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Short-term earnings weakness ahead for Japan Foods but long-term trends intact

Samantha Chiew
Samantha Chiew • 3 min read
Short-term earnings weakness ahead for Japan Foods but long-term trends intact
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SINGAPORE (May 6): RHB is keeping Japan Foods on “neutral” with a new target price of 35 cents, down from 40 cents previously as it expects near-term earnings weakness caused by the circuit breaker measures.

In a Wednesday report, analyst Shekhar Jaiswal says, “We expect FY21 (Mar) earnings for the food & beverage (F&B) unit to stay under pressure amidst the ongoing social distancing adoption.”

See: Appetite grows for Japan Foods' brand despite concerns about its joint ventures

However, initiatives announced in recent government budgets, such as deferment of rental payments and 75% coverage for staff costs, should help partially offset some of the near-term earnings weakness.

“The long-term trend seems positive, as net cash balance sheet and positive FCF generation should enable a refocus on growth when competition and operating costs are lower in FY22,” adds Jaiswal.

In early April, Japan Foods said it will maintain a skeletal operational model and keep only 13 out of 58 restaurants in Singapore open during the circuit breaker period. But this has dropped to 11 now.

Although Japan Food has seen a rise in takeaways and delivery services, but the revenue impact is not significant. Hence, the analyst has lowered FY20 profits estimates by 6%.

Japan Foods is planning to start operations at its currently closed restaurants from mid-May, as an anticipation of the relaxation in the circuit breaker measures by early June. However, the continuing implementation of social distancing measures should imply that it will have to operate its restaurant at sub-optimal capacities for the next 12 months, at least. This should translate into a 30% decline in FY21 revenue.

“With limited scope to negotiate lower rental in the near term, margins pressure will remain elevated. We lower FY21 profits by 46%,” says Jaiswal.

Meanwhile, Japan Foods has been paying out 60-90% of earnings as dividends in the last five years, but this could drop to the mandated minimum of 50% for FY21, implying a dividend yield of just 1%.

“We expect the payout ratio to increase once earnings recovery kicks in FY22. Given its robust business model, Japan Foods is still expected to generate a FY21 FCF yield of 4.2%,” says Jaiswal.

Nonetheless, compared to other locally-listed F&B players, Japan Foods has a strong net cash balance sheet – net cash is 37% of its market cap and far superior financial metrics. This should enable it to sustain operations beyond the weak FY21 period.

“In the next 1-2 years, we expect a good number of F&B players to exit operations in Singapore, therefore reducing competition for Japan Foods. Moreover, operating costs could also decline in FY22, amidst lower expected labour and rental costs,” says Jaiswal.

As at 11.25am, shares in Japan Foods are trading at 35 cents or 1.8 times FY20 book with a dividend yield of 6.0%.

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