Equity Research Report 29 May 2014 Jollibee Food Corporation (JFC) Rating: HOLD SHARE PRICE PERFORMANCE We are initiating coverage of JFC with a Hold rating Jollibee Foods Corporation (JFC) is involved primarily in the development, operation and franchising of quick service restaurants under the trade names Jollibee, Chowking, Greenwich, Red Ribbon, Yong He King, Hong Zhuang Yuan, Mang Inasal, Burger King, San Pin Wang and 12 Hotpot. With a global footprint with operations spanning 9 different countries. China as Strategy for Growth Today, the company is present in only four major cities in China, specifically Beijing, Shanghai, Guangzhou, and Wuhan. Together the provinces where in these four cities operate already account for one fifth of China s GDP. With the Chinese based operations expected to grow 20-30% per year, the company is slowly positioning itself for its 10-year target to have 25% of revenues come from China. Diversification through Taste The company s quick service restaurant (QSR) approach caters specifically to the middle income and lower price segment points where it strives to dominate the segment by offering a variety of choices. This approach has been widely successful in the Philippines and is not being implemented in their Chinese Operations. Intrinsic value of 160.02 We valued JFC using the Free Cash Flow to Equity (FCFE) valuation model. Jollibee Food Corporation vs. PSEi Source: Bloomberg KEY DATA Ticker JFC Sector CONSUMER Price (5-29-2014) 185.90 Current Price Target 160.02 Downside Potential -16.17% 52-Week Range 124.70 192.00 Market Cap (in M) 197,291 Shares Outstanding (in M) 1,055 Free Float (%) 41.38% DIV. YIELD (%) 2.25 1.07 2.20 3.36 1.24 FORECASTS (IN PHP M) Year End Dec 31 Revenues 53,372 62,555 71,059 80,283 88,633 Operating Income 3,599 3,939 4,345 5,931 5,301 EBITDA 5,577 6,341 7,051 9,004 9,309 Core Income 2,563 2,621 3,027 4,151 3,964 Carlo Chua Laput, CSS Equity Analyst The First Resources Management and Securities Corporation DISCLAIMER: This document was prepared by (FR) for information purposes only. It is not to be considered as an offer to sell, or as a solicitation of an offer to buy. Although reasonable care has been taken to ensure that the information contained therein is accurate and complete, FR makes no representation as to its accuracy or completeness. No liability is accepted for any loss arising from the reliance on this information. This document cannot be reproduced in whole or in part by the recipient or another per son, nor should it be redistributed by the person or the company to whom it was first addressed. All recipients are urged to make their own assessment as to the accuracy of the information contained herein. All information and opinions are subject to change without prior notice.
INVESTMENT THESIS Branded Consumer Business Jollibee Foods Corporation (JFC) is involved primarily in the development, operation and franchising of quick service restaurants under the trade names Jollibee, Chowking, Greenwich, Red Ribbon, Yong He King, Hong Zhuang Yuan, Mang Inasal, Burger King, San Pin Wang and 12 Hotpot. The other activities of the Jollibee Group include manufacturing and property leasing in support of the quick service restaurant systems and other business activities. Global Presence The company is present in 9 different countries which include US, China, Hong Kong, Vietnam, Indonesia, Singapore, Brunei, Middle East, Saudi Arabia, Qatar, Kuwait, and the United Arab Emirates. Despite the drive to broaden its geographic reach, the company maintains that priority in terms of development will remain here in the Philippines, with China coming in second place. Management also sees a potential in Vietnam because of the similarities between Filipino and Vietnamese preferences. Jollibee Big Picture Targets as of 2014 The company strives to grow system wide sales by an average of 10% per year with 5% coming from same store sales, while the remaining 5% to come from the construction of new stores. The Philippines segment which accounts for 80% of the group s net income is expected to grow 12% according to management targets while the foreign segment comprised of US, China, Southeast Asia, and Middle East stores which accounts for the remaining 20% of net income is expected to grow at a rate of 22-25% per year, with 15-18% of that growth attributed to network expansion through the construction of new stores while the remaining will come from the organic growth of same store sales. Importance of China for Long Term Growth Today, the company is present in only four major cities in China, specifically Beijing, Shanghai, Guangzhou, and Wuhan. Based on 2012 data, the provinces where in these four cities are found already account for 20.36% of China s GDP. Today, about 13% of Jollibee Group s revenues come from China and plans to consolidate its position in these four cities for the next 2-3 years with the ultimate plan for to have 25% of total sales to come from China in 7-10 years time. Based only on store network growth, the company s Chinese operations has been growing at an average of 20.23% since 2010. `Page 2 of 9
The Jollibee Strategy on Branding and Taste Preferences Unlike other companies that strive to position their products and services at different price points in order capture the largest possible share of the market, Jollibee strategy uses a diversification on taste. The company s quick service restaurant approach by its nature keeps the companies offerings catering to the middle income or lower price segment points. What it does however is to completely dominate this segment by offering a variety of choices. This is best showcased with the company s drive in china. Chinese consumers consume both traditional Chinese and western food. If the company simply offers its core brands here, which are mostly influenced by the west, once the consumer chooses to have traditional Chinese food, then the company has lost those customers. For this reason Jollibee has acquired Yonghe King which specializes in Chinese noodles, Hong Zhuang Yuan which makes congee and San Pin Wang which specializes in beef noodles. Today the company is looking to acquire one more brand that caters to the local Chinese cuisine before they feel they have covered the taste pallet for the middle to low income price segment. Fuelling Domestic Growth Despite the focus on deepening its hold within China, the company maintains that the Philippine market continues to provide good organic growth towards the future. Management tells us that based on the macroeconomic data specifically with the expected growth of the Philippine economy between 6-7%, two thirds of our GDP coming from domestic consumption, a growing middle class segment, strong remittance inflows into the country, and the rapid urbanization; there is strong evidence to support management decision on its healthy capital expenditure for this year and the years to come. Capital Expenditure The company has allotted 9.3 billion worth of capital expenditures for 2014 where 4.3 billion will be used to build new stores, 2 billion on store renovations, another 2 billion for the upgrade of their food commissary and a new information system. `Page 3 of 9
Discussion on Network Growth Integral to the growth of Jollibee is its organic expansion of its store network. Each year new branches will open, but also a certain number of old stores due to one reason or another will close. When the company announces that they plan to open for example 50 new Jollibee stores, they do not account for the number of stores that will close or the closures. Below is a table showing the actual increase or decrease of stores per year net of closures. This is a more realistic view of the rate at which the company grows their network of stores. We have also included my forecasted number of stores net of closures for 2014. In the next table you can see that for the Philippine segment, Greenwhich stores have consistently been declining while for the Chinese segment, the Hong Zhuang Yuan brand has also experienced a protracted decline. Meanwhile, in the US segment, the Red Ribbon stores are seen as a cause for concern. Store Growth - Net of closures Philippine Segment Jollibee 31 28 35 31 32 Greenwich -3-18 -3-3 -6 Red Ribbon 14-13 4 66 46 Chowking -3-9 -4 14 2 Mang Inasal 0 84 36-6 6 Burger King 0 0 6 5 6 Chinese Segment Yonghe King 0 65 32 17 38 Hong Zhuang Yuan -2 0-6 -3 1 San Pin Wang 0 0 5 5 4 US Segment Jollibee 4 1 0 2 2 Red Ribbon 3-3 -2-1 -1 Chowking 3 0 0 1 1 SOUTH EAST ASIA and MIDDLE EAST Total Jollibee S.E.A and M.E. Stores 11 10 14 7 10 Total Chowking S.E.A and M.E. Stores 0 1 4 2 2 `Page 4 of 9
Discussion on Short and Long Term Debt Because of the nature of the business, the company is constantly cash rich, and for this reason, the company doesn t require any short term loans that are traditionally used as a revolver for the company s daily operations. The company will only take on long term debts in the event it plans to make acquisitions. This was the case with the recent acquisition of the super foods chain in Vietnam. Management Policy on Dividends The company has a dividend policy of declaring one-third of Jollibee Group s net income for the year as cash dividends. The company has however declared consistently over the past 10 years an effective dividend payout above this, averaging about 47% for the above mentioned period. Actual dividends per share declared as a percentage of the EPS are 75.5%, 61.5% and 33.8% in 2013, 2012, and 2011 respectively. `Page 5 of 9
FINANCIAL STATEMENT AND RATIOS INCOME STATEMENT (in PHP M) Revenues 3,212.54 3,284.78 3,712.00 4,722.81 3,964.50 Operating Profit 3,599.33 3,939.42 4,345.02 5,931.10 5,301.00 Depreciation 1,978.01 2,401.59 2,705.63 3,072.46 3,951.99 EBITDA 5,577.34 6,341.02 7,050.64 9,003.55 9,309.43 Interest Expense 190.10 272.62 185.86 133.77 109.66 Pre-Tax Income 3,655.18 4,185.93 4,394.96 4,861.70 6,245.51 Net Income 3,212.54 3,212.54 3,284.78 3,712.00 4,722.81 EPS 3.091 3.147 3.499 4.360 3.766 Outstanding Shares 1039 1044 1061 1072 1053 BALANCE SHEET (IN PHP M) Cash 8,170.49 6,655.31 8,848.59 9,903.88 6,787.70 Accounts Receivable 1,837.71 2,085.66 2,454.63 2,853.90 2,952.55 Current Assets 13,572.46 13,258.95 15,623.20 18,384.18 15,575.65 PPE 8,770.52 10,580.37 11,059.46 11,772.44 17,134.13 Total Assets 33,746.01 38,550.52 41,768.13 46,026.63 48,626.96 Short-Term Debt 4,183.16 1,677.30 4,572.84 1,106.28 690.60 Accounts Payable 3,601.60 4,727.84 4,717.06 6,006.64 6,051.49 Current Liabilities 13,693.81 12,102.38 16,621.23 15,618.61 15,914.73 Long-Term Debt 51.59 3,942.74 854.62 4,062.97 3,422.67 Total Liabilities 16,064.56 18,135.65 20,036.83 22,665.69 22,583.78 Total Equity 17,681.44 20,414.87 21,731.30 23,360.94 26,043.18 KEY RATIOS Operating Margin 6.74% 6.30% 6.11% 7.39% 5.98% EBITDA Margin 10.45% 10.14% 9.92% 11.21% 10.50% Current Ratio 1.18x 0.98x 0.85x 0.79x 0.83x Return on Total Assets 9.52% 8.52% 8.89% 10.26% 8.15% Return on Invested Capital 16.00% 13.07% 13.67% 16.55% 13.15% DUPONT ANALYSIS Return on Equity 18% 16% 17% 20% 15% Asset Turnover 1.58x 1.62x 1.70x 1.74x 1.82x Net Profit Margin 5.56% 6.02% 5.25% 5.22% 5.88% Leverage 1.91x 1.89x 1.92x 1.97x 1.87x `Page 6 of 9
FINANCIAL ANALYSIS Profitability PROFITABILITY RATIOS Gross Profit Margin 22% 21% 21% 22% 22% EBITDA Margin 10% 10% 10% 11% 11% Operating Profit Margin 7% 6% 6% 7% 6% Net Income Margin 6% 5% 5% 6% 4% Return on Assets 10% 9% 9% 10% 8% Return on Equity 18% 16% 17% 20% 15% Return on Invested Capital 16% 13% 14% 17% 13% The company is expected to reach 80.2 billion in revenues for its full year 2014 driven by solid growth from its domestic operations with Jollibee stores net of closures expected to increase by 31 stores every year for the next three years while the drive for Red Ribbon stores should see 46 additional stores net of closures per year until 2016. Despite an expected strong performance we remain wary of two local brands which could serve to drag down performance in the future. Greenwich has experienced a net decline in total number of stores for the past 5 years while Mang Inasal s once robust expansion has slowly declined with the number of closures increasing from only two in 2010 to twenty four closing by 2013. Gross profit margin is expected to remain stable at 22.16% for this year while the net income margin is expected to decline as the higher depreciation takes effect due to the 9.3 billion allotted for this year but will be partially offset by lower interest expenses which will be declining by 18.02% as the company is set to settle about 750 Million in long-term debt this year. The higher Capex will cause an expected decline on our return on assets as the new assets to be purchased have yet to contribute to the bottom line. ROE is expected to decline affected by the lower net income margin but should promptly return to the high teens as the new assets begin to contribute to the bottom line. Return on Invested Capital should come in it at 13.15% affected by the large Capex to be deployed, though lower than last years, the 13% level has not been breached for the past 7 years. The Level is also well above our WACC of 8.16% signaling that the company's activities remain value accretive. `Page 7 of 9
Liquidity and Solvency LIQUIDITY AND SOLVENCY RATIO Cash Ratio Current Ratio 0.60 0.55 0.53 0.63 0.43 0.99 1.10 0.94 1.18 0.98 Quick Ratio 0.84 0.86 0.78 0.95 0.76 Debt to Equity Ratio 0.14 0.23 0.25 0.22 0.16 Debt to Capital Ratio 0.12 0.19 0.20 0.18 0.14 Debt Service Coverage Ratio 2.33 1.34 1.30 1.74 2.26 Cash ratio is expected to decline as the company will have to pull cash from its coffers to pay for the expected 9.3 billion in capital expenditures this year. Despite this, our current ratio which remains close to its historical average of 1x shows that the company remains capable of repaying its current liabilities. Debt to Equity and Debt to Capital Ratios will decline while the Debt Service Coverage Ratio should improve improves as 750 million in loans will be retired in 2014. All our activity ratios bellow shows that Jollibee operates as a cash rich business with high receivable turnover. Likewise, activity ratios are expected to remain stable in the future. ACTIVITY RATIO Receivable turnover 29.71 31.89 31.30 30.25 30.02 Average collection period 12.28 11.45 11.66 12.07 12.20 Inventory turnover 21.46 19.69 20.39 20.18 19.63 Days inveotry on hand 17.01 18.53 17.90 18.08 18.76 Payables turnover 11.52 11.75 12.05 11.64 11.44 Days of payable outstanding 31.68 31.06 30.30 31.35 32.02 `Page 8 of 9
VALUATION Assumptions used to arrive at the intrinsic value of 160.02 using the Free Cash Flow to Equity (FCFE) Method includes the following: VALUATION ASSUMPTIONS Cost of Debt (After Tax) 1.65% Cost of Equity 8.65% WACC 8.16% Perpetuity Growth Rate 3.00% Risk Free Rate 4.95% The risk-free rate assumption is the YTM of the 25-year Philippine bond. The rational for this is that we assume a long-term perspective on investing to perpetuity, hence, the most sensible assumption to perpetuity is the longest tenor bond. `Page 9 of 9