The BreadTalk 4% 2023 notes are priced just right

• BreadTalk reported decent financial results with most of the reporting segments delivering positive revenue growth. Food Atrium was the key performance driver with EBITDA margin rising to 19.9% in 2018.
• BreadTalk’s liquidity is decent with sufficient cash to cover short-term debts. Leverage ratios are healthy albeit likely to increase in the coming years due to changes in accounting standards. Overseas expansion plans may also push net gearing higher.
• We think the BREAD 4% ’23s are fairly priced, offering reasonable yield pickup against the FNNSP curve and some real estate credits that have exposure to the retail sector.

A home-grown global brand

Established since 2000, BreadTalk Group Limited (“BTG”) is a leading bakery and restaurant operator based in Singapore. The company was listed on the mainboard of SGX since 2003 and sported a market cap of S$487.7m at market’s close yesterday.

The group was founded by Dr George Quek Meng Tong, who drives the strategic direction and development of BTG and lead the board of directors as chairman. His wife, Ms Katherine Lee Lih Leng, oversees the group’s product research and development initiatives and sits on the board as deputy chairman. The Quek couple controls around 52.6% of BTG’s shares.

Besides the founders, BTG’s substantial shareholders include Primacy Investment Ltd and Paradice Investment Management LLC, which own 14.0% and 6.3% of BTG’s shares respectively. Primacy is a wholly-owned subsidiary of Minor Food Group PCL, which is in turn 99.7%-held by Minor International Public Co Ltd, a hospitality and leisure company listed on the Stock Exchange of Thailand with a market cap of THB175.5 billion (~S$7.6 billion). Paradice is a fund manager in the US and holds BTG shares in its client portfolios.

Started off with just one BreadTalk outlet at Bugis Junction selling its signature floss bun with spiralling queues in 2000, BTG has expanded its business over the years to be a bakery that is known to almost every Singaporean today. The group reports four main business segments namely bakery, food atrium, restaurant and 4orth. Each reporting segment has its own operating brands, such as BreadTalk, Toast Box, Food Republic and Din Tai Fung (see Chart 1).

Bakery segment generates the most revenue at S$282.0m in FY18 (FY17: S$297.0m), while the food atrium segment is the most profitable by segment earnings before interest, depreciation and amortisation (“EBITDA”), posting S$31.2m of EBITDA in FY18 (FY17: S$25.1m). Overall, these four segments sported EBITDA margins (segment EBITDA/revenue) of 8.0%, 19.9%, 18.5%, and negative 20.4% respectively in FY18.

Chart 1: BTG’s revenue and EBITDA segmental breakdown (FY18)

BTG has grown its operating scale significantly over the years. The group now owns a total of 963 (FY17: 956) outlets, with 863 (642 of which are franchise stores) operating under the bakery segment, 60 under food atrium (55 food courts and five direct operated restaurants), 28 Din Tai Fung outlets under the restaurant segment, and twelve under the 4orth segment, which runs food and beverage (“F&B”) chains like Song Fa and Sõ.

These outlets spread across mainly Asia, including Singapore, China, and Hong Kong. As a home-grown brand, around S$354.5m out of S$609.8m of total revenue in FY18 was generated in Singapore. China also contributed substantially with S$160.1m of revenue during the year, while Hong Kong and the rest of the world contributed S$49.7m and S$45.6m respectively (see Chart 2).

Chart 2: BTG’s revenue breakdown by geography (FY18)

The F&B sector is fragmented, with players from boutique cafes to large F&B food chains. While we are unable to determine the exact market share of BTG, we believe the group has a sizeable presence. Among the SGX-listed F&B companies listed in Table 1, BTG topped the list in terms of both market cap and revenue (See Table 1).

Table 1: SGX-listed F&B entities

2018 operating performance review

Decent revenue growth from all segments

Revenue from bakery division fell 5.1% YoY to S$282.0m during FY18 due to lower revenue from directly-managed stores in Shanghai, Beijing, and Hong Kong, and lower franchise revenue from China. That said, stronger revenue from directly-operated stores in Singapore and higher international franchise revenue helped to offset some of these weaknesses. During the year, the bakery segment closed 19 directly-operated outlets and added 11 franchise outlets.

Revenue from food atrium division rose 5.1% YoY to S$156.9m, corresponding to more stores added to the segment. In FY18, the group opened one food atrium each in Shenzhen, Hong Kong, and Cambodia, and closed its only Hangzhou store. BTG also opened three directly-operated restaurants in smaller store formats in shopping malls under the “Sergeant Kitchen” brand.

Restaurant division, which houses the well-known “Din Tai Fung” brand, saw revenue rise 8.2% YoY to S$152.3m on the back of the net addition of three outlets.

Finally, the 4orth division recorded a revenue of S$14.2m in FY18, up from S$7.9m in the previous year due to a widening brand portfolio. The 4orth Food Concepts Division was formed recently in 2017 to create new F&B concepts and foster partnerships with established brands, and it operated just five Sõ Ramen stores in the previous financial year. In 2018, the segment added four Song Fa Bak Kut Teh, one TaiGai, one Nayuki, and one Wu Pao Chun Bakery outlets.

Food atrium is the biggest earnings contributor

EBITDA in the bakery and restaurant segments fell 1.8% and 6.6% YoY to S$22.6m and S$28.1m respectively. The bakery segment saw lower EBITDA mainly due to lower profitability from its China operations, while higher staff and administrative costs related to the start-up costs of UK operations weighed on the restaurant segment’s EBITDA. Overall, EDITDA margin in bakery was flattish at 8.0% (FY17: 7.8%), while restaurant’s EBITDA margin fell to 18.5% (FY17: 21.4%).

Food atrium outperformed the other segments and overleaped restaurant as the biggest EBITDA contributor, generating S$31.2m (+24.3% YoY) of EBITDA in FY18. The robust performance was supported by low stall vacancy and stronger same-store sales growth momentum. EBITDA margin for the segment rose to 19.9% (FY17: 16.8%).

Last but not least, 4orth Division reported a loss before interest, tax, depreciation and amortization of S$2.9m primarily due to pre-opening expenses incurred ahead of new outlets opening towards 4Q18. We note that the segment is still at its start-up phase as the group began to introduce more franchised brands only in 2018. Therefore, the segment may need more capital expenditure (“capex”) going forward before it enters into a matured phase and starts generating stable profitability.

Besides injecting new brands, BTG also seeks growth in its matured segments like bakery via strategic partnerships. For example, the company partnered in March with Wu Pao Chun Bakery to operate bakeries under the eponymous brand in several cities of China. Thereafter in June, the company formed a new strategic partnership with Mr Ge Ying to operate the BreadTalk brand of bakeries in Chongqing and potentially expand in the South-western region of China.

Despite the effort in striving for business growth, share of results from associates and joint ventures aggregated to a combined loss of S$1.8m, compared to a profit of S$0.2m in FY17. However, we think the losses may be temporary, as newly opened stores and business initiatives typically take some time to get off the ground.

Thankfully, cost of sales barely moved from the S$266m level (FY17: S$266.5m), reflecting the group’s effective cost management through centralised procurement. On the other hand, distribution and selling and administrative expenses rose 0.7% YoY and 16.0% YoY to S$243.3m and S$93.7m respectively in FY18, at a faster pace than the increase in revenue. This is in line with the net addition of outlets during the year. Overall, profit before tax dropped 23.7% YoY to S$31.1m.

In summary, it seems to us that the bakery segment remained as BTG’s largest operating segment while the group explores possible options to groom more anchoring brands, on top of the existing “BreadTalk” and “Din Tai Fung” brands. We are encouraged by the management initiatives, but are aware that this may come at the cost of higher capex. Capex as a percentage of sales rose from 5.0% in FY17 to 7.9% in FY18.

Credit Highlights

Net gearing may increase due to change of accounting standards and capex needs

BTG has a debt load of S$226.7m as at 4Q18, up from S$183.3 in 4Q17 mainly due to the issuance of the S$100m BREAD 4.000% 17Jan2023 Corp (SGD) in January 2018. Despite the increased debt balance, net gearing (net debt/equity) dropped to 25.6% as at 4Q18, down from 27.2% in 4Q17. The improvement in net gearing was largely due to an increase in total equity to S$162.7m (4Q17: S$154.9m), which was attributable to the earnings generated in 2018.

In 2019, BTG will adopt new accounting methods pursuant to Singapore Financial Reporting Standards (International) 16 (“SFRS(I) 16”). Under SFRS(I) 16, BTG is required to recognise most leases on its balance. This means that the group will classify most assets previously categorized under operating leases as “right-of-use” assets, with corresponding lease liabilities. BTG will also separately recognise the interest expense on the lease liability and the depreciation expense on the right-of-use asset.

On the adoption of SFRS(I) 16, BTG expects to recognise right-of-use assets of S$343.4m and lease liabilities of S$369.4m. If we include such leases liabilities to BTG’s borrowings, the changes in accounting treatment of leases are likely to bring about higher gearing ratios.

In its financial statements for the year ended 31 Dec 18, BTG claimed that it has done the necessary preparation work to comply with loan covenants upon the transition, and leave sufficient debt headroom to fund the group’s expansion plans.

In any case, while the changes in accounting standards should push BTG’s gearing ratios higher, they do not fundamentally alter the company’s overall healthy credit standing and business profile. In other ways, it is the same company before and after the adoption of the new accounting methods; only the way it presents itself to the world will change.

Other off-balance sheet commitments include corporate guarantees given by BTG in connection with loan facilities undertaken by some of its subsidiaries. The exposure on corporate guarantees amounted to S$47.4m as at 4Q18 (4Q17: S$82.3m).

Finally, higher capex needs for the group’s expansion plans in the coming years will likely deploy BTG’s cash pile and lead to higher financial leverage.

Moderate interest coverage

In FY18, BTG generated an EBITDA of S$78.5m, down from S$84.3m in FY17 for reasons explained above. Net interest expense rose to S$6.0m from S$3.2m over the same period, reflecting BTG’s heavier debt load.

Another contributor to the increase in interest expenses is likely the rise of borrowing cost on the group’s floating-rate loans. The range of effective interest rates on BTG’s floating-rate loans rose from 2.0-3.9% at the end of 2017 to 2.8-4.9% as at 31 Dec 18. This largely reflects the broad-based increase in interest rates and credit spreads we have seen over 2018.

As a result, BTG’s interest coverage ratio (EBITDA/net interest expense) fell to 13.0x in FY18 (FY17: 26.4x), which is still healthy in our view. As measured by EBIT/net interest expense, BTG’s interest coverage would be 6.1x (FY17: 13.7x).

We note that financial covenants in the bond documentation stipulate a minimum interest coverage ratio (EBITDA/interest expense) of 3.5x. The current level of interest coverage hence reflects a comfortable margin of safety.

Strong cash flow position and ample liquidity

BTG has S$185.0m of cash as at 4Q18, up from S$141.2m a year ago largely with the help of the issuance of BREAD 4% ’23s. The company’s net cash flow from financing activities in 2018 was S$30.0m.

The F&B industry typically exhibits quick cash collection, and BTG’s cash conversion cycle (“CCC”) has been excellent. We estimate BTG’s CCC—the length of time between the purchase of raw materials to receipt of cash from sales—at negative 2.7 months in FY18 (FY17: negative 2.5 months). Bloomberg data shows that the company has been recording negative cash conversion cycles since FY09. This means that BTG is getting paid by its customers long before it pays the suppliers, which is a great situation to be in.

With its high efficiency in converting sales to cash, BTG is able to translate most of its reported income into cash. The group’s cash flow from operations (“CFO”) stood at S$75.2m in FY18 (FY17: S$87.7m), compared to its EBITDA of S$78.5m (FY17: S$84.3m). We estimate that BTG’s CFO-to-total debt ratio stood at 3.0x in FY18 (FY17: 2.1x), which could be translated to mean that the company has the ability to pay off all its debt with operating cash flows within a three-year period.

Liquidity is ample, though may be reduced by higher capex needs

BTG’s current ratio and quick ratio remained largely unchanged at 0.88x (4Q17: 0.87x) and 0.81x (4Q17: 0.78x) respectively at the end of 2018. While current and quick ratios below one times generally signal weak liquidity, BTG can afford to be in such position due to its strong cash flow generation (negative CCC).

BTG’s reported free cash flow (net cash flow from operating activities minus capex) stood at just S$17m in FY18, down from S$47m in FY17. While cash flow has remained healthy, the company’s capex jumped 60% YoY to S$48m (FY17: S$30m). Drilling down into the numbers, we find that the bakery and restaurant divisions show the highest capital intensity with estimated segmental capex-to-asset ratios of 10.9% and 9.9% respectively.

BTG’s short-term debt of S$98.0m is well covered by S$185.0m of cash as at 31 Dec 18. Furthermore, the group has additional financial flexibility from its S$39.7m of investment properties (office space in Shanghai and shophouse in Singapore) and 29% interest in Chijmes, which has a carrying value of S$334m as at 31 Dec 18.

BreadTalk goes overseas

BTG’s business milestones in 2018 mostly took place overseas. The bakery business took the Toast Box brand to Indonesia, the food atrium business entered Cambodia under its directly-operated restaurant brand “Sergeant Kitchen”, and the restaurant division opened the first Din Tai Fung restaurant in the UK. Moving forward, we think the company will adhere to this strategy of expanding overseas.

In January, the group opened its first restaurant in Beijing, China, in partnership with Song Fa Holdings. The previous Song Fa outlet that was opened in Shanghai in January 2018 averaged RMB1m of sales monthly.

Also in January, BTG proposed to acquire a 25% interest in Food Republic Guangzhou F&B Management Co Ltd at a consideration of S$150k. The next month, BTG proposed to acquire the remaining 50% stake in BTM (Thailand) Ltd for a total consideration of THB160m (~S$6.8m).

Owing to its ambitious overseas expansion plans, we expect capital expenditures to stay heavy for the foreseeable future. Given that BTG is still in the early phase of its earnings turnaround, we think it is too early to judge the results of its global expansion strategy.

While it is encouraging to see BTG venturing into new territories, we are mindful that its businesses in Singapore remained as the primary contributor. The matured local businesses should continue to help support BTG’s earnings in the short term.

The outlook for Singapore’s retail and F&B sectors looks promising. According to the food & beverage services index published by the Department of Statistics Singapore, sales of F&B services increased 5.9% YoY in January, with all categories including restaurants, fast food outlets, food caterers, and other eating places delivering positive YoY growth.

The BREAD 4.0%' 23s are fairly priced

Having just redeemed the S$75m BREAD 4.6% ’19s on 1 April, BTG has only one bond outstanding—the S$100m BREAD 4.000% 17Jan2023 Corp (SGD)—which is indicating at an ask YTM of 3.89% (Z-spread: 196bps) as at 3 Apr 19.

We think the BREAD 4.0% ’23s are fairly priced. As a pricing reference, Fraser & Neave, Limited’s (“F&N”) 3.09% ’22s and 2.8% ’22s offer YTMs of 3.34% and 3.38% respectively, which translate to spreads of 141bps and 145bps above SGD swaps (see Table 2). F&N is a SGX-listed F&B player that is focused on beverage productions.

We may extend the pricing comparisons to issuers that have exposure to the retail sector given the limited number of directly comparable F&B issuers in the SGD bond space. The BREAD 4.0% ’23s provide decent yield pickup against bonds issued by some of the retail real estate investment trusts. For example, CapitaLand Mall Trust’s 2.8% ’23s and Frasers Centrepoint Trust’s 3.185% ’23s carry ask YTMs of 2.76% (Z-spread: 91bps) and 3.04% (Z-spread: 111bps) respectively.

Table 2: Relative valuation

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produces this report own none of the above mentioned securities.