This article first appeared in The Edge Financial Daily on April 1, 2019

Berjaya Food Bhd
(March 29, RM1.63)
Maintain buy with an unchanged target price (TP) of RM2.05: We are encouraged by the promising performance of Kenny Rogers Roasters (KRR) Malaysia operations which broke even in the third quarter of financial year 2019 (3QFY19) (versus losses of RM6.7 million for FY18). The introduction of KRR Express (centred around OMG Fried Chicken) is expected to grow its store count by up to 10 stores in FY20. Berjaya Food Bhd (BFood) will continue to grow Starbucks, with a target of 30 new outlets in FY20. Of the 30 new outlets, 13 are expected to be drive-throughs and two are expected to be Starbucks reserve outlets. As the recent meeting yielded no surprises, we have kept our forecasts unchanged. Our “buy” call and TP of RM2.05 pegged at an unchanged 25 times price-earnings ratio on calendar year 2019 earnings per share remain unchanged.

We note that 3Q is typically the strongest quarter for food and beverage operators due to it being a festive season, boosting sales volumes. We expect KRR Malaysia to return to profitability in FY20, led by the closing of unprofitable stores as well as the opening of KRR Express concept stores.

We are positive on BFood’s introduction of the KRR Express grab-and-go concept, which has a minimal seating area and therefore less rental requirements. The concept is centred around its OMG Fried Chicken, which is a fried chicken menu option fried with a low amount of oil. Currently, there are three KRR Express outlets (at Plaza Shah Alam, R&R Rawang and Johor Premium Outlets), with plans to open up to 10 more in FY20. We reckon that BFood is using the KRR Express venture to field-test the popularity of OMG Fried Chicken among consumers with the possibility of introducing the menu item at regular KRR restaurants.

We expect the group’s high effective tax rate of about 40% to remain for the foreseeable future. We understand that this is due to: i) a large chunk of the group’s interest cost being non-tax deductible as the borrowings are held at the holding company level (which was borrowed to fund the acquisition of the remaining 50% stake in Starbucks Malaysia operations); as well as ii) much of the renovation costs of Starbucks outlets being non-tax deductible.

We note that approximately half of Starbucks’ raw material costs are denominated in US dollars as BFood purchases select ingredients (coffee beans, Frappucino mixes and so on) from Starbucks corporation in the US as part of their agreement.

We are encouraged by the change in fortunes of the KRR Malaysia operations. Nevertheless, we expect the combination of positive same-store sales growth and the opening of new Starbucks outlets to drive growth of the group. — Hong Leong Investment Bank Research, March 29