I have been monitoring Jumbo's stock for the past few months. After a spectacular run up since its IPO, Jumbo's share price hit an all time high of $0.79 earlier this year. At that point, Jumbo stock was trading at a P/E ratio of 30, which reflected the market's strong optimistic sentiment, along with expectations that Jumbo would continue to report strong growth in its earnings. After two quarters of reporting flat earnings, Jumbo's share price has tumbled to a 52-week low of $0.53.
This shows us how emotion driven the market can be in the short term - within slightly more than 6 months, the variance in price is close to 50%. Either the market had grossly overvalued Jumbo back in late 2016, or Jumbo is at fair value or undervalued today. Jumbo's underlying fundamentals didn't change much, the only factor that changed was the market's optimism. While Jumbo has increased its earnings year on year, the rise has not been up to market expectations.
Jumbo operates 16 restaurants in Singapore and 3 in Shanghai under the brands which include JUMBO Seafood, JPOT, Ng Ah Sio Bak Kut Teh, Chui Huay Lim Teochew Cuisine and J Café. An interesting point to note would be that the Jumbo Seafood Restaurants contribute the largest proportion to revenue, at 77%. Jumbo has also ventured into the Vietnamese market through a franchise agreement in Ho Chi Minh City, and seeks to expand its network in China and other cities in Asia.
|Source: Jumbo Corporate Presentation, May 2017|
Personally, I have dined Jumbo Seafood, JPOT and Ng Ah Sio Bak Kut Teh. My personal observation is that while Jumbo Seafood and JPOT outlets are usually popular, Ng Ah Sio lacks the differentiating factor compared to other Bak Kut Teh eateries. I am unable to find financial information to compare the profitability of the different brands, but I assume that Jumbo Seafood probably has the highest margins.
Perhaps Jumbo would be better off closing down some of the non-performing outlets, which would reduce its operational costs. Furthermore, I doubt many customers are actually be aware that Ng Ah Sio is affiliated to Jumbo.
Jumbo has successfully ventured into China, with 3 restaurants in Shanghai. Currently, only 17% of its revenue is contributed by its restaurants in China.
Leveraging on Jumbo Seafood's strong brand reputation, Jumbo seeks to expand further to other Chinese cities such as Beijing and Shenzhen, either through join ventures or franchising. This positions Jumbo well to ride on the expected increase in purchasing power of the Chinese middle class. As the Chines middle class becomes more affluent, demand for higher end dining options would increase, and the proportion of revenue from China would be larger.
Jumbo has also opened a franchise outlet in Vietnam, and plans to further expand their network there, with three more planned openings of JUMBO Seafood outlets there within the next two years. I believe that this is the right strategy, as licensing a franchise is an asset light model, which reduces start up costs. Based on the local consumers' response to the franchise outlet, the company can then decide on whether it is viable to expand in the country.
These growth plans, if executed smoothly, would materially add to Jumbo's earnings. If successful, we could well see Jumbo transform into a region wide restaurant chain within the next few years.
For 3Q 2017, Jumbo's net profit fell by 1.1%. The market's reaction to its second quarter results was strong, sending its share price down by 5% after the results were announced.
|Jumbo 3Q Financial Results|
Revenue increased by 6.4%, however, this was offset by the rise in operating lease expenses and depreciation 24.5% and 29.8% respectively. I'm not too concerned about the rise in depreciation, as a higher depreciation has to be booked along with new outlets opened. Depreciation is a non-cash expense and does not affect Jumbo's free cash flow. For the higher operating lease expenses, I believe that this is also expected as new outlets generally need some time to breakeven, which would incur higher operating expenses initially.
As a result, even though revenue increased, Jumbo's net profit was flat. Net profit did not fall much, which indicates that there hasn't been a huge change in fundamentals, yet the share price tumbled. This is probably because Jumbo missed investors' expectations, rather than a deterioration of fundamentals.
Jumbo's balance sheet remains robust, with $48 million in cash and cash equivalents as at 30 June 17, and no borrowings. Jumbo continues to generate strong operating cash flows, which has been able to cover its capital expenditures for the past two financial years. This gives Jumbo a positive free cash flow. However, if Jumbo continues to execute its ambitious expansion plans, Jumbo may probably have to dip into its cash pile or borrow to fund future capital expenditures. As operations at new outlets ramp up, this would further strengthen Jumbo's cash generating abilities.
Apart from a sharp slowdown of our local economy or some economic crisis in China, I can't really think of any significant risks to that would severely affect Jumbo's business. There is probably some execution risk involved as Jumbo carries out its expansion plans, as new outlets may take longer to breakeven and incur some operating losses for a longer than expected time period. Another possibility is that when entering new markets, Jumbo may not appeal strongly to the local consumers.
An unlikely but damaging scenario that a friend pointed out would be that consumers avoid eating crabs due to some scientific research or epidemic, which I believe is an extremely low possibility.
After the recent correction, Jumbo's price to earnings ratio has dropped to 21. While this is still relatively high compared to many other stocks, I believe that it is decently price for a company with strong growth prospects. Furthermore, companies in the food and beverage industry generally trade at higher price multiples, probably due to the perceived stability of the industry.
As investors re-evaluate the prospects of Jumbo, I feel that its current share price presents us with an attractive opportunity to purchase a well run company with substantial growth.
Note: I am vested in Jumbo at $0.54