75m. According to the firm, its bank covenants are similar to those of its bond covenants.

Upon a technical breach of financial covenants, BreadTalk’s total debt load of S$347.2m (31 Dec 18: S$226.7m) has been reclassified as short term debt, immediately tightening its liquidity profile with a cash balance of S$157.6m. Meanwhile, net gearing (net debt/equity) due to increased total borrowings climbed to 1.3x (31 Dec 18: 0.3x).

We are not overly concerned about the breach of financial covenants in view of the ongoing privitisation attempt which could trigger a cessation put on the bonds if successful. In addition, the group has also announced a list of proposals (see Table 1) regarding the matter, seeking bondholders’ approval to waive the technical breach.

Table 1: Consent solicitation proposal

At this juncture, we will reserve our recommendations on the proposal until more details on the group’s consent solicitation package is announced. To our understanding, the covenant breach resulted from a challenging operating environment and mandatory adoption of new accounting rules. As such, waiving off the breach would better allow time for the group to focus on its business strategies so as to turn around its loss-making divisions. Per BreadTalk, the group is expected to be in a position to pay interest payments on the notes as and when they are due.

Meanwhile, the proposed package in Table 1 suggests that BreadTalk is seeking more flexibility from noteholders which would elevate the credit risk of holding the bonds. For example, items 3 and 4 implies a weak business outlook which may be related to uncertainties from the COVID-19 situation. Overall, the amendments in essence mean that noteholders have to anticipate a possible greater degree of financial deterioration from its business operations.

In view of the consent solicitation proposal and a weak credit outlook for the company,  we think noteholders should be reasonably compensated in exchange for the additional flexibility to stay invested with BTG. Moving forward, we will update bondholders as more information is released. As of now, the indicative timeline to launch a consent solicitation exercise is in late March.

Privatisation in the works

On 25 Feb 20, BreadTalk’s major shareholders Dr George Quek and his wife Ms Katherine Lee launched a voluntary conditional cash offer to acquire all of the issued ordinary shares in the firm at a price of S$0.77 apiece. This represents a 19.4% premium from the last traded price before the announcement on 21 Feb 20.

The group of consortium partners including Minor BT, an investment holding company ultimately controlled by Thailand-listed hospitality and leisure firm Minor International PCL, are initiating this offer. Altogether, these consortium partners own 70.53% of controlling stake in BTG. Upon completion of the transaction, the acquirers intend to delist BreadTalk from the SGX.

Pursuant to the offer announcement, the consortium partners believe that privatising the company will enable a greater flexibility to address ongoing challenges. The acquirers intend to refocus and strengthen core business activities, and explore potential corporate actions including the disposal of non-core property assets. Additionally, there are no plans to introduce major changes to the business of the company, re-deploy any of its fixed assets or discontinue the employment of its employees.

We think there are pros and cons to BTG’s privatisation. On the positive side, delisting would save the group costs relating to maintaining its listing status. As previously mentioned, the privatisation will not substantially manoeuvre BTG’s operations away from its core business competencies. The co-founders Dr Quek and his wife Ms Lee will also likely remain in their positions as the Chairman and Deputy Chairman of the group respectively.

On the other hand, taking BTG private means bondholders may receive limited financial disclosures from the group. While BTG’s credit profile broadly remained at a healthy level, it has nevertheless showed deterioration in recent years largely due to a change of accounting standards and capex needs for its overseas expansion plans and new business initiatives. Bondholders may face difficulties in gauging BTG’s credit risks when there is less financial disclosures.

In our opinion, it is likely that the privatisation bid will go through successfully and BreadTalk will be delisted thereafter given that the offer represents a decent premium over the closing price on 21 Feb 20. Per its SGX filings, the offer will remain open for acceptances by shareholders for a period of at least 28 days from the date of the posting offer documents.

Conclusion

In summary, we conclude that BTG is sailing into many headwinds. On the external front, the Coronavirus outbreak is likely to impact BTG’s business operations, especially on its F&B retail outlets in mainland China and Hong Kong. Internally, the group is experiencing leadership changes and strategic directions which embeds uncertainties.

In addition, its 4orth food concepts division formed in 2017 remains at a loss-making phase as the group began to introduce more franchised brands only in 2018. Therefore, the segment may need more capital expenditure going forward before it enters into a mature phase where it will start generating profits.

On the other hand, we think BreadTalk still exerts brand value to many Singaporeans as a home-grown bakery, as evident by its steady growth in revenue over the years. In view of the deteriorating financial performance, uncertain business plans and challenging business outlook, we will continue to monitor the group’s business developments moving forward. Accordingly, bondholders will be updated on the implications of future engagement exercises.

Declaration: 

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a principal interest in the BREAD 4.000% 17Jan2023 Corp (SGD). The analyst who produces this report own none of the above mentioned securities.