Valuation Expensive – Hence Avoid

Speciality Restaurants Limited (SRL) is tapping the capital markets with its issue for 1.17 lac shares in a price band of Rs 146-155. The issue has opened on Wednesday the 16th of May and closes today the 18th of May 2012. The company has allotted 17.61 lac shares to anchor investors at a price of Rs 150 per share. With just one day left for the issue to close the company has received subscription for 2.23 lac shares which is a mere 2% of the issue size. All the bids have been received from retail investors, and not a single bid as yet has been received from QIB’s or HNI’s.

Business
SRL as the name suggests is a speciality restaurant chain operating 69 restaurants and 13 confectioneries under the brand name Sweet Bengal. The restaurants have the flagship brand as ‘Mainland China’. The other brands under the company include Mainland China, Oh Calcutta, Sigree, Flame & Grill, Haka, Just Biryani, KIBBEH, Kix, Machaan and Shack. The company operates a mix of company owned and company operated or a ‘COCO’ model as well as a franchisee owned company operated ‘FOCO’ model. Of the 69 restaurants, 49 are company owned and 20 are franchisee owned. The flagship brand Mainland China has 36 outlets mainly in Western India. The second brand Oh Calcutta has seven restaurants in India and one in Bangladesh. Sales from Mainland China accounted for over 60% of total sales for the company in March 2011 and a little over 61% in the nine month period ending December 2011.

The company SRL believes in offering the guest a fine dining experience and this necessarily means that the guest has to visit the restaurant and experience the service, ambience and food. The business is all about dining in the restaurant. This cannot be experienced by taking the food away or ordering the food at home. The profits come from Mainland China and the business going forward would be to increase the number of stores or restaurants under this model.

In case of franchisee stores the model is that the company takes an upfront fee depending upon the individual location and city and then a fixed percentage of revenues. All other expenses are borne by the franchisee owner. Effectively this means that only the revenue share of SRL is booked in the financials of the company and this effectively goes to the bottom line increasing margins.

Objects of the Issue
The objects of the issue are as follows: –

The company plans to open 16 stores in fiscal 12, sixteen stores in Fiscal 13 along with the food plaza and banqueting facilities in Kolkata and 12 stores in Fiscal 14. The focus would be on leveraging Mainland China brand name and using the same to open multi brand restaurants in Tier 1 and Tier 2 towns.

Financials
The company’s revenues have grown from Rs 130 crs in year ended March 2010 to Rs 175 crs in March 2011 showing a growth of 34%. The revenues in the nine month period ended December 2011 have reached a level of Rs 152.11 crs implying an annualised turnover of Rs 202.81crs. The growth in the current year is therefore fairly muted at 15.89%. The company has added 8 stores in the eleven month period up to Febraury 2012 compared to the previous year.

The slower growth can be attributed to the challenging environment and the fact that the flagship brand is the one that does well, while other brands are yet to be established. It would be the endeavour of the company to ensure that the other brands particularly Oh Calcutta is stabilised. All future growth would evolve leveraging Mainland China and trying to cross sell the brand with other brands.

Track Record of Merchant Bankers
The merchant banker for the issue is Kotak Mahindra Capital Company Limited. In the three year period track record that the banker has given shows that of the 13 issues that were brought by the banker, 4 were trading at a discount one month after listing and 9 weretrading at a premium. The 10 issues that he has given details of, show that as many as 8 were trading at a premium, 30 days after listing while a mere 2 were trading at a discount. If one were to change the same to current prices as of date, the data and situation is dramatically the opposite. Of the same 10 issues as many as 8 are trading at a discount while a mere 2 are trading at a premium. Very clearly the track record indicates that the investor needs to look at the issue on his own and take a conscious decision and also do his own homework before applying to an issue.

I am tempted to write about one glaring issue which was handled by a galaxy of merchant bankers including the current Banker Kotak Mahindra. The issue in question is SKS Microfinance. This company raised Rs 1,629 crs at a price of Rs 985. The share touched a high of Rs 1,489 and in less than 6 weeks began to fall and made a low of Rs 75.85 last week, and closed yesterday at Rs 81.95. The point being emphasised is the amount of due diligence being done in assessing risk. One single political risk has destroyed the company and its shareholders wealth. The share price has fallen more than 94%. This is a rare case but has happened in the last two years. This makes us believe that the principle of Caveat Emptor ‘BUYER BEWARE’ is applicable only for investors and to be ruthlessly followed by investors in letter and spirit.

Comparisons
There is no comparison for SRL from any listed entity. The closest one can compare this company from the non-listed space is the brand Blue Foods which runs restaurants like Copper Chimney, Cream Centre, Bombay Blue and Noodle Bar. The company has not compared itself with anybody as there is no comparable in the listed space. The market is trying to compare this chain with a Quick Service Restaurant (QSR) like Dominoes Pizza. In the case of Dominoes they are an international chain and their business depends primarily on home delivery and takeaways. Jubilant is a master franchisee and pays royalties to the parent. In the case of SRL the brand is owned by the company. The concept of fine dining does not exist. For such stores, the time to deliver, number of orders per delivery boy or revenue per delivery boy, revenue per square foot, same store growth, number of outlets added etc become key matrix for evaluation of the company.

Some of the key statistics for Dominoes which is listed in India under Jubilant Foodworks Limited shows that the company added 87 stores in the year ended 2012 to take the total stores to 465 stores. The stores added in 2012 are slightly more than the total number of restaurants and confectioneries run by SRL. In terms of growth, the overall revenue grew by 50% to Rs 1,017.50 crs while same store growth was 29.6%. The EBITDA was up 59% at Rs 190.6 crs while Profit after tax was up 97% at Rs 105.6 crs. The numbers are strong and there is no way a fine dining restaurant can ever have similar additions in number of restaurant or this kind of growth. Trying to compare apples and oranges is neither fair to the apple nor orange. I believe investors should look at the business of SRL as the concept of eating five star food in five star ambience at affordable rates and certainly much cheaper than five star charges.

Valuations
The shares of Speciality Restaurants are being offered in a price band of Rs 146-155. The EPS of the company for the year ended March 2011 is Rs 4.55 on the pre-IPO equity capital of 352.18 lac shares. This translates into a PE of 32.09 times at the lower end of the price band and 34.07 times at the upper end. If one looks at the EPS for nine months on old capital it is Rs 4.26. If one were to annualise the same to 12 months and then consider the new capital, the EPS becomes Rs 4.36. On this EPS the PE ratio is 33.51 times at the lower end of the price band and 35.58 times at the upper end of the price band. This valuation is certainly not cheap even considering that the company is in the ‘Consumption’ theme, which is one of the better sectors of the economy.

Clearly the valuation which is at roughly 34-36 times leaves nothing for the investor and one would have to wait patiently for returns.

Concerns
The biggest concern is that it is only the flagship brand Mainland China which is doing well. Secondly the company was able to add only 8 stores in the 11 month period ended February 2012 and it appears the targeted growth/addition of 16 stores each over the next two years may not be achievable. Same store growth seems to be quite poor and it looks the growth is at best linked to inflation which does not augur well for the company. The fine dining segment or the premium segment in which the company is currently is not earning enough margins to justify the positioning or the premium being charged.

Conclusion
It’s a good theme based company tapping the capital markets. The issue was being pushed around or marketed as the second QSR, or a company comparable to Jubilant Foodworks. The company is good, has a great potential, is likely to do well in future if it capitalises purely on the Mainland China brand. Everything is good except the price. As new stores open and the company add to its total number of stores over the next three years, there would be a severe pressure on net margins. This pressure would affect the earnings of the company and therefore its market price. The management of the company says it costs roughly 3crs to set up on large restaurant of Mainland China along with the lease deposits for the place. IF one does a back calculation one is unable to understand how the valuation of Rs 515-546 crs is arrived at.

The current market scenario is quite depressing globally. One needs to conserve cash at this point of time. Sectors which are favoured do well at good times and seem over valued at bad times. The challenges outweigh the growth prospects and whatever is left on the positive side gets balanced out because of the over aggressive pricing. It is in the interest of investors to avoid investing currently and look at the same company post listing.

SEBI Disclaimer:- I do not intend to subscribe to the above issue.