Shorting The Breadtalk Stock? Don't Get Scalded!

| About: Breadtalk Group (BTKGF)
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The Breadtalk Group has been facing headwinds like all the others in the Food and Beverages sector.

Profitability has suffered as a result of one-off items as part of its consolidation plans.

Headwinds expected to persist but the management has demonstrated its handle on the situation.

The Breadtalk Group (OTCPK:BTKGF) (SGX:5DA) was founded in 2000 as an owner of several bakery outlets in Singapore. It later branched out into the business of operating food atria and restaurants. At the same time, it also expanded overseas, particularly in China. The Breadtalk Group won the franchise rights to operate Din Tai Fung in Singapore and Thailand, in 2003 and 2011 respectively. Din Tai Fung, a Chinese-styled restaurant brand with origins in Taiwan, is "[r]anked as one of the world's Top Ten Best Restaurants by The New York Times", according to the company's website. The Breadtalk Group was instrumental in bringing the Taiwanese brand to an international audience, and it continued to uphold the brand's "exacting culinary and service standards", according to the owner of the brand.

Fellow Seeking Alpha contributor wrote an article on the Breadtalk Group last week, calling for a short trade in the share with "a potential gain of up to 54% within a 12-month time frame". The thesis revolved around two key themes: 1) the ongoing store rationalization plan would reduce revenue growth, and 2) limited ability to pass on cost increases to customers. Combining lackluster revenue growth and poor margins together, he was expecting the Breadtalk Group to post weaker-than-consensus earnings. Consequently, the share price of the Breadtalk Group would then plunge following supposed disappointing results.

With all due respect, I believe he missed notable positive metrics which have been reported in the company's third-quarter earnings release. In addition, he also failed to recognize the mid-to-long term benefits of the restructuring exercise. Most critically, the negatives raised in the article are not new and have probably been reflected in the share price which has fallen from a peak of S$1.56 in early 2015 to the current price at S$1.15.

Breadtalk Group Share price history

(Source: Google Finance)

Current State of Business

In the recent two years, the Breadtalk Group has been undergoing a consolidation process in its business, especially in China, in view of the competitive food and beverage retail environment with numerous new players and increasingly sophisticated consumer tastes. The tough climate is understandable given that even established Western brands such as KFC and McDonald's have struggled on their own. With its efforts in tightening cost controls and improving its supply chain operations showing positive results, the Bakery Division of the Breadtalk Group has progressed to reviewing its existing franchise portfolio with the aim to consolidate its operations. The Food Atrium Division has been grappling with profitability for years. However, the company's management has indicated during the last earnings briefing (3Q FY2016) that a clear turnaround plan is now in place. New outlet openings in the future will largely be concentrated in key cities where the company has "existing strong operating track record, and capital expenditures on such outlets will be more stringently controlled to shorten the payback period". The track record of the Restaurant Division is impressive and it continues to see a steady performance. The company intends to explore new opportunities for growth in this division both in existing and new markets. There remains high potential for new outlets as its restaurants still see healthy queues and long waiting time for customers to be served, at least based on the author's anecdotal experience.

Din Tai Fung restaurant queues

(Source: Tripadvisor )

Din Tai Fung long waiting time

(Source: Travel In Asia)

Improving Operating and Financial Metrics

One major bright spot highlighted in the company's latest available quarterly earnings report (3Q FY2016) is the vastly improved "cash & cash equivalents" versus net debt position. Traditionally, the company has a net debt position above its "cash & cash equivalent". However, the company has demonstrated its intent to reduce its debt obligations and strengthen its balance sheet with consistent improvement in this direction in the past few quarters. This change in direction appears to coincide with the appointment of the current Chief Financial Officer in the middle of 2015. The new CFO, Mr. Chan Ying Jian, is of J.P. Morgan pedigree.

cash and cash equivalent versus net debt

(Source: Breadtalk 3Q16 results announcement)

As mentioned in the introduction, the Breadtalk Group is continuing on its consolidation path and in the first nine months of FY2016, it has already closed 15 Bakery stores and eight Food Atrium outlets. In contrast, the company opened two new Din Tai Fung-branded restaurants in the period, demonstrating the management's clear intent to redeploy its resources effectively. The previously underperforming Ramen Play line of restaurants has now stabilized its operations as the company has already closed down several outlets often in line with the expiry of rental contracts.

outlet distribution by business segment

(Source: Breadtalk 3Q16 results announcement)

After achieving revenue growth in the Food Atrium Division in the past years, the company has now focused its attention on improving the Same Store Sales Growth at its existing outlets. During the first nine months of FY2016, a total of nine outlets were closed while one new outlet opened at the much hyped Shanghai Disneyland. Due to a S$4.8 million write-off in property, plant, and equipment as a result of four pre-mature closure for the period, the EBITDA more than halved when compared with the previous year. Therefore, the deterioration in margins is an anomaly as the write-off is a one-off event. With the closure of non-performing outlets, we should, in fact, be looking at an improvement in margins going forward.

Food atrium revenue and ebitda

(Source: Breadtalk 3Q16 results announcement)

Shanghai Disneyland Food Republic (Source: Disneyland Shanghai)

Despite a decline in revenue in the Bakery division attributed to weakness in the China franchise business, albeit mitigated by the strong performance of its directly operated stores in Singapore and Shanghai, the company achieved better EBITDA margin at 10.7% (9M FY2015: 6.9%) on the back of tighter cost control and productivity gains. This margin improvement was the positive surprise element which led to a re-rating of the shares of the Breadtalk Group. Previously, analysts were concerned about the company's ability to weather the rise in raw material costs, wage increases, and higher rental expenses. Therefore, it would be grossly unfair to attribute the jump in the share price solely to the announcement of an expansion in business operations to London.

bakery division revenue and ebitda

(Source: Breadtalk 3Q16 results announcement)

Finally, the crown jewel in the Breadtalk Group, the Restaurant Division, did not disappoint. Besides a revenue increase, EBITDA also rose, and EBITDA margin showed an improvement over the same period the previous year as well.

restaurant division revenue and ebitda


It is most unfair to the Breadtalk Group when the margins achieved in 2016 are used to project the profitability for the new financial year. This is due to the fact that the company incurred one-off costs as part of its consolidation and rationalization plan. While the oft-mentioned headwinds, namely the rise in raw material costs, wage increases, and higher rental expenses, show no signs of abating, the company has demonstrated its ability to mitigate the rise in costs through productivity improvement and tightening cost controls. Despite the ongoing closure of non-performing outlets, revenue might still surprise on the upside if the company turns more aggressive in its expansion in Europe, following the inaugural Din Tai Fung restaurant which is expected to open in London in this year.

While the company is not expected in the near future to return to the growth trajectory experienced before FY2014, the profitability appears to be on track for a recovery in the next quarters. As such, it might be unwise to short the shares. For opportunistic and longer term investors, there might even be good upside potential to be gained as the current bearish sentiment on the company has already resulted in a depressed share price performance in the past year.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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