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Arden Hah
Arden Hah
Articles (11)  | Author's Website |

Snack Empire: A Multi-Bagger Stock

The stock is dramatically undervalued

This stock has been on our radar since its initial public offering last year, which made headlines when its shares soared 188% on its first trading day but ended up below its debut price of 0.65 Hong Kong dollars (0.08 cents).

As an investor in Asia, Snack Empire Holdings Ltd. (HKSE:01843) quickly gained our interest because its business, Shihlin Taiwan Street Snacks, sells its signature fried chicken and other popular Taiwanese street snacks in both Singapore and Malaysia.

Founded in 2003, the restaurant chain opened its first store in Singapore and has since expanded into more than 230 outlets and restaurants in locations including Singapore, Malaysia, Indonesia, the U.S. and, more recently, Egypt and Cambodia.

Valuation and growth

Even before the Covid-19 pandemic, the stock was in a precipitous decline.

At its current share price of 22 cents, for a market capitalization of HK$182.57 million, it is dramatically undervalued at 6.4 times 2019 earnings. Factoring out its net cash of HK$122.8 milion, an investor is getting the business at a mere 1.9 times earnings. This is in stark contrast to its direct peer, Old Chang Kee (SGX:5ML), with only 88 outlets located entirely in Singapore, yet having a market cap of 85 million Singapore dollars ($64.4 million) and valued at 27 times its pre-Covid earnings.

What is attractive about Snack Empire is its huge runway for expansion. According to its IPO prospectus, the Shihlin business will continue to grow its store count at a compound annual rate of over 20% until 2023. In comparison, Old Chang Kee has saturated its home market and faces a decline in store count from a peak of 90 in 2018 to the current 88 locations.

Other high-growth peers like Shake Shack Inc. (NYSE:SHAK) and Chipotle Mexican Grill Inc. (NYSE:CMG) are also expanding at a fast clip. Before Covid, Shake Shack was opening about 50 to 60 net new stores per year, with an annual increase in store count of over 30%, which was valued at 100 times pre-Covid earnings. Chipotle had an annual increase in store count of over 5%, which was similarly valued at 100 times earnings.

As such, Snack' s valuation at 6.4 times earnings and 1.9 times excluding net cash is simply astonishing.

We believe such extreme undervaluation resulted from investors' inability to recognize Snack's business prospects as too little public information is available and due to the fact that its main markets are in Singapore, Malaysia and Indonesia while its stock is listed in Hong Kong.

Letter to management

The two founders hold a combined 75% stake in Snack Empire, which we believe represents the bulk of its net worth as they did not cash out a single share in the IPO. Rather, they did it to raise capital to ramp up the expansion of Shihlin stores worldwide.

We believe the founders will be very incentivized to have the stock trade at its intrinsic value, so we sent a letter to them detailing a roadmap to how they can increase shareholder value and net worth.

The roadmap covers two important factors which we believe have resulted in the chronic undervaluation of Snack Empire shares to date:

  1. Poor communication on Snack Empire's Shihlin business growth plans and business economics.
  2. Lack of a dividend policy.

We urged management to look into both of these factors immediately and, in addition, provided remediation steps that we believe would rectify the issue on hand:

  1. Having a comprehensive investor day presentation, describing in detail the company's growth plans and the economics of Shihlin's business.
  2. Instituting a 50% dividend payout policy.

Going forward

With more information available on its four-year growth plan, investors would benefit by being able to make better judgments on Snack's business and give an appropriate multiple that incorporates its growth prospects. We believe Snack will trade at a substantially higher valuation multiple, one that is at least in line with its peers, given its runway growth in store expansion and earnings growth potential going forth.

The next crucial remediation is the implementation of a 50% dividend payout policy, or annual dividend payout of about S$2.4 million based on fiscal 2019 earnings.

With a current cash position of S$23.3 million and being profitable even through the pandemic, the company has no issue financing its growth expansion plans, while at the same time paying out a 50% dividend from current earnings for shareholder returns.

At the current share price, a 50% dividend payout would have a yield of almost 8%.

The sustainability of the dividend would force the market to revalue the stock to a much higher level based on yield. For example, a rerate to a reasonable dividend yield of 2.4% in the stock market, where 10-year H.K. treasuries are yielding only 1.23%, Snack will be valued close to S$100 million, making it a three- to four-bagger from its current share price.

Yet at this valuation, it would still be cheap at 21 times earnings given its growth prospects relative to peers and their respective valuations.

Disclosure: We, together with the entities we managed, are shareholders of Snack Empire.

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About the author:

Arden Hah
We are a 2 partners team managing a concentrated portfolio, with the intention to hold our investments for as long as the fundamentals stay intact. We do not chase, nor wish to participate in the short-term race for returns, choosing instead for the best opportunities to invest in. The time we do so is the time we invest big, taking outsized stakes in what we call the “misguided & misunderstood” investments. Contrary to many, we subscribe to the notion of low risk, high return.

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Comments

arbasd
Arbasd premium member - 1 month ago

Why would anyone expect a company in an expansion phase and increaseing store counts at 20% over the next few years pay dividends (let alone at 50% of earnings)?

Steven CHEN
Steven CHEN - 4 weeks ago    Report SPAM

And what did the management reply to your letter?

Valueground
Valueground - 4 weeks ago    Report SPAM

To Arbasd:

First, the founders raised capital during the IPO in 2019 to fund their expansion plans till 2024. Due to Covid, their expansion plans got stalled, and cash piles up. As of 1H2021, they have a total of 23.3mil in cash, way more than they require at least over the next 3 to 4 years. Each store requires a capital outlay of average 216k in Singapore and only 127k in Malaysia, do the math. Hence, they dont require any of their retained earnings at all to fund any store expansions.

Second, Snack Empire has a wonderful business model that has the bulk of their store network operated by their Master franchisees, Master licensee, and independent franchisees. The capex for store expansions is entirely bore by them, imagine the model of Mcdonalds with 93% of their total stores franchised.

Valueground
Valueground - 4 weeks ago    Report SPAM

To Steven Chen:

The management has been cautious since the onset of the Covid, and hence as of 1H2021, not declared any dividends until the situation stabilize. We believe the upcoming 2H2021 report, they will start to address the issue on capital allocation and hence dividend payout.

arbasd
Arbasd premium member - 4 weeks ago

As a former CFO, I cannot even imagine the converstion I would have after raising capital and then declaring dividends. Full discosure, I have not read their offering documents or subsequent financials and it is was disclosed they intended to use the money to pay dividends then let the investor beware.

Steven CHEN
Steven CHEN - 3 weeks ago    Report SPAM

Thanks for the reply! Also, just wondering about your perspective on their founders' overwhelming 75% controlling stake in the company with relations to any downside risk to minority shareholders?

arbasd
Arbasd premium member - 3 weeks ago

Hello Steven,

Being a minority shareholder in any enterprise decreases the value significantly and adds an element of risk to the investment. I can't speak to the protections offered in Hong Kong to minority shareholders but in the US there are many legal battles that arise when the majority takes actions that beneifts the majority sharholder to the detriment of those in the minority. Unfortunately it is not uncommon.

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