#3 Mar 04, '24: LH Group
HK restaurant operator, 10% dividend yield with potential earnings catalyst
Full 40-page PowerPoint Deck (click image below to download):
3-statement financial model (click image below to download):
This is just a brief summary, please refer to the PowerPoint deck and Excel spreadsheet above for full details.
LH Group is a HK-based restaurant operator with both its own brand stable (Mou Mou Club) and operating franchised brands such as Gyu-Kaku (Japanese BBQ) and On-Yasai (Japanese hotpot). It is the #2 Japanese cuisine operator in HK after Maxim’s.
What the market has overlooked
Rebounding tourism. While HK only saw 600k visitors for the whole of 2022, 34 million are estimated to have come during 2023. Moreover, 75% more visitors came during the second half of the year than the first half. Based on a regression analysis, we conservatively estimate that H2 revenues will be at least HK $40-$90 Mn higher than H1, which brought in $660 Mn. All told, this would mean 2023 revenues of HK $1360-$1410 Mn versus only HK $1063 Mn in 2022, or a 28-33% YoY increase. While the share price did initially rise during hopes for the China reopening in 2022 to above HK $1.30 and again upon the announcement of LH Group’s special dividend, it subsequently fell, creating a discrepancy between share price and business reality.
Low rents going forward. Rent is a key cost for HK restaurant operators, and HK retail rent is strongly related to commercial property prices (with a correlation of 0.98). Conveniently, commercial property prices have fallen close to 20% and are expected to stay low for years going forward. This gives a boost to net margins going forward, compared to the pre-pandemic era when net margins of 4% or below were the norm.
Earnings catalyst. One other positive factor is that HK Tourism Board distributed HK $100 dining vouchers for tourists to spend in restaurants starting from H2 2023 to run into Q1 2024. This will increase the willingness to spend and the potential for a further upside surprise.
Thesis
Import to HK model. Rather than creating new concepts from scratch, LH Group first found success with Gyu-Kaku, gaining the franchising rights for HK. This lowers the probability of new restaurants failing, and taps into branding power of the existing franchise, lowering marketing costs. Unfortunately, subsequent franchised brands have been rather less successful, likely because while Gyu-Kaku is a global brand with ~700 stores, later franchises have been much smaller chains. However, we believe that this is a very low-risk model, with potential upside if any brand gains sufficient traction, e.g., Hikiniku To Come, which LH Group will bring to HK.
Strong management. Simon, the chairman of LH Group, is charismatic and a natural marketer (as well as efficient operator). He has a significant social media following, effectively helping the company gain free marketing. Simon is also very involved in the local community, and alongside LH Group’s board members sits on multiple influential advisory bodies. One of these is the HK Tourism Board, which as mentioned is involved in creating industry schemes such as distributing dining vouchers, and also deals with complaints.
Solid operator. In every year since 2017 (start of its track record period for the IPO), revenue growth at LH Group has been higher than the broader restaurant market growth - i.e., it has gained market share every year. Nor is growth limited to opening new stores; instead, same-store sames growth appears to account for a significant part of the growth as well.
Reasonable valuation. TTM P/E for LH Group stands at around 6.5X, which is comparable to Taste Gourmet at a similar multiple, though the former has a stronger balance sheet, and the latter faster growth.
Capital allocation. As evidenced by its special dividend and high dividend yield, the management appears to be eminently willing to share its profits with minority shareholders. We also like the anti-cyclicality of its capital expenditures, when it invested to grow during the pandemic, when prices were low.
Risks
Competitive pressure. Most of LH Group’s earnings depend on the success of its flagship chain Gyu-Kaku. However, competitors such as Maxim’s have launched Yakuniku LIKE, and Taste Gourmet has Yakiniku Guu.
Reputational. PR or hygiene crises can threaten any restaurant, though LH Group does not appear to be particularly vulnerable - indeed its management may be able to handle or avoid these better than most.
Macros. Economic downturns (which especially affect mid-market brands like those with LH Group), social unrest and epidemics can bring the share price down 30-50%.
Full disclosure: We hold a long position in LH Group - this is not a solicitation to buy or sell. We have no business relationship with the companies mentioned in this note, and are not paid to write this piece (other than paying fellow exponents of the research).
Disclaimer: This should not be construed as investment advice. Please do your own research or consult an independent financial advisor. Alpha Exponent is not a licensed investment advisor; any assertions in these articles are the opinions of the contributors