Meet XiabuXiabu: a surprisingly cheap, rapidly growing, Chinese Fast-Casual chain

The below is the thesis abstract which I believe is enough to attract initial interest for anyone interested in the exposure to this specific opportunity in the Chinese QSR industry.

For a more comprehensive research report, you can download the attached PDF (as well as conduct your own research). 

Abstract

XiabuXiabu (HKG:0520) is a Chinese Hot-Pot fast-casual restaurant chain, operating ~550 restaurants in mainland China. It is currently on-track with management’s plan to operate 1,000+ restaurants by the end of 2018 while due to the overall weakness in China it trades for multiples that reflect practically no future growth. This might be a unique opportunity to jump on board with a business that enjoys rapid growth, scalable business model and solid profit margins, while paying attractive, “value-stock”, prices (4.9x EV/EBITDA, 5.1x EV/OCF).

There are actually two main reasons for XiabuXiabu’s depressed stock price. The first is the overall weakness in China and EM in general, and the other is the deceleration in top-line growth rates. This deceleration derives from Same-Store-Sales (SSS) decline, while new restaurants are still being opened at a 20% annual rate.

SSS growth is in decline in recent years and has actually decreased for the first time in H1-2015. This is a broad-industry decline that is probably due to the economic slowdown in China. However, there are reasons to believe this trend is about to change:

1. Comps. data point to Q3 improvement - while XiabuXiabu doesn’t report quarterly earnings, some other Chinese fast-casual/fast-food chains (Yum & Ajisen Ramen) saw their SSS numbers improve in Q3 2015 (XiabuXiabu has performed significantly better among this peer group in the past).

2. Direct Initiatives - XiabuXiabu was launching both a breakfast menu as well as a home delivery service during H2 2015, with the clear goal of returning to SSS growth and expanding both services into 2016.

3. Long-term Macro trends (mainly urbanization) still favorable for QSR industry despite overall slowdown. Additionally, in the US, the QSR industry has been pretty resilient to past recessions.

Given the pace of new restaurant openings, a stabilization in SSS should result in a top-line growth of ~20% per annum in the next 3 years.  If SSS growth is back to low single digits (2%-3% as I expect) - we should see top line growth of 25%-29% p.a.

To achieve the 1,000 restaurants target, management doesn’t plan to expand overseas. In fact, it doesn’t even expect to expand to Hong-Kong, Macau or Southern China at this point. The market is big enough for it to double restaurant count while staying in the northeast, northwest and central China (for the sake of the argument, California has 325 Chipotle locations with a population of 39m. Hebei province, including Beijing and Tianjin, has a population of about 108m and only 282 XiabuXiabu restaurants).

Additionally, XiabuXiabu is committed to pushing for high-growth rates due to its 32% shareholder - General Atlantic, which bought its stake in 2012 supposedly for a similar price the company currently trades for.  

When IPO’d in Dec 2014, XiabuXiabu was growing top-line at 20%+ per annum. It traded for 15.0x EV/EBIT which was still a discount to the US fast-casual peers. Since then growth decelerated and outlook for China became more bearish, hence the company currently trades for 7.5x EBIT and 4.9x EBITDA. Both are significantly lower than its American peers, who do not share the same compelling Macro outlook in the longer term (urbanization, wage growth, personal consumption growth & untapped QSR market in China).

Even after recent declines, fueled by a 40% drop in Chipotle’s share price, American Fast-Casual peers (CMG, Shake Shak, Zoe’s Kitchen, Panera, Noodles & Co. and the Cheesecake factory) are still trading for 18x EBITDA and 34x EBIT on average (however, it’s very likely that they are overvalued).  

Little Sheep, XiabuXiabu’s largest Hot-Pot competitor in China, was sold to Yum! Brands in 2011 for valuation multiples approximately 2.5x higher than XiabuXiabu’s current valuation (Appendix A details the comparison).

XiabuXiabu reports CAPEX needed for a new location to be Rmb 1.2m on average. Combining this metric with the number of new locations opened during the last 3 years, we can see that maintenance CAPEX is very low - probably lower than 2% of revenues.  The lack of in-restaurant central kitchens (since Hot-Pot is about DIY) also makes the business very asset-light, resulting in ROE of over 30% in 2012-2014, with peers ranging from 12% (in China) to 18% (globally/US).

Cash flow has historically been stronger than earnings. The company reports Net Cash from Operations, which is cash from ops minus taxes paid plus interest received (Xiabu has always had a net cash position so there are no interest payments). Net Cash from Operations have been growing at a 22% annual rate since 2011, reaching Rmb 315m in 2014 (reflecting a 5.1x multiple measured against EV).  

Due to the net cash position and the negligible maintenance CAPEX needs, I believe an EBITDA multiple will be most appropriate in order to value the company. I’ve used a 10x EV/EBITDA multiple on 2018 EBITDA, which is about 22% lower than the multiple paid by Yum! Brands for Little Sheep in 2011, and 80% lower than the American peer group of fast-casual chains. To arrive to the 2018 EBITDA figure, I used the following assumptions:

• Management meets the 1,000 restaurants target by 2018.

• SSS growth averages 2% per annum in 2016-2018.

• EBITDA margin improves modestly, from 14% in 2014 to 15% in 2018.

The above assumptions result in a 2018 EBITDA of Rmb 730m, and a valuation of Rmb 7.3b, 180% higher than today’s market cap (excluding assumed ~3% dividend yield along the way).