Friday, July 25, 2014

Future Bright Holdings - Part 1


Future Bright is a food and beverage business in Macau with six sources of value: (1) Retail catering; (2) Industrial catering; (3) Food wholesale; (4) Macau rental; (5) Food souvenirs; and the (6) Hengqin project.

I think it will be worth HK $20, or 5x its current market price, in three years.






(1) Retail catering


Retail catering mostly consists of in-casino restaurants and food court concessions.  The restaurants are mid- to high-end establishments with average ticket prices ranging from HK $750 at the Edo nameplate, to $150 in the "Other" category which consists mostly of the Pacific Coffee chain for which Future Bright is the franchisee.

These store fronts are leased from cooperative landlords who want the punters to stay on their property, and serve time-conscious and price insensitive tourists.

Constant, recession-resistant traffic; high margins; no advertising and marketing expense; rapid turnover of inventory; and low rents: the economics of this segment are as good as it gets in food retail. 




By the close of 2014 there will have been a big step up in this segment's footprint and earning power. The star next to "2014" in the table above indicates my estimate of the run-rate values based on the 268K sq ft in operation at the end of 2014 and adjusted for the slightly different mix of formats and locations. (Each format has its own gross operating margin: Japanese = 38%: Chinese = 30%; Western = 50%; "Other", which is mostly coffee shops, = 38% , and  food court concessions = 50%. Casino restaurants earn more than mall and airport locations, etc.)

Casino, resort and hotel rooms will double from ~29,000 now to 60,000 in 2017.  Future Bright is the largest food and beverage company in Macau, its owner operator is the Chair of the Food & Beverage Merchants Association (and a Macau legislator), it has working relationships (and has renewed its existing leases) with all six casino operators. The company has made plain its intent to open 28 new restaurants in the Cotai Strip between 2015 and 2017 as new hotel/casinos open. I therefore don't doubt that its footprint and earnings power will close to double over that period - as indicated in the "2017" column above.  



Finally, Macau's problem has long been a shortage of accommodation. Rooms are (and have long been) 95% occupied on average, placing a limit on the number of overnight visits to Macau. As a consequence, the average length of a stay in Macau is something like 0.96 days compared to 3.5 for Las Vegas. More rooms means more overnight stays, which means more -- and more evenly distributed -- traffic at Future Bright's restaurants and food court concessions. 

If the length of the average stay lengthened to 1.5 days,  the retail catering segment could enjoy up to a 45% increase in its earning power (56% more revenue per sq ft x 74% gross margins). I haven't accounted for that in the table above.




Some context:



.. to be continued in the next post

Disclosure: I am long Future Bright. My facts could be wrong and my judgment warped. Do your own research and use your own judgment.


36 comments:

  1. Hey great post, probably a small detail, but there will also be a 30 min train connection from Hong Kong airport to Macau. Given how large that airport is, that will probably add visitors as well.

    And another thing is that they want to change Hengqin island into a entertainment zone to lengthen stay in Macau. Macau has relatively few entertainment options besides gambling compared to for example Las Vegas.

    Thanks for the idea, the more I read about it, the more bullish I get on it. But that might be bias.

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  2. Well, if you think it may be worth a lot more than the current valuation, you have plenty of time to double check its particulars and to examine Macau's prospects generally. No sense in rushing out to buy before you do; I didn't.

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  3. yeah i think this is a case of, you don't need a man's weight to see that he is fat. There is plenty of fat on this one.

    The only risk I can see is that they scale up and quality control goes down. I find that a risk hard to assess. They haven't proven themselves yet on such a large scale.

    Currently at abotu 140k sqft I think. With Hengqin in 2018 finished, that could be close to a million square feet right? That is a big ramp up. But even if they succesfully run only half that in the end, there is big upside.

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  4. One thing - I don’t think hotel rooms are the main cap on length of stay.
    A lot of people coming in are from Guangdong (don’t have the stats at hand and I may have actually been given this by local operators)
    So these guys aren’t super interested in staying overnight and Tbh chinese people are just not that interested in entertainment or the rest of Macau from talking to people at the main operators. Admittedly, I do think you could hit 1.5 days but I doubt the stay in Macau will ever get above 2 days.
    So I think Chinese visa rules into Macau a more important driver of foot traffic than hotel rooms?

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  5. The high share of visitors from Guangdong is at least partly a function of the the fact that there's a shortage of hotel rooms. No point in coming from more than 1/2 day's journey away if you can't stay overnight.

    "Tbh chinese people are just not that interested in entertainment"

    This is nonsense.

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  6. anon -

    For example: Many of the company's restaurants (and all of its food wholesale operations) are Japanese. in case of conflict/war etc between China and Japan, financial results will suffer badly.

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  7. Red
    I used to own this stock and have since sold. I think your numbers/assumptions are too much blue sky.
    obviously the high end japanese restaurants are the big earners but their scalability is limited compared to the rest of their brands. also the catering, branded food gifts I think will take more time to ramp than you think and usually when a restaurant opens it takes a good 18 months-2 years to trade at the same rates per sq ft as established locations; i dont think you account for this even in your 'low' model.
    anyway maybe you are right that you think its worth over $20,but for me that sort of price even in the medium-term assumes a move away from realistic multiples into another territory altogether.
    cheers

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  8. Red - by entertainment I take it you mean anything outside of gambling?
    Ask some of the people who run the shows in the casinos what their estimates of local foot traffic are vs. say HK'ers, or go to a pool party at the Hard Rock - look at mainlanders vs. expats and HKers.
    Or talk to restaurant owners outside of the casinos.
    I would say outside of gaming mainland footflow is very small.

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  9. Thanks for the post.

    Your #'s seem too blue sky scenario. I have no idea what will happen in 2017, but 2014 looks high:
    (i) In your operating profit calculations, you seem to be assuming 100% margin for industrial catering?
    (ii) $10mn from the souvenir business as low case is probably also too high. It would be a good outcome if they can break-even during the first six months. Having said that, I like their entry into this NB and medium-longer term, this will be a value accreting business because it will be easy to steal share, especially for them as they can cross-sell
    (iii) Assigning a $4.9bn value to the Hengqin project seems aggressive. I look forward to your post on that, but for the "low" case, you should probably be more conservative. You are assuming they achieve a ROI of ~4x. I like management, they have backed their past promises with good execution and even achieved 4x on their investment property, but counting on that type of return feels risky for your low case.
    (iv) You are assuming revenue close to double in 2014? You're making an assumption that all their new sqft become fully ramped up on day 1 and that all this new sqft is there since beginning of year?

    While I have some reservations about your forecasts, I agree with your general thesis and what you have laid out regarding the potential of the Greater Macau region. This company is in a unique position and will do well just riding on the wave. Returns will be good, but if it gets to your target of 5x, it would require some multiple expansion.

    Disclosure: I am long and I would be delighted if your forecasts are spot on.

    ReplyDelete
  10. Thanks for reading and for the comment.

    2014* is not the same thing as 2014.

    Future Bright is a simple idea that I've managed to convey in an unclear way. Let me try it this way:

    1. FB's restaurant footprint at the end of 2014 will be double its footprint at the end of 2013

    2. FB's restaurant footprint at end of 2017 will quite likely be double its footprint at the end of 2014

    3. FB's incremental restaurant margins will be at least equal to its historical margins

    4. FB will win 0 to N casino catering jobs, each generating ~790m at 17% gross operating margins.

    That's the current food business. I'd be surprised if any of these propositions proved controversial.

    You've been following this stock so you know that the company has been negotiating sq footage, format mix etc with the concessionaires re: Cotai strip openings in 2015.

    5. This projected footprint is associated with an earnings power that corresponds to X/sq ft x Y margin.

    6. That run-rate (emphasis) earnings power can command a 10x EBIT multiple. There is a ramp up period of, say, 3 years and the market will assign the late openings a fwd multiple of say, 15x.

    Finally

    6. The Hengqin project is a (80%) build-to-let operation and an (20%) build-to-operate operation.

    Estimate 3750/sq ft in lessee food sales x 14% as rent expense paid to FB ==> implied rental income is 262m and, at 15x = 3,664m

    Its own food business at 3750/sq ft, 30% gross operating margin and a 10x multiple = ~1,200

    Together = ~4,900.

    Sell side want to take residential land values x 1.5 = HK 5000 / sq ft ==> ~2,700. That's fine though I find it inaccurate and unnecessarily abstract. Down that road lies SOTP analysis which is to be avoided if it can be.

    And none of the above matters all that much since all of the above are close to free options. The market will be surprised at every development until its not and at that point we'll get a re-rating one materially higher earnings.

    I won't mention FB's effort to become a franchisee of major QSR brands since that, too, is a free option.

    If you think any of the steps above are wrong, unreasonable or unlikely, I'd be glad if you let me know.

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  11. Your second retail catering chart shows 248 GOP after you calc using specific margins. Yet your chart above that for run-rate calcs shows 259. How come? TIA.

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  12. Red,

    Apologies, I missed the note regarding the * and that clears up a lot of the assumptions.

    Regarding sales per sqft and operating margin for 2014*, I think that will come down more than you expect. With all new locations in 2014 outside of casinos, sales/sqft and profitability will be much lower, even after being fully ramped up. I like the openings at the airport, mall and university, but the foot traffic and profitability at these locations will be much lower, and the impact to the average is significant - as you noted, their sales footage doubles in 2014. With that said, foot traffic / profitability will probably be higher in 2017** as their 2015-17 new locations will be in casinos.

    Anyway, there's no right or wrong here as we both do not have a crystal ball, and how accurate your numbers turn out to be should not impact the investment thesis at today's valuation. I share your view that all these future plans are like free options and not in the price, and we will see re-ratings at each step of the way when they are delivered.

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  13. Why do you think it trades at conservative multiples given what looks like obvious growth? Especially when comps in analyst reports all trade higher. TIA.

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  14. Birthed via a backdoor listing 10 years ago. Prior business was amusement rides and lost money and couldn't be turned around though they tried for too long. So there's some stigma attached.

    Smallish company at a time when China skepticism is at a high means that institutional money (aka value funds) are looking at more liquid names.

    No obvious route to expansion to the mainland. FB has deluded itself in the recent past that it owns brands that can be leveraged in the mainland market. It doesn't and it has lost money in the trying. Understandable if someone looks at FB and, say, Tsui Wah and concludes that the latter is cheaper over the long term.

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  15. 100k of their 158k sqft will be opened in Zhuhai. It seems they are stepping outside of their boundary's?

    Isn't this a different market then Macau? I could see how revenue/sqft might only reach 3-3.5k tops? With lower foot traffic concentration.

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  16. Red,

    I´ve take a look to the annual report and in 2013 the gross operating profit is 272. I think you were wrong because you take 297.

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  17. Red,

    Reading 2013 annual report FB say that they are going to open 3 new restaurants. And in your 2014* estimates you say they are going to double their sq ft. Where do you get this information?

    Also I would like to ask if you calculate future revenues multiplying future sq ft by past gross operating profit.

    Last question I normally calculate net debt as cash plus their building assets less long term liabilities. For you I think net debt is aproximatly cero. Is that right?

    Thanks.

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  18. anon - anything not in a casino is going to have lower footfall and rev per sq ft. I think your estimate of 3k to 3.5k tops is probably right.

    As for "their area", they've been pretty clear that they think of the greater Macau area as their playground. I can see why and don't think it unreasonable.

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  19. Hi Red

    In your calculations, the NOPAT for 2013 is 183. But for my calculations, it is only ~130, after taking out all the revaluation gain. How do you get that number?

    Chris

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  20. Can you explain why FB chose to issue shares to fund Hengqin project? Company has hk$650M+ gross cash and generates hk$200M a year. Seems more than capable to self-fund without diluting future upside.

    Also, I don't understand why hk$208M deposit is pledged to secure a bank loan of similar amount. What's the point?

    Thanks.

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  21. Sure.

    It looks like the Hengqing project is going to cost about 1,120 all in (purchase plus construction & development). One could run the cash well dry or one could issue shares.

    In their shoes, I'd issue shares since (1) strong financing capability is a likely precondition for winning the bid in the first place; (2) the project is so value-enhancing and (3) the one thing you don't want is to be caught in a liquidity crunch in case of the unknown unknowns.

    This fellow likes to shoot first and aim second. (see the central kitchen, for example).

    That's ugly and scary in normal environments but it probably accounts for a good deal of Future Bright's success thus far.

    The heart of the thesis is that Macau is no ordinary place, and that it has a long and prosperous future ahead of it.

    Based on Vegas, Oz, Sing etc comps, Macau today may be at 5% of its penetration potential. Add 20x the traffic & some number for per capita income growth and one does start to appreciate the tailwind.

    You second Q - I have seen that sort of thing before and I can't pretend that I understand it. I can guess, though, that one might take the view that developing and maintaining banking relationships may be viewed as in the long-term strategic interest of the company, and this would be one way of facilitating that.

    -----

    Chris -- I'll have a look.

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  22. Thanks for the reply Red. Just a couple more comments/questions:

    1. If Cotai and Hengqin get built out go according to plan, could the new supply of venues actually reduce tourist spending away from existing locations/restaurant? Number of visitors are growing low to mid single digits, but the amount of "entertainment options" will more than double.

    You did mention Macau is capacity constrained. But I find it hard to believe number of visitors will grow proportionately with number of hotels/casinos. So while total spending and foot traffic may increase (in greater Macau), spending and traffic at each location may decrease (unless each visitor will go to the new places with the same intensity as present).

    2. According to DianPing (Chinese Yelp-alike), it appears Huafa Mall is a success. Here's the link:

    http://www.google.com/translate?hl=en&ie=UTF8&sl=auto&tl=en&u=http%3A%2F%2Fwww.dianping.com%2Fshop%2F18283474

    http://www.dianping.com/shop/18283474 (non-translated version)

    Common thread is that restaurants are packed. Also some reviewer mentioned restaurants yet to be opened. Seems about right given FB is opening the new restaurants just about now. Good number of people in the pictures. And according to one reviewer, its the only mall in Zhuhai.

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  23. 1.
    Important question & rather than waffle on I'll upload a report that examines the "build it and they will come?" aspect of the story.
    https://www.dropbox.com/s/iw190kfj6hjv4dk/Macau%20Gaming%20Nomura%20Feb%202014.pdf

    and another one that examines Hengqing angle
    https://www.dropbox.com/s/s3k86szxyq6b6za/Macau%20by%20DBS%20April%202014.pdf

    Happy to chat about it after you've looked through them.

    2.

    Thanks very much for linking to those two interesting items on Huafa Mall. A lot seems to have gone right for the company in the last couple of months.

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  24. Red what about Illegal gambling? Isn't that a risk. The argument is that in the US Vegas has a lot of competition. But how does illegal gambling and online gambling play into that in China?

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  25. It is a risk. Here's a brief narrative
    http://www.gamblingandthelaw.com/index.php/columns/327-chinas-gambling-problem

    So, if you think that businesses like Chow Tai Fook and Oriental Watch are somewhere between the junket operators & UnionPay at the sharp end, and FB downstream, it's worth looking at their YOY SSS collapse and mulling over the implications for FB.

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  26. Chris -

    EBT = 322.6
    Net interest expense = 0.3
    Revaluation = -120
    SUBTOTAL = 202.9

    FV of financial assets = 0.7
    Stock-based compensation = 1.3
    Dividend income - -0.2
    OPERATING EBIT = 204.7

    Operating income tax @ 12% = -21.8
    NOPAT = 182.9

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  27. Thanks for your reply.

    But how about the minority interest?

    Shouldnt it be deducted from your number?

    Chris

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  28. Well, you'd want to separate out the income generated from the business (i.e. NOPAT) from the way in which those profits are distributed -- to debt holders, minority interests, and to the common.

    So, I'd do:
    NOPAT minus net interest expense = EBT

    EBT less taxes = Income
    Income less MI = earnings to common

    MI is currently 10% or so of income and is related to the operation of 3 restaurants. I therefore expect that it will command a smaller share of income over time.

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  29. Red,

    You are calculating EV as 10 times EBIT. Do you use NOPAT also for having an idea of EV, or just for knowing what the company is really earning?

    Also in your 2017 estimation for obtaining the share price (in the low & in the high ) you divide EV by total number of shares(EV/Nº Shares). But don´t you have to include net debt?

    Thanks.

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  30. David, I'll post my excel spreadsheet with my next post on Future Bright

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  31. Hi Red,

    I was just wondering how you came by the figures for Gross Operating Profit for individual restaurant types (Japanese, Chinese etc). I see the revenue numbers in the 2013 AR but no breakdown on that granular a level of the gross operating level.

    Are you backing them out somehow or you have some analyst reports or some such with that data?

    Thanks,

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  32. Hi George,

    I backed it out and saw that the numbers on page 7 here (http://www.chinastock.com.hk/ewebeditor/uploadfile/20130911091217700.pdf

    agreed with what I got.

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  33. Red

    Do you have any views on the capex (other than for Henquin) needed to get to the projected 2017 sqf?

    Thanks

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  34. I think it will take HK $75m to get there. If we back out $70m for the central kitchen it looks like capex runs at roughly $295/sq ft

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  35. I saw they released interim results today, any thoughts on those? Everything in line with expectations or is there something to look out for in particular?

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  36. Restaurant footprint up 10%,
    Sales per sq ft up 9.6%
    Consolidated operating margins up
    Return on capital steady at 57%

    Pleasant reading so far

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