Jeffrey Au

October 22, 2016

Tao Heung Analysis

I do not recommend purchasing Tao Heung. It is operating in a highly competitive

environment with rising rental pressure and increasing labor, renovation, and material
(food) cost. Its expansion into the Southern China region has increased its revenue,
but profit margins seem to shrink.
In 2011, for the China division, net profit after tax was 76 million. In 2016, it is only
12.2million.
The most important factor for going into the Chinese market is to introduce itself as a
brand, so it can franchise itself to other provinces are other places in Asia on a
commission basis. Yet, Dao Heung Cheun, or Tao Heung Village, a competitor, has
already registered that name. Trademark issues are a concern. Despite upcoming tax
cuts for restaurants in China, it wont help the affect the bottom line enough.
At a share price of $2.23, and at 1.02billion shares, there is a 2.26Billion dollar market
cap. Over a period of 5-6 years, the average net profit is about $240-270 million. Can
Tao Heung sustain these earnings? I think so, but in June 2016, its profit margins were
only 4.14%, while Aijsen had 8.07% and Fairwood had 10%. For the 2.1billion Hong
Kong in revenue, there is only a 4 percent margin, which means only 92 million in
profits.
Cash available at the end of the year seems to be decreasing. In 2012, TH had 421
million, 2013, 371 million, 2014, 336 million, 2015, 331 million (Google Finance, not
capital IQ). Furthermore, Tao Heung is not the smallest listed restaurant conglomerate,
but is not on par with Caf De Coral (16.15B market Cap) and Maxim to create
economies of scale to reduce costs, acquire profitable restaurants, and gain more
bargaining power over suppliers. While Fairwood has not been profitable in its China
Segment, it has a healthy 10% or more profit margins, and has shown a consistent
increase in profits every year.
Another point I am skeptical about is there 280 million total debt and 194 million
short term debt. If they have at least 300 million cash on hand, shouldnt they be
borrowing less? Total debt to equity 5 years ago was 2-4%, now it is at 14%. Working
capital is another consideration also. Current Assets = 791 Million. Current Liabilities =
685 Million. At 106 Million, I will prefer a bigger working capital. Assume receivables
account for 130million, if this and cash equivalents items were over stated, working
capital might be even less. While Fairwood has a slightly larger working capital at 128
million, their earnings are more consistent, and their long term debt to equity is only
0.5%.
Tao Heung has a higher dividend yield than restaurants that have similar revenue. It
has a high dividend yield of 5.29%, while Tsui Wah has 2.59%, and Caf De Coral has
2.99%. Tao Heung has a good 45,000 m2 testing facility and food center in Dong Guan
and a food processing center in Hong Kong and ties to VTC college in Hong Kong. But
it still doesnt warrant a purchase. Another thing to note is that Caf De Coral use to
(or still has) a 10% ownership of Tao Heung.
One thing to note is the significant amount of buybacks in 2016. Perhaps there are
things outsiders do not know?