http://www.cashon-line.com
CELESTIAL RESEARCH

Café De Coral Buy

Price: $2.80 7 November 2000

Key Data Investment Opinion

Stock Code : 341
12-month High/Low ($) : 3.182/2.172 ► Increasing popularity of fast food allowed Café de
Coral maintaining encouraging growth over the
Hang Seng Index : 15,820 past few years. The economical fast food
Issued Shares (m) : 549.12 services even reaped more amid financial crisis
Market Capitalization ($m) : 1,537.55 two years ago, under the situation of subdued
Average Daily Turnover (K) : 647.69 purchasing power. The group’s net profit
attained of 16% CAGR over the past five years.
Major shareholders : GZ Trust (21.83%) As influx of mainland immigrants would underpin
Relative Performance - 1 month (%) : -6.0 the demand for fast food industry, Café de Coral
- 3 months (%) : +7.2 has huge growth potential given its 4% market
- 12 months (%) : -30.1 share restaurant segment at present.

► Fiscal 1999 net profit ascended to its historical

Earnings Estimates high of $220mn, mainly thanks to stringent cost
(Yr-end Mar) 00A 01F 02F 03F control measures. The operating efficiency has
been enhanced due to the closure of non-profitable
Net Profit ($m) 221 268 306 331 stores and outlet relocation to higher-traffic areas
Change (%) 25.2 21.7 13.8 8.4 to take advantage of low rental rate.
EPS (cents) 39.9 48.9 55.7 60.4
Change (%) 19.2 22.4 13.8 8.4 ► The group recently evolved an important move of
globalization through acquiring Manchu Wok, an
DPS (cents) 16.8 20.5 23.4 25.4 US sizable Chinese food restaurant chain. Based
PER (X) 7.0 5.7 5.0 4.6 on the well acceptance of Chinese food as a
Yield (%) 6.0 7.3 8.4 9.1 healthy product, Manchu Wok has a first mover
BVPS 1.99 2.16 2.43 2.71 advantage for huge expansion on the back of its
nationwide brand recognition.
EV/EBITDA (x) 3.3 3.1 2.9 2.8
► The group maintains a sound financial position
Chart with abundant cash reserves. After acquiring
Manchu Wok, the group still retains net cash
totaled $300mn. The budgeted capex of around
$150mn for current financial year would exert no
financial burden.

► Net earnings are forecasted to reach $220m and

$310m in FY2001 and FY2002 respectively. With
estimated earnings posting 15% CAGR over next
three year, the PER-to-growth ratio would only be
0.39X, implying current valuation not enough to
justify the group’s future growth impetus. The
stock could also be considered a defensive play
given prospective yield of 7.3%.

Analyst: Felix Ho
2287-8191
felix.ho@cash.com.hk
Company Profile
Listed in 1996, Café de Carol Group is a sizable catering
company in Hong Kong, which involves in the operation
of fast food, institutional catering, specialty restaurant
chains, and food manufacture business. Café de Coral, the
largest local fast food chains in Hong Kong, remains its
core business of the group with number of outlets
exceeding 100. Specialty restaurant businesses include
chains of Spaghetti House, Ah Yee Leng Tong, Bravo le
Café, and Super Super Congee & Noodles. Institution
catering mainly provides catering service in various public
and private organizations in Hong Kong under brandname
of Asia Pacific Catering, and is also engaged in student
catering business under brandname of Luncheon Star.
Aside from Hong Kong, the group has presence in Macau
and the PRC market.
Business Analysis
The group recorded promising business performance over
the past five years with net profit’s CAGR of 16%, mostly
thanks to the growing popularity of fast food culture.
Despite facing adverse impacts amid the financial turmoil
two years ago, its operations maintained income growth, as
people were looking for ways to spend in fast food shops
which offer cheaper price.
The company recently reported fiscal 2000 results that beat
market expectations. Sales grew only by 2.5%, mainly due
to pursuance of a stable pricing strategy to deal with
deflationary, as well as counteracting the ‘cut throat’ price
competition by rivals. Net profit, however, increased by
25% to its historical high of $220mn, merely driven by the
expansion of profit margin.
The pre-tax margin rose from 9.5% to 11.0% year-on-year,
mainly attributable to cost savings such as reduction of
salary, rental, and food purchasing expenses. The company
also renewed 30 lease agreements during the year and thus
achieved 8% reduction of rental on average, of which
proportion to sales also decreased from 12.8% in FY99 to
11.5% in FY00. We believe the rental-to-sales ratio
would further decline over a couple of years, on continual
renewal of leases that would ease the rental burden of the
group.
The group's strategies to enhance efficiency were also
compelling. Closure of non-performing stores and
allocation of resources to upgrade its outlets in higher-
traffic locations with lower rental completely strengthened
the operating yield. Its vertical operation strategy by
acquiring Scanfoods for ham production and Denny’s
Bakery earlier also derives synergistic benefits for internal
supply.
2
The group management always cherishes its brand image
with ultimate goal to broaden customer base. Renovations
for some of its fast food shops and specialty restaurants are
undergoing to revitalize the shop environment, in addition
to the introduction of cyber concept and internet access for
customers. Accompanied by the new marketing campaign,
the renovation programme started to bear fruit, as
Spaghetti House, for instance, quadrupled its profit last
year.
The group seized the valuable opportunities of economy
setback for branch development last year, with net increase
of 6 restaurants under the group’s business, including 2
mega-stores. Currently, the number of units for whole
group is 181. We expect the company to continue its
regular pace for expansion, with number of outlets
reaching 189 by the end of current fiscal year. For its
eight loss-making operating units in China and Macau, a
turnaround is expected in this year, helped by the earlier
write-off of fixed assets totalled $20mn that will
substantially minimize the depreciation charge.
Categorization of Restaurant
(By end of FY2000)
109 Café De Coral Fast
Food (Hong Kong)
8 Café de Coral Fast Food
(Macau)
38 Institutional Catering
Restaurants
16 Spaghetti House
10 Other Specialty
Restaurants
Source: Annual Report
Acquisition of Manchu Wok for Globalization
The group announced to acquire the Manchu Wok (MW)
chain in October. MW is currently the largest oriental-style
fast food chain in Canada, and the second largest in the US,
where having 74 and 119 shops respectively. Besides, MW
has 2 outlets in Poland. In the US, MW mainly focuses at
the northeastern region. MW has been expanding its
scale rapidly through franchising, which accounts for 75%
of existing outlets.
Café de Coral group entered the JV agreement with Ken
Fowler Enterprise, and also the management of MW, for
the entire interest acquisition of MW, on a total
consideration of CAD32.5mn (approx. HK$169mn).
Café de Coral group will inject HK$7.8mn, and
HK$14.8mn by means of shareholder loan to swap for the
47.765% of interest of MW. The remaining considerations
will be financed by the injection of two JV partners,
according to their equity stake in proportion, and also the
5-year term loan of HK$13bn yielding 8% pa. The
acquisition price represented an attractive EV/EBITDA
multiples of 5x, which compared favorably against with
industrial average in the US.
Valuation Comparision
EV/EBITDA
McDonald 12.2
Starbucks 26.8
Wendy's 6.1
Tricon Global 5.2
Papa John's 6.1
CKE Restaurant 4.3
Manchu Wok 5.0
Source: CASH
At present, fast food accounts for 30% of US dinning in
terms of total revenue, of which China fast food accounts
for only 2%. We therefore believe there is a huge growth
potential for Chinese fast food market, as US consumers
have recognized that as premium product in pursuance of
healthy life style. As a market leader, with over 90% of
outlets located at high traffic areas that generates sound
brand recognition for consumers, MW inevitably has the
first move advantage for further expansion. MW plans to
add the chain-stores from 195 at present to 363 over the
next five years.
MW has modest risk exposure with minimal capital
investment, and collecting franchise fees by granting
franchises to operators. Yet, there are apparent synergies
between MW and Café de Coral Group. The
computerization plays an important role for logistic
support for Café de Coral, at which an intelligent Branch
Management System is used for productivity enhancement.
Such information system could be jointly applied for
providing assistance in logistic and materials purchasing
for MW after the acquisition, and we thus believe margin
improvement as a result. MW recorded turnover of
HK$635mn, EBITDA of HK$34mn, and net profit of
HK$20mn in last financial year. We expect the EBITDA
for MW at 2003 to increase to HK$750mn after the
synergies become effective.
Business Prospects
The group opened 14 new stores during the first half of
this year, by keeping its regular pace of expansion while
bolstering its turnover at double-digit increase. Given fine-
tuning its strategy in boosting store traffic rate as well as
consuming frequency, and continuously adding new stores,
the group is expected to post an increase of turnover by
7% this financial year.
For cost perspectives, the rental expense would still be
declining given that around 60 stores would renew leasing
contracts within this year. However, there is upside
pressure for the cost of salaries and sourcing of food, in
light of the recovery of the local economy. On the other
hand, there is room for the group to lift its product price,
which would help offset the cost burden. We expect the
operating margin to further rise to 12.3%. On the back of
popularity of fast food, and increasing influx of inland
immigrants that would be the target clients of fast food
industry, Café de Coral certainly has enormous capacity
for future growth, given that its has only 4% of the market
share for restaurant business in Hong Kong.
We expect no material contribution from the acquisition of
MW near term, as its operating profit would be merely
offset by the interest expense at the intital stage. Longer
term, we see MW is a vital growth driver for the group,
along with the business synergies in the making. We
estimate the profit generated by MW to account for 6% of
the group profit in FY2003.
Financials
The group’s financial positions have been strengthened
after servicing the debt totaled $270mn over last year. And
the company was reversed its debt position from the net
debt-to-equity of 13% in last year to net cash position of
$300mn at present. The budgeted capex for the group is
$150mn, which would be used for the opening of 10 new
outlets, renovation of 20 to 25 existing stores, and
acquisition of food processing facilities.
Projections and Valuation
The net profit for FY2001 and FY2002 are estimated to
grew by 22% and 14% respectively, while the projected
net profit CAGR of 15% over the next three years is in line
with past years, implying that the growth impetus could be
maintained. The stock is currently trading at prospective
earning multiples of 5.7x, current valuation does not fully
reflect the Café de Coral’s forthcoming growth potential.
Having abundant cash pile, the group is expected to
maintain generous dividend policy with payout ratio
maintained at around 40%. Therefore, the prospective
dividend yield of 7.3% makes the stock a defensive play.
3
Income Statement (HK$m
(HK$m)
HK$m) Cashflow (HK$m
(HK$m)
HK$m)
(Yr-end Mar) 00A 01F 02F 03F (Yr-end Mar) 00A 01F 02F 03F
Turnover 2,409 2,560 2,740 2,896 EBIT 265 295 316 333
Cost of Stocks (718) (771) (830) (882) Dep/Amort 118 116 115 117
Staff Costs (630) (676) (729) (774) Other Non-cash items 7 0 0 0
Rental Expenses (277) (288) (301) (313) Changes in NWC (2) (2) (10) (9)
Other Operating Expenses (432) (440) (471) (498) Interest Received 30 33 43 52
Rental Income 12 12 12 12 Interest Paid (39) (25) (25) (26)
Other Net Revenue 19 14 10 7 Tax Paid (32) (42) (46) (49)
EBITDA 384 411 432 450 Others 19 0 0 0
Dep/Amort (118) (116) (115) (117) CF from Operation 367 376 394 418
EBIT 265 295 316 333
Purchase of FA (132) (100) (110) (120)
Interest Income 30 33 43 52
Disposal of FA 1 0 0 0
Interest Expense (40) (25) (25) (26)
Construction in Progress (5) (0) (0) (0)
Operating Profit 256 303 334 360
Investment Securities 0 0 0 0
Associates 0 6 17 21
Investment in Associates 0 (8) 0 0
EBT 256 310 351 381
Due from related Co. 0 (15) 0 0
Taxation (35) (42) (46) (49)
Others 250 0 0 0
MI 0 0 0 0
CF from Investment 113 (123) (110) (121)
Net Profit 221 268 306 331
Source: Annual Report, CASH Shares Issue 4 0 0 0
Buyback of Shares (8) (20) 0 0
Balance Sheet (HK$m)
HK$m) Bank Loans Repaid (266) (1) (2) (10)
Dividend Paid (79) (93) (113) (128)
(Yr-end Mar) 00A 01F 02F 03F
CF from Financing (349) (114) (114) (138)
Fixed Assets 861 846 840 844
Construction in Progress 5 6 6 6 Changes in Cash 130 139 170 159
Source: Annual Report, CASH
Trademarks 63 61 59 57
Investment in Associates 0 23 23 23
Investment Securities 19 19 19 19
Due from Related Co. 0 15 15 15
Current Assets 696 779 959 1,127
Current Liabilities (502) (531) (567) (589)
Total Assets Less CL 1,142 1,216 1,353 1,501
LT Bank Loans (32) (30) (20) (10)
Deferred Taxation (12) (1) (1) (1)
Net Assets 1,099 1,185 1,332 1,490
Share Capital 55 55 55 55
Reserves 1,044 1,130 1,277 1,435
Shareholders' Fund 1,099 1,185 1,332 1,490
Source: Annual Report, CASH

Neither this document nor its contents shall be constructed as an offer, invitation, advertisement, inducement or representation of
any kind or form whatsoever. While the information contained herein has been obtained from sources believed to be reliable,
we do not represent that it is accurate or complete and it should be relied upon. We hereby expressly disclaim all liabilities
arising out of or incidental to the accuracy and completeness of the contents and information herein contained. We further
advise that the contents and information in this document will be subject to change without further notice. The document may
not in whole or in part be reproduced or furnished to any person other than the addressee. Celestial Research Ltd. and its
officers may from time to time have a position in the securities mention and may, as principal or agent, buy and sell such
securities.