CFA Institute Research Challenge · PDF file · 2016-06-06CFA Institute Research Challenge ... We forecast its OPM will fall to 10%, 9% and 8% in 2012-2014 respectively, ... Depreciation

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GOURMET MASTER

The Way West; Initiate at Underperform We initiate coverage of Gourmet Master with an Underperform rating and TP of

NT$166, based on 20x 2013E PE, implying 17% downside. Our TP is supported by

DCF valuation with WACC of 9.6% and a terminal-growth rate of 2%. For the last two

years, Gourmet Master has traded between 22x-28x PE, considering its fast top-line

growth and in-land potential. However, we expected the momentum would weaken on

slowing expansion and narrowing operating margin. Thus we think that Gourmet

Master will underperform market’s expectation.

Competition lowered same store sales

Bakery chains experienced major expansion in China. Up to 9M12, Gourmet Master

opened 90 stores, or +54% YoY; however, its revenue grew only 33%. Declined

average store sales could be attributed to intensified competition. We expect SSS in

China to decline 3% YoY in 2013 and 2% YoY in 2014, leading to lower sales growth

of 14.6% in 2013 and 10% in 2014, we believe market consensus of 27% is too

optimistic about the company’s growth.

Demand for quality remains low in inland cities, as consumption and

westernization still low

Gourmet Master positioned in middle-high end market. Consumption per capita and

our McDonald index (MDI) indicate low purchasing power to food and un-Westernized

dietary habit in Gourmet Master’s target region. We expect inland store sales to be

60% of amount in Shanghai. Expansion further at inland areas lowered average store

sales in China. Lower operating leverage and lacking economies of scale should pull

back its expansion. Our model indicates that the more stores it open, the lower its EPS

would be. We believe the expansion option is still deeply out of the money.

Narrowing operating margin

Gourmet Master’s OPM has dropped from 13.07% in 2010 to 10.44% in 9M12 and

8.71% in 3Q12 (-3.02 ppts YoY). Labor Cost in Food and Beverage industry has

increased 11.8% in 2011 while average rent has increased dramatically (+20% YoY,

2010). We predict that rental cost would account for 16.5% and 18.7% of its sales in

2013 and 2014 and labor cost for 18%-20% of sales. We forecast its OPM will fall to

10%, 9% and 8% in 2012-2014 respectively, which results in EPS CAGR of 3.6%,

implying 20x PE, compared with current PE of 24x, we believe the stock is overvalued.

High potential growth in the US but little contribution

Management announced to open 1 store each quarter in the US in 2013. We expect

US sales will account for 10% of revenue in 2014, but we doubt whether the trend can

overweight the shrinking of China and Taiwan market.

Rating:

Underperform

Target Price: from N/A

$166

Price (4 January 2013) prior N/A

199.5

Upside/Downside:

-17%

Ticker:

2723:TT

Trading Data:

52-wk range NT$ 172.86 - 253.33

Market cap. NT$ 28,153mn

Avg. daily volume 373,875 shares

Shares O/S 141.12mn

Beta 0.78

Free float 37%

Dividend Indicated Gross Yield 2.01%

BV per share NT$44.87

ROE 17.96%

Debt Ratio 28.16%

Price performance Chart, LTM

NCCU Team

Benson Pan

Andre Lin

Andrews Miao

Angus Lin

Elise Lu

27 January 2013

80%

100%

120%

140%Ja

n

Feb

Mar

Ap

r

May Jun

Jul

Au

g

Sep

Oct

No

v

Dec

2723TT TAIEX

Gourmet Master Financial Summary

(NT$ mn) 2009 2010 2011 2012E 2013E 2014E

Sales 6,283 8,347 11,456 13,595 15,383 17,351

Gross Margin 3,173 4,410 6,133 7,518 8,575 9,717

Operating Profit 1,043 1,090 1,404 1,398 1,452 1,491

Net Income 741 827 1,121 1,100 1,169 1,197

EPS (NT$) 11.25 7.18 8.34 7.92 8.29 8.5

DPS (NT$) 8.3 4.0 4.5 4.0 4.6 6.0

Source: Company Data, NCCU Team

CFA Research Challenge | NCCU Team

27 January 2013

2

Balance Sheet

(NT$ mn, unless noted otherwise) 2009A 2010A 2011A 2012E 2013E 2014E Current assets 1,875 4,583 4,964 4,734 4,828 4,872 Cash and equivalent 1,360 4,014 4,143 3,842 3,871 3,843 Short-term investments 9 9 9 9 9 9 Receivables (A/R and N/R) 142 158 193 202 226 253 Inventories 203 227 371 360 400 445 Other 162 176 247 321 321 321 Long-term assets 1,323 1,745 3,023 4,080 4,550 4,969 Long-term investments 23 23 - 101 101 101 Net fixed assets 949 1,193 2,135 2,892 3,361 3,780 Intangibles and other 350 528 888 1,087 1,087 1,087

Total assets 3,198 6,328 7,987 8,814 9,378 9,840

Current liabilities 1,151 1,313 2,016 2,429 2,530 2,642 Short term borrowings 84 - - - - - Account payables 543 501 755 900 1,001 1,113 Other current liabilities 524 811 1,260 1,529 1,529 1,529 Long-term liabilities 41 49 54 53 53 53 Long-term debt 1 1 1 0 0 0 Other long- term liabilities 39 48 54 52 52 52 Total liabilities 1,192 1,362 2,070 2,482 2,583 2,695 Equity 2,006 4,966 5,917 6,332 6,795 7,145 Common stock 700 1,280 1,344 1,411 1,411 1,411 Additional Paid-in Capital 509 2,742 2,850 2,696 2,696 2,696 Retained earnings 809 1,082 1,763 2,259 2,721 3,072 FX adjustments -11 -138 -40 -34 -34 -34

Total liabilities and equity 3,198 6,328 7,987 8,814 9,378 9,840

BV/share (NT$) 28.66 38.80 44.02 44.87 48.15 50.63

Income Statement

(NTD$ mn, unless noted) 2009A 2010A 2011A 2012E 2013E 2014E Net sales 6,283 8,347 11,456 13,595 15,383 17,351 Cost of goods sold 3,110 3,936 5,323 6,058 6,807 7,635 Gross profit 3,173 4,410 6,133 7,518 8,576 9,717 Operating expense 2,130 3,320 4,729 6,121 7,124 8,226 Operating income 1,043 1,091 1,404 1,398 1,452 1,491 Net non-operating income 10 65 122 159 154 154 Pre-tax income 1,054 1,156 1,526 1,557 1606 1,645 Income tax (credit) 296 319 388 421 402 411 Minority interest 17 10 17 36 36 36 Net income 741 827 1,121 1,100 1,169 1,197

Shares (mn) 65.8 115 134.4 141.12 141.12 141.12 EPS (NT$) 11.25 7,18 8.34 7.92 8.29 8.49 EBITDA 1,188 1,350 1,778 1,861 1,983 2,072

Cash Flow Statement

(NTD$ mn, unless noted) 2009A 2010A 2011A 2012E 2013E 2014E Operating cash flow 1,177 1,192 1,969 1,916 1,735 1,819 Net profit 741 827 1,121 1,100 1,169 1,197 Depreciation and amortization 142 259 374 463 530 581 Decrease in receivables (1) (16) (35) (9) (24) (27) Decrease in inventory (97) (24) (145) 11 (40) (45) Increase (decrease) in A/P 239 (42) 254 145 101 112 Other adjustments 136 177 383 178 0 0 Investment cash flow (741) (613) (1,582) (1,574) (1,000) (1,000) Capital expenditures (422) (444) (1,104) (1,145) (1,000) (1,000) Decrease (increase) in lt invt (25) 0 0 (113) 0 0 Decrease (increase) in st invt 0 0 0 0 0 0 Other adjustments (295) (169) (478) (315) 0 0 Financing cash flow 645 2177 (443) (538) (706) (847) Proceeds from new issues 790 2,382 0 0 0 0 Dividends and bonus paid (62) (140) (448) (538) (706) (847) Increase (decrease) in st debt (77) (84) 0 0 0 0 Increase (decrease) in lt debt (57) (0) (0) (0) 0 0 Other adjustments 52 19 5 0 0 0 Other cash flow adjustments (4) (101) 185 (105) 0 0 Total cash flow 1,076 2,654 129 (301) 29 (28) Cash, beginning 284 1,360 4,014 4,143 3,842 3,871 Cash, end 1,360 4,014 4,143 3,842 3,871 3,843

Source: TEJ, Company Data, NCCU Team


27 January 2013

3

Investment Summary

Lowering SSS as competition intensified

Gourmet Master expands rapidly in Shanghai in last two years (figure 1). Intensified

competition in chains and cannibalization forced the company to implement new inland

expansion strategy. While most major chains stalled their expansion and Chantilly, a

famous bakery in Shanghai, exited the market in 1H12, we believe that Bakery market

in Shanghai has come into the Shakeout phase, making it hard for Gourmet Master to

maintain its past performance. We forecast SSSG in China to be -3% in 2013 and -2%

in 2014, and top-line growth will decelerate to 14.6% in 2013 and 10% in 2014

respectively (figure 2).

Inland China expansion will face intense competition

Gourmet Master has large customer base in Shanghai rather in inland cities, whose

income levels are much lower than that of Shanghai Existing chain competitors have

penetrated inland cities, including Holiland which has more than 900 stores in several

minor cities. Moreover, income levels in inland cities remain low so that Gourmet

Master’s new strategy of foraying into inland cities hasn’t shown significant

contribution, evidenced by declining average sales per store and worsening OPM%. In

view of that, Gourmet Master gave up fast expansion strategy in 2nd and 3rd tier cities,

which we believe to be the key strategy to build up its brand name in a new market.

We expect Gourmet Master’s way west will be tough in the years to come.

Operating margin will continue slumping

We found that Gourmet Master's operating margin has been narrowing while the

company kept expanding. We believe rising operating expense could be attributed to

rising labor cost and higher rent in inland cities. Following the twelfth five-year plan,

minimum wage is expected to rise at CAGR of 15% in the next 5 years in China, which

puts pressure on the company’s headcount cost. Rentals in Chinese cities have also

increased by 10% generally. While labor costs and rental costs accounted for more

than 30% of the company’s sales, we expect Gourmet Master’s OPM to continue its

downward trend (13.07% in 2010 to 8.71% in 3Q12) to 8.5%. With regard to

competition and cannibalization, we forecasted 2012-2014 EPS CAGR of 3.6% (figure

3).

Taiwan market shrinking with hopes on its new brand

We expect 4Q12 revenue in Taiwan to be dim while its beverage sales, which

contribute the largest part of its total sales in Taiwan, face severe competition while its

major competitor, President Chain, frequently launched promotion campaign. On the

other hand, we believe Gourmet Master's new brand will have difficulty in highly

competitive Taiwan market. Existing chains had occupied existing commercial district

while high upfront investment and its high-end position will find it hard to generate

profit in the short term. We forecast Gourmet Master's revenue in Taiwan will to

remain flat in 2012 and gradually decline in 2013 and in the next few years.

Competitive in overseas market but little impact

In the next 5 years, Gourmet Master plans to add 20 stores in the US, where the

company claimed sales per store is US$0.7mn per months (7 times average monthly

sales per store in China) with high OPM% of 20%. However, sales from USA will only

account for 7% and 10% of total sales in 2013 and 2014 respectively, which are still

trivial to sustain whole company’s growth, so we believe the growth in USA is not key

driver for its stock performance.

Figure 1: Competitor Expansion by stores in

China


Figure 2: Gourmet Master, Stores vs. Sales Growth


Figure 3: Operating Margin Trend, Gourmet

Master


636

22 114

763

93 158

818

169 211

898

270 259

972

360 264

0

200

400

600

800

1000

Christine GourmetMaster

BreadTalk

2008 2009 2010 2011 9M12

169

270

380

460 540 81%

44% 32%

15% 10%

0%

30%

60%

90%

0

200

400

600

2010 2011 2012E 2013E 2014E

# of stores Revenue growth %

14.9%

10.9%

13.0%

13.5%

14.2%

10.8%

11.5%

12.7%

14.1%

8.6%

8.7%

9.9%

11.8%

7.3%

8.9%

8.5%

10.8%

6.7%

8.6%

8.2%

5%

7%

9%

11%

13%

15%

17%


27 January 2013

4

Business Description

Company Introduction

Gourmet Master Co. Ltd., the holding company of 85℃ bakery café, is a well-known

chain store in greater-China, providing a wide variety of food products including bread,

western dessert, and beverage. Gourmet Master recently launched two sub-brands in

Taiwan, namely Better Simple Bakery and TopOnePot hot pot restaurant.

1H12 revenue breakdown: bread (39%), western dessert (32%), and beverage

(29%)(figure4, 5). Beverage has the highest gross margin, followed by bread and

western-style desserts. Gourmet Master Co. Ltd. operates in Taiwan (27% of revenue),

China (68%), and others (5%)(figure 6).

Ownership structure

Infinity Emerging Markets Limited, the largest shareholder of Gourmet Master, holds

22.96% of GM’s share. Cheng-Hsueh Wu, chairman of Gourmet Master, is

second-largest shareholder of the company with 14.32% of shares(figure 7).

Henderson I Yield Growth Limited has 8.84% of the shares. Other major holders

include Special account of Morgan Stanley hosted by HSBC, Circle Garden

International Limited and Hua-Ting Chang, wife of the CEO.

Product development and variety enhanced pricing power

Gourmet Master has diverse product mix of 160, with 100 different bread products.

Some competitors might offer many bread varieties, but the bread products are

packaged and not freshly baked bread. Besides, Gourmet Master launched 10-15 new

bread products, 3-4 new beverage products and 2-3 new cake products per month to

drive customer traffic. This strategy also gave Gourmet Master the ability to pass down

price pressure to consumers, since each ingredients count for less than 5% of COGS.

Attractive pricing for fresh-baked goods

Luxury at a friendly price is the motto, which Gourmet Master has been operating by. Its

average retail price for bread in China is around RMB 3-18, which is one-third to half of

Starbuck’s selling price of RMB 10-22. In Taiwan, Gourmet Master’s average coffee

price per cup is NT$35-85 compared to Starbuck’s NT$80-150 and 7-11’s NT$35-55

per cup.

Industry Overview and Competitive Positioning

Consumption growth sustained as disposable income rises

Private consumption in China has grown at CAGR of 14.6% during the past ten years

(2002-2011) and is expected to grow in the future as Chinese government has

announced to continue its stimulus policies in the twelfth five-year plan (2011-2015),

aiming to raise household disposable income by 7% annually.

Over the past ten years, China’s restaurant sales have grown at a 19.6% CAGR,

faster than overall private consumption growth of 14.6% CAGR during the same

period. Despite fast growth, sales per capita in restaurant sector are still low compared

with South Korea, Taiwan and Japan. We believe Chinese restaurants will maintain a

stable and healthy growth.

Figure 4: Sales Breakdown by Product


Figure 5: China Sales Breakdown by

Product


Figure 6: Gourmet Master sales by Region


Figure 7: Ownership Structure, 3Q12


Beverage 29%

Bread 39%

Western dessert

32%

Beverage 25%

Bread 50%

Western dessert

25%

China

Taiwan

Others

0

2

4

6

8

10

12

14

NT$

Mill

ion

s

Infinity Emg. Mkt Limited

23%

C.H. Wu Family

21%

Henderson I Yld. Growth

9%

Other 47%


27 January 2013

5

Table 1: Industry Structure

Source: NCCU Team

Market fragmented, rapid growth fuels intense competition

China’s bakery industry is highly competitive and fragmented with 50,000 to 70,000

bakeries due to low entry barriers. According to Euromonitor, sales of top five brands

accounted for only 6.2% of total bakery industry (Figure 8) in 2010 while most bakeries

remain independent.

For bakery products, Bakery stores are the most important distribution channels in

China. According to Euromonitor, 55% of bakery product sales came from bakeries,

32% came from supermarkets, while remaining portion from other channels in 2010

(figure 9). In the past few years, competition between chain stores became intensified

as peers launched similar expansion strategy at the same time.

Gourmet Master faces fierce competition from chain brand bakeries, local independent

stores, supermarkets and convenience stores. Differentiation will be next winning point

in current market situation.

Type Competitive Force Content

Competition Substitutes Light meal, Snack stores

New Entrants Independent bakery and coffee shop (with low barrier), Chain brands (with

higher barrier)

Existing Rivals Café: Starbucks, Dante Coffee, Barista Coffee, Ikari Café, UBC Coffee, illy,

Ming-Tin-Tien etc.

Bakery: Convenience stores (7-11, Family Mart), Holiland, Christine,

Croissants de France, Daoxiangcun, BreadTalk, Ichido etc.

Supply Chain

Bargaining Power

Suppliers Relatively low, Raw material prices rising

Customers Neutral, Somehow depends on brands

Figure 8:Market share of top 10 China bakery chains,

2010

Source: Euromonitor, NCCU Team

Figure 10: China Private Consumption

Source: World Bank data, NCCU Team

CAGR 14.6%

Figure 9: Bread Sales breakdown by Channels, 2010

Source: Company Data, Yano Research Institute

55%

30%

32%

50%

13% 20%

0%

25%

50%

75%

100%

China JapanBakery Supermkt/Conv. stores Others


27 January 2013

6

Table 2: Gourmet Master SWOT Analysis

Source: NCCU team

Gourmet Master in Shanghai: innovative and diverse on-site baked

products at attractive prices

In Shanghai, main competitors are brand chain bakeries such as Christine, Bread Talk

Ganso, and Paris Baguette. Gourmet Master’s rapid expansion strategy, providing

innovative and diverse on-site baked products with attractive price, was a success.

However, according to Yano Research Institute, bakery account for less than 30% of

bread sales channel in Japan, while convenience stores and supermarkets together

account for more than 50%. We believe this indicates that, contrary to Gourmet Master

management’s view; fresh-baked bread is not a trend as bread consumption increases

and bakery chains will be more competitive while entering mature stage.

Inland expansion strategy

Facing fierce competition inland, Gourmet Master adopts a strategy of unit price

nationwide, while Holiland, a popular inland chain store bakery, and local independent

bakeries provide package and cheaper products.

Private consumption per capita and awareness to product quality are low in inland

(figure 10,11). Ratio of population to McDonalds stores shows that the level of

westernization of inland areas is much lower than that of Shanghai (figure 13). Thus,

Gourmet Master’s product is less attractive to inland consumers, whose determining

factors are price and convenience.

Furthermore, with slow disposable income growth in inland, we believe Gourmet

Master’s present inland strategy will hurt the top line before it earns profit in the future.

We see no significant contribution from this strategy yet, evidenced by deteriorating

average sales per store and worsening OPM%.

Strengths Weaknesses

Competitive R&D team: launch innovative products

frequently

Each ingredients count for less than 5%

Standardization: HR management, logistics, central

kitchens, etc.

Already one of the leading brands in China cities

Do not understand inland market

Low central kitchen utilization ratio

Opportunities Threats

Increasing income and consumption in China

Chinese consumers’ increasing consumption of coffee

and western desserts

Increasing brand recognition in China (Brand of Taiwan

can gain trust in Chinese consumers)

Potential market share for chain brand restaurants

Rising raw material prices, wages, and other operating

expenses

Slow disposable income growth

Low level of westernization

Mass existing independent bakeries

Low entry barriers

Hard to hire, train and retain skillful employees

Figure 12: China GDP per capita, 2012

Source: National Bureau of Statistics of China, NCCU Team

Figure 13: Residents per McDonalds, 2012

Source: National Bureau of Statistics of China, Company Data, NCCU Team

Figure 11: Consumption per capita by

region, China 2010

Source: National Bureau of Statistics of China

15.97

11.10 11.78 12.08

8

12

16

20

RM

B¥

Th

ou

san

ds


27 January 2013

7

Financial Analysis

Revenue: Lackluster SSSG is our major concern

China: Declining SSSG and lower sales of new store encumber growth

Aggressive store expansion in China has been the key growth driver for Gourmet

Master. Up to 9M12, the number of stores in China has increased to 360 (+54% YoY);

however, China’s sales grew only 33% YoY. We attribute slower revenue growth

(fugure14) to 1) declining SSSG, especially in Shanghai (where one-third of its China

stores are located), and 2) lower sales of new stores, which we estimated only 2/3 of

the sales of old stores. In view of intense competition in Shanghai, the company

launched new inland penetration strategy in 2H11. However, we haven’t seen

significant contribution from this strategy yet, evidenced by declining average sales

per store and worsening OPM%. We thought market has been too optimistic on its

turnaround in 2013, and we believe the downward trend will go on in views of 1)

cannibalization and the fierce competition in 1st tier cities, and 2) low disposable

income and comparatively low acceptance of western food in Mid and Southwestern

China, which have been regarded as a potential market for the company. We expect

the company to add both 80 stores in 2013 (+21% YoY) and 2014 (+17% YoY),

however, due to lower SSSG we employed (2013E: -3%; 2014E: -2%), revenue can

grow by 14.6% and 10% respectively.

Taiwan: saturated market and price competition

Gourmet Master has 344 stores in Taiwan, and its sales in Taiwan was NT$2.5bn (flat

YoY) in 9M12, which accounted for 27% of its total revenue. In Taiwan, beverage is its

major source of income. Recently, its competitors such as City Café, Let’s Café, and

Starbucks launched promotion more frequently. Therefore we estimated that this

would lower its SSSG in the future (2013E: -3%; 2014E: -2%, figure 15). Moreover,

Taiwan market is entering a saturated stage, so we expect that there is little expansion

in the future. Although the company has now launched new brands such as

TopOnePot and Better Simple, we believe these two brands will contribute little to total

sales in the short term. In summary, we estimated the revenue from Taiwan would be

NT$3.4bn (-3% YoY) and NT$3.3bn (-2% YoY) in 2013 and 2014 respectively.

Other areas: U.S. is treated as a future star

For the company, the US market is viewed as the key growth driver in the future. The

company claimed that US monthly per store sales is around US$700k, and they plan

to expand 20 more stores within 5 years. The new stores will be 100% self-owned,

compared with previous JV stores. We believe there will be 7 and 11 stores in 2013

and 2014, contributing NT$1bn and NT$1.9bn, and accounting for 7% and 10% of total

revenue respectively. Although U.S. business may enjoy robust growth, we believe

contribution is still too minor to offset the deceleration in China and Taiwan market.

Creditable GM%, but deteriorating OPM% is more crucial for earning

performance

Gourmet Master has good record of its gross margin, even during the period of rising

commodity price. From 1Q10 to 3Q12, prices of its three major materials (sugar, wheat,

and coffee bean) rose 14%, while Gourmet Master’s gross margin increased from 52%

to 55%. We don't have too much concern on its gross margin in views of 1) increasing

revenue percentage from higher GM% China business, 2) diversified cost pool (each

material accounting for less than 5% among total COGS), 3) innovation and product

differentiation, by such way the company could transfer cost to its customers. We

expect the company’s gross margin will remain at 55%~56% during 2013 and 2014.

Despite stable gross margin, deterring OPM is more crucial to its earning outlook. The

Figure 14: Number of Stores vs. Revenue growth in China


Figure 15: Number of Stores vs. Revenue growth in Taiwan


169

270 380

460 540 81.1%

44.0% 32.2%

14.6% 10.0%

0%

20%

40%

60%

80%

0

200

400

600

2010 2011 2012E 2013E 2014E


324 324 344 344 344

0.74%

9.95%

-3.59% -2.72% -2.00%

-5%

0%

5%

10%

15%

0

200

400

2010 2011 2012E 2013E 2014E



27 January 2013

8

company’s OPM has dropped from 13.07% in 2010 to 10.44% in 9M12, and even

worsen to 8.71% (-3.02 ppts YoY) in 3Q12. The company blamed that for upfront

CAPEX cost due to new stores and central kitchens. However, we believe this might

not be the key factor because the company has adopted fast expansion strategy for

many years without significant OPM% decline previously, and the depreciation cost

of central kitchen only accounts for less than 1% of revenue. In our view, we believe

following reasons should be the main factors:

Declining Same-Store-Sales

Operating margin in bakeries is highly related to scale due to high operating

leverage. Gourmet Master faces fierce competition in Shanghai, resulting a negative

SSSG and enormous pressure on OPM. Furthermore, the company has shift its

concentration from eastern regions to inner lands, where sales per store are

estimated only two-third of Shanghai stores, slumping average sales per store from

RMB$1.8m/Q in 3Q11 to RMB$1.5m in 3Q12 (-17% YoY, figure 16).

Piling up labor cost

Labor cost accounts for 16-18% of its revenue in China while wage in food and

beverage industry has an annual growth rate of 11.8% in 2011 in China. We predict

wage will rise higher owing to the major theme advocated by the twelfth five-year

plan, aimed to narrow fortune gap by increasing the minimum wage by average 15%

annually (figure 17). Since most of its employees are low-paid worker, the policy will

harm its profit and we expect labor cost will further rise by 18-21%, putting huge

pressure on its OPM%.

Increasing rental expense

Being the second largest component of OPX, rental cost 15-17% of revenue in

China. Despite the company claim that signing favorable contracts with landlords

can control rentals, we doubt the effectiveness of the contracts because of default

risk. We believe rentals in China will grow by 10% annually and will account for

16.5% and 18.7% of sales in 2013 and 2014 (figure 18).

Sensitivity analysis

We take new stores open and SSSG in China, the two major factors driving for

Gourmet Master’s top-line, to check its sensitivity to the company’s 2013E EPS

(figure19). 2013 EPS of 8.29 implied -3% SSSG and 80 new stores open. As the

table illustrated, the fewer stores it opens, the higher EPS. This was because we

believe the new stores in Mid and Southwestern China need more time to break

even. Moreover, EPS is more sensitive to the change in SSSG, and we believe our

estimated -3% SSSG is appropriate because its SSSG is now in a downward trend

and hard to turnaround in the short run.

Solid balance sheet even with stagnant earning growth

Despite slowing growth that Gourmet Master facing, the company still has strong

balance sheet. Ended in 3Q12, the net cash positions was NT$3.46bn (or NT$24.6

per share), and there wasn’t any bank debt outstanding (debt ratio: 28%). Due to

inherent nature of retail business that receiving cash promptly but paying to

suppliers slowly, it enjoys negative cash cycle days of -19 days as of 3Q12 so that

the company could generate more cash flows once it increased its sales scale.

Overall, we have little concern on its financial situation, however, what triggers our

negative outlook is its lackluster earnings growth to support current high PE

multiples.

Figure 16: Average Store Sales in China vs.

Operating Margin


Figure 17: Minimum wage level in China,

2012


Figure 18: Rent index in China cities

Source: Wind

Figure 19: Sensitivity, 2013 EPS

SSSG

in C

hin

a (2

013)

New stores open in China (2013)

60 70 80 90 100

3% 10.37 10.32 10.27 10.22 10.17

0% 9.4 9.34 9.28 9.22 9.16

-3% 8.44 8.36 8.29 8.21 8.15

-6% 7.47 7.39 7.31 7.22 7.14

-9% 6.5 6.41 6.32 6.23 6.13


2.1 1.7 1.9 1.8 1.8 1.6 1.8 1.6 1.6 1.4 1.5

14.9%

10.9%

13.0% 13.5%

14.2%

10.8% 11.5%

12.7%

14.1%

8.6% 8.7%

8%

10%

12%

14%

16%

1.2

1.4

1.6

1.8

2

RM

B¥

Mill

ion

Quarterly average sales per store OPM%

0.5

0.8

1.1

1.4

1.7

Tho

usa

nd

s 2010 2011 2012

90

110

130

150 Shanghai Ningbo

Chongqing Chengdu


27 January 2013

9

Cash flow analysis

Contributed by its retail business nature, the company could generate sufficient cash

flow to support its store expansion without debt offerings. However, its free cash flow

had been declining from NT$573mn as of 2010 to NT$342m as of 2012 due to

aggressive store expansion plan in China. (CAPEX for one store and one medium

central kitchen are RMB$1.3m~$1.5m and RMB$15m respectively). However, the

sales of new stores is lower than company’s expectation, so we guided that the

CAPEX for 2013 and 2014 were lowered to NT$1.2bn and the company would

increase its dividend payout ratio. However, Gourmet Master is now treated as a high

growth stock, and the decrease in CAPEX and increase in dividend payout ratio would

be seemed as a signal that the company is facing difficulties in duplicating business

model, putting downward pressure on its stock performance.

Valuation

PE Method

Our 12-mth target price is NT$166 based on 20X multiple of 2013E EPS of NT$8.29;

and it’s now trading at 24X of 2013E EPS. For 2012, Gourmet Master was traded at an

average PE multiple of 24X. However, we believe this number should be revised

downward because the company’s growth of EPS should decelerate to 4.67%/2.41%

for 2013/2014 compared to market consensus of 27%/24%. As we previously

mentioned, despite China market is very attractive, low entry barrier of bakery industry

would result in intense competition and the strategy of penetration into inland cities

wouldn’t make significant contribution in the short-term. This is why we employed a

lower PE multiple than that of historical average. Our employed multiple is also lower

than 23X of Taiwan peers’ average because of its slower 2013 EPS growth of 4.67%

compared to 19% of peers’ average. Thus, we believe the company is overvalued at

current price.

DCF Method

By our DCF model, we assess the fair price of Gourmet Master to be NT$152, which is

consistent with our 20x PE expecting price of $166. Our DCF model is under the

assumption of 9.6% WACC (Risk-free rate: 1.14%, Beta: 0.78, Market risk premium:

10.83%) and 2% terminal growth rate.

Revenue: For the 1st stage (2013~2017) and 2nd stage (2018~2022), we forecast

CAGR of 17% and 8% respectively. The top-line growth was mainly from store

expansion in China, and we believe China market would step into saturated stage

after 5 years because many competitors are entering huge potential market.

OPM%: The rising rental and labor cost in China would continuously put downward

pressure on its OPM. We apply 8.37% OPM% for the 1st stage in our DCF model and

7.36% OPM% for the 2nd stage because of lower revenue growth rate in 2nd stage.

Net Working Capital (NWC) investment: Due to its retail business nature, the

company has negative NWC requirement. Historical pattern shows NWC

requirement for the company is about -10% of sales. Which is also our assumption of

NWC estimation.

Depreciation& Amortization: According to historical pattern, Depreciation&

Amortization expense accounted for 3.6% of revenue, and we use this number for

our DCF model assumption.

CAPEX: Gourmet Master claimed that the CAPEX for a new store and a medium

central kitchen are RMB$1.3~$1.5m and RMB$15m respectively. Based on our

expectation of its expansion plan, we forecast CAPEX of NT$1.2bn/year and

NT$1bn/year for the 1st and 2nd stage respectively.

Figure 20: PEG regression


Figure 21: PE Band

Source: TEJ, NCCU Team


27 January 2013

10

Table 3: Peer Comparison

Company Ticker Mkt. Cap. M$

EPS CAGR PE (x) PB (x) ROE (%)

11 12E 13E 08- 12F

11- 13F

11 12E 13E 11 12E 13E 11 12E 13E

Gourmet

Master 2723.TT 923 8.34 7.92 8.29 N.A. 0 25.2 25.2 24 4.8 4.4 3.9 20.6 17.9 17.8

Taiwan Peers Wow prime 2727 TT 984 N.A. 15.78 19.45 N.A. 3.8 N.A. 25.7 20.9 N.M. 8.2 6.8 46.9 37.9 14.9 TTFB CO LTD 2729 TT 154 9.42 8.66 10.98 N.A. 5.2 N.A. 21.9 17.3 8.7 2.6 2.3 45.4 17 13

An-Shin Food 1259 TT 93 6.45 4.06 4.43 N.A. -11.8 20.1 20.5 18.8 1.8 N.A. N.A. 17.4 9.6 10.1 President Chain 2912 TT 5,564 5.90 6.30 6.80 16.4 2.5 25 24.7 23.2 7.6 7.3 6.8 31 31 30.6 Family Mart 5903 TT 1,039 4.50 4.25 5.15 22.3 3.7 36 31.4 25.9 7 6.6 5.8 23.4 20.6 24

Greater China Peers Christine 1210.HK 146 0.13 0.06 0.18 -18.7 -7.3 8.5 14.5 9.9 1 0.9 N.A. 12.2 7.2 N.A. BreadTalk BREAD.SP 156 0.04 0.04 0.05 12.4 10.2 14.6 13.6 12 2.2 1.9 N.A. 15.8 15.2 N.A.

Ajisen 538 HK 935 0.33 0.12 0.2 -10.6 -14.9 54.9 59.4 36.1 2.7 2.6 2.5 12.3 5.1 5.9 Global Peers Starbucks SBUX US 41,173 1.52 1.79 2.16 22.9 21.4 30.3 25.2 25.2 7.9 7.5 7.1 30.9 29.2 28.9

McDonalds MCD US 90,990 5.27 5.32 5.79 9.2 8.3 16.9 16.9 15.6 6.5 6.4 6.0 37.9 38.4 41.6 Panera Bread-A PNRA US 4,834 4.70 5.90 7.00 36.7 21.9 29.9 28.3 23.6 6.3 5.8 2.6 21.7 23.8 22.8 Yum! Brands YUM US 30,533 2.87 3.26 3.68 11.9 16.2 20.9 20.4 18.0 13.7 12.9 10.3 77.6 72.1 68.3

Source: Bloomberg, NCCU Team data as of Jan 4 2013

Investment Risk

Faster than expected top-line growth

We expect that Gourmet Master's expansion in China will slow down in 2013, causing

top-line growth rate to decrease. However, the economy in China is still experiencing a

hyper-speed growth and management might change its expending guideline to take

new opportunities. A leap in top-line might drive higher than expected bottom-line and

thus would affect our forecast.

Same store sell growing higher

Past trend has shown that SSSG is declining for the existing stores. In this case, the

company would improve its operating margin and raise its net income. The

improvement might come from higher capacity utilization and lower average fixed cost

and therefore affects our estimation.

Short data period

Given that Gourmet Master's trading history is short (listed since November 2010), its

trend might revert while the market, during the period, is volatile and the company's

operating strategy is changed dramatically. Although we believe the trend might

continue, volatile share price might maintain in the foreseeable future.

New CEO, James Hsieh, comes with new hope

James Hsieh, ex-COO of President Chain, has more than 30 years of experience in

retail industry. His background and experiences may help Gourmet Master in store

operations, logistics and distribution system construction and marketing innovation to

improve its performance.


27 January 2013

11

Appendix

Appendix 1: Gourmet Master- DCF Valuation

First Stage Growth ( FCF CAGR=17%) Second Stage Growth (FCF CAGR= 8%)

NT$ mn 2013(F) 2014(F) 2015(F) 2016(F) 2017(F) 2018(F) 2019(F) 2020(F) 2021(F) 2022(F) Net Sales 15,383 17,351 19,292 21,329 23,073 24,227 25,438 26,710 28,046 29,448

Total cost of good sold 6,807 7,635 8,488 9,385 10,152 10,902 11,447 12,020 12,621 13,252

GROSS PROFIT 8,576 9,717 10,804 11,944 12,921 13,325 13,991 14,691 15,425 16,196 Operating expenses 7,123 8,225 9,261 10,234 11,046 11,489 12,192 12,682 13,438 13,977

OPM 1,453 1,492 1,542 1,710 1,875 1,835 1,799 2,009 1,987 2,219 Total non-operating gain 38 38 38 38 154 40 158 41 163 42

EBT 1,491 1,530 1,580 1,748 2,029 1,875 1,958 2,049 2,150 2,261 Taxes or tax credit 402 411 424 466 507 469 489 512 538 565

NI 1,169 1,198 1,236 1,362 1,485 1,406 1,468 1,537 1,613 1,696

+Dep. & Amr. 530 581 695 768 831 872 916 962 1,010 1,060 -Change in NWC -179 -197 -194 -204 -174 -115 -121 -127 -134 -140 -CAPEX 1,200 1,200 1,200 1,200 1,200 1,000 1,000 1,000 1,000 1,000

FCF 678 776 924 1,133 1,291 1,394 1,505 1,626 1,756 1,896 Terminal Value of FCF 25,789

Equity Value Analysis (NT$M) Value %DCF

PV UCF 7,512 35.1%

PV of Terminal Value 10,406 48.7% -Long-term Dabt 0 0.0% +Cash 3,465 16.2%

DCF Value 21,383 100% Shares outstanding (M shares) 141

DCF Value per Share 152


27 January 2013

12

Appendix 2: Key Ratios

2009A 2010A 2011A 2012E 2013E 2014E

Liquidity ratio

Current ratio 1.63 3.49 2.46 1.95 1.91 1.84

Quick ratio 1.45 3.32 2.28 1.80 1.75 1.68

Efficiency ratio

Days of inventory 21 22 23 20 20 20

Account receivable days 7 7 5 5 5 5

Account payable days 55 48 46 50 50 50

Cash Conversion Cycle -28 -19 -18 -25 -25 -25

Total asset turnover 1.96 1.75 1.60 1.62 1.69 1.81

Fixed asset turnover 6.62 7.79 6.89 5.40 4.92 4.86

Profitability ratio

GM% 50.50% 52.84% 53.53% 55.38% 55.75% 56.00%

OPM% 16.60% 13.07% 12.25% 10.29% 9.44% 8.59%

Net Margin 11.80% 9.91% 9.79% 8.10% 7.60% 6.90%

EBITDA% 18.90% 16.18% 15.52% 13.71% 12.89% 11.94%

ROE% 36.96% 23.73% 20.60% 17.96% 17.80% 17.18%

ROA% 23.18% 17.37% 15.66% 13.09% 12.85% 12.46%

Solvency ratio

Debt ratio 37% 22% 26% 28% 28% 27%

Debt to equity ratio 59% 27% 35% 39% 38% 38%


27 January 2013

13

Appendix 3: Group Structure

Self-owned:

40 stores

Franchised:

302 stores

Central

Kitchen: 3

Self-owned:

360 stores

Central

Kitchen: 8

JV with

Café de

Coral (ticker

0341.HK)

Opened 1st

store

In 2012/07

Self-owned:

1 store

Plan to

open 1st

store in

2012/4Q

JV:

2 stores

Central

Kitchen: 1

(small)

JV:

5 stores

Central

Kitchen: 1

(small)

New Brand

TopOnePot Better Simple

Self-owned

1 store

Open in

2012/11

Self-owned

2 stores

Gourmet Master

Taiwan China Hong Kong USA USA Australia

100% 100% 50% 65% 100% 51%


27 January 2013

14

Appendix 5: Gourmet Master Sales Breakdown by brands

Appendix 4: Bakery peer comparison in China

100% 99.93%

96.30% 94.55%

92.75% 91.57%

91.34%

0.07%

3.70%

5.45% 7.25%

8.43% 8.66%

0

5000

10000

15000

20000

25000

30000

2011 2012E 2013E 2014E 2015E 2016E 2017E

NT$ Millions

Top One Pot 85 Degree

Comparison Table: Gourmet Master vs. competitors

Brands

Number of Stores 360 972 264 260 71 1000

Central Kitchen Yes Yes Yes Yes Yes Yes

Product Diversity High High Med High Med High

Product Quality Med Low High Med High Low

Price Level Med Med Med Med High Low

Brand Awareness

In Shanghai

High High Med High Med Low

Brand Awareness

Inland

Low Med Low Low Low High


27 January 2013

15

Appendix 6: Market share of China bakery chain: slightly increased

Rest 92.77% Rest 92.21%

Top 10 7.23% Top 10 7.79%

0%

20%

40%

60%

80%

100%

2009 2010

Holiland 1.84% Christine 1.32%

Ganso 1.17%

Dao Xiang Cun 1.08%

Gourmet Master 0.83%

Michie 0.40%

BreadTalk 0.37%

Andersen 0.29%

Sunmile 0.27%

Rosa 0.22%

Rest 92.21% Top 10 7.79%

Top 10 China bakery Market Share, 2010


27 January 2013

16

Appendix 7: Risk Matrix

Significant

Higher than

expected SSSG

Improvement of

OPM

Effective new inland

strategy

Moderate

Faster than

expected growth

Franchising

Minor

Success in new

brand

Higher inflation

Low Medium High

EPS

Significance

Probability

Disclosures: Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director:

The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making:

The author(s) does not act as a market maker in the subject company’s securities. Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society Taiwan, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

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CFA Institute Research Challenge · PDF file · 2016-06-06CFA Institute Research Challenge ... We forecast its OPM will fall to 10%, 9% and 8% in 2012-2014 respectively, ... Depreciation