Within the past few years, Hai Di Lao’s meteoric rise has made it the “Starbucks” of Coffee or the “Breadtalk” of bread.
Before we delve deeper into investigating whether the Hong Kong listed company is worth investing in, here are several fun facts!
The hotpot chain, Hai Di Lao, was named after a famous move in Mahjong whereby one wins the game with the very last tile. Its literal translation also means “fishing treasures from the bottom of the sea”. This is very much similar to the concept of hotpots where one fishes for ingredients out of the soup.
Did you also know that if you dined alone at Hai Di Lao, they would place a teddy bear to accompany you?
Hai Di Lao’s IPO in 2018
During its debut in the Hong Kong stock exchange on the 26th of September, the counter climbed as much as 10.3% after raising around S$1.37 Billion in its initial public offering.
Since then, the stock has been on the rise…
This has led to the surfacing of many articles who claim that Hai Di Lao is severely overvalued/overpriced, all based on their PE ratio of 78 (calculated at the time of writing). In other words, at today’s prices, investors are paying HK$78 for every HK$1 in prior year profit.
We agree that the P/E ratio is sky high (compared to an industry average of 37) and unjustified due to it’s Financial Year revenue and profits growing only at only 60% and 59% respectively.
Put it another way, IF Haidilao’s earnings do not grow, it would take the company 78 years to see the investor’s money fully earned back in its profit and loss statement.
However, this metric should never be the only number one looks at when determining whether a stock is worth investing in.
Does Hai Di Lao (HDL) still deserve a place in investors' portfolios?
We would use our extremely quantitative strategy to determine whether it is a buy or no-buy. This way, we would attain a much more definitive and convincing answer which we could stand behind.
This forms a much more convincing and compelling answer rather than simply telling our friends and family that we didn’t buy Haidilao as it is overvalued according to its PE ratio.
We analyzed Hai Di Lao’s financials using our Dividend Growth strategy in today’s article to find out whether the Haidilao naysayers have a legitimate point.
- Dividend Investing: The Growth Dividend Strategy
- Step 1: What is Haidilao’s Gross Profitability?
- Step 2: Determine attractiveness of Dividend Yield
- Step 3: Determine the sustainability of Dividends
- To buy or not to buy?
The Dividend Growth Strategy
In this article, we will use Dr Wealth’s Dividend Growth Strategy to evaluate Haidilao International (HKEX:6862).
We utilize much more than one simple metric to investigate a counter.
Furthermore, as Haidilao is becoming a household brand, this makes one susceptible to ‘Brand Anchoring’ whereby one falls in love with the company’s name and completely ignores its financials. Read more on how to avoid some of the common investor’s bias here.
This quantitative approach eliminates such biases as we let the numbers do the talking.
In a nutshell, this strategy can be executed in just 3 simple steps:
- Determine HDL’s Gross Profitability
- Determine Attractiveness of HDL’s Dividend Yield
- Determine the Sustainability of the Dividends
You can read more about the strategy at our Factor-Based Investing Guide.
Let’s dive (pun intended) in!
Step 1: What is Haidilao International’s Gross Profitability?
What Is Gross Profitability?
This metric has been proven to produce market-beating returns by Robert Novy-Marx.
A profitable and good company is able to use very little assets (very scalable, efficient and less capital expenditure is needed to keep business running) to produce a lot of gross profits (profits after deducting variable costs is the cleanest accounting profit in the income statement).
Step 1A: Determine Gross Profits
Gross Profits can be manually calculated by taking Revenue – Cost of Sales = Gross Profits
We’ve extracted the relevant numbers from Haidilao’s annual report and the 520 paged prospectus, which can be found here.
Step 1B: Determine Total Assets
Total Assets can be extracted from the Balance Sheet of the Annual Report or in this case, its prospectus.
Total Assets can also be manually calculated by taking Non-Current Assets + Current Assets = Total Assets
Total Assets can be extracted from the Balance Sheet of the Annual Report or in this case, its prospectus.
Step 1C: Determine Gross Profitability
To calculate Gross Profitability:
Gross Profits / Total Assets = Gross Profitability
G1 represents the bottom 20% of companies with the lowest profitability. G5 represents the top 20% of companies with the highest profitability.
We have ranked all the HKEX-listed stocks by their GPA (as calculated above) and Haidilao International falls in:
According to our strategy’s rules, we invest only if the stock falls into the G5 range.
This means that Haidilao International meets our gross profitability criteria.
However, one should note that Haidilao’s GPA has been decreasing since 2016 and it might cause the GPA rank to fall further into the G4 range should the downtrend persist.
Step 2: How attractive is Haidilao International’s dividend yield?
You can determine the historical dividend yield by taking:
Dividend Distributed in previous year [$0.076] / Current Trading Price [$32.65] = Historical Dividend Yield [0.23%]
D1 represents the 20% of companies with the lowest dividends. D5 represents the 20% of companies with the highest dividends.
We ranked all the stocks in SGX by their dividend yield and Haidilao’s yield is in the D3 range.
Our rules state that one should ideally purchase stocks that fall in the top 20% (D5) range.
With a yield of 0.23%, it is not as attractive as there are better counters that fall in the top 20% which provides a higher dividend yield.
Even if investors are looking towards the growth prospects of the company and potentially investing for capital gain, we would like to point out that there are much better choices in the market which have such growth prospects and yet fall in the G5D5 range such as:
- Hop Hing Group (HKSE:0047)
GPA: 114.6 (G5), Div Yield: 4.5% (D5)
- Hisense Home Appliances (HKSE:0921)
GPA: 31.2 (G5), Div Yield: 3.7% (D5)
Conveniently, we have a case study on Hisense too!
The aforementioned stocks were stated for comparison purposes and are not recommendations, please always do your own due diligence.
Step 2A: Is it G5D5?
We investigate further only if the stock falls into this category for both profitability and dividend yields paid.
If it does not pass this criterion, we do not bother investigating further into it.
Since Haidilao International failed to pass this test, we would naturally not move on to investigate further, but let’s go through the exercise to illustrate the process.
Step 3: Determining the Sustainability of Haidilao International’s Dividends
To determine if the dividend distribution of a stock is sustainable, it can be analyzed with two simple metrics:
- Payout Ratio
- Average Free Cash Flow Yield
The Payout Ratio indicates the fraction or percentage of the earnings being paid out as dividends. One should always check for the Payout Ratio so as to ensure that the seemingly high yield is not due to a one-off special dividend given that year.
We cannot rely on earnings alone and analyzing the cash flow is crucial to any business. A company with losses but good cash flow will last a longer time. A company with large profits but poor cash flow will run the risk of bankruptcy.
As dividends are given in cash, we check for the Average Free Cash Flow yield to ensure that there is enough cash being generated to fund the distributions every year.
Step 3A: Determine Payout Ratio
We deem that the dividend distribution of a stock sustainable if the payout ratio is less than 1.
However, due to the fact that Haidilao International recently IPO-ed late last year, we would only have 2018’s ratio. A low Payout Ratio indicates that most of the earnings are retained by the company, especially if the funds are needed to fund growth opportunities.
When the payout ratio is more than 1, it is usually due to the fact that a special dividend is announced and the dividend is likely to drop the following year. Hence, it is important to check this condition and not just rely on the dividend yield alone. One might be tricked by a one-off event.
Hence, having a payout ratio of 0.2, it passes the criteria.
Step 3B: Determine Average Free Cash Flow
Free Cash Flow is calculated by deducting the capital expenditures from its Operating Cash Flow.
Free Cash Flow tends to be lumpy as Capital Expenditure may not happen every year. Haidilao might only require to buy new pots, stoves and utensils every 4-5 years.
It is thus more useful to average the FCF across five years before comparing to the latest dividend distribution.
We deem the dividend distribution sustainable if:
Dividend Distributed is less than Free Cash Flow
Due to the fact that we were only able to extract data from the Prospectus and 2018 Annual report, we were only able to attain 4 years of data.
Haidilao International’s average Free Cash Flow yield is 0.059% which is lower than the dividend yield of 0.23%. A low persistent free cash flow yield would also imply future dividends could be reduced.
Hence, it fails the Average Free cash flow criteria, deeming the dividend distribution unsustainable.
The Qualitative Side
Due to the fact that Haidilao has failed the quantitative side miserably, one should not be moving on to analyze the qualitative. However, for learning purposes, we would expand a little into the qualitative side.
Today, we would be touching on two qualitative points:
- The Brand Moat
- Skin in the Game
The Power of Branding
To be honest, I am not a huge fan of the place, having only eaten at the restaurant twice. However, this did not impede my market research as I posted several questions on my social media, prompting the response of Haidilao die-hards.
To my surprise, there was an overwhelming response with several common answers…
Haidilao has focused its business model on delivering high-quality ingredients, strong customer service coupled with interesting and unique experiences. This includes the “Noodle Man Performance” and the “Happy Birthday Fruit Cart”
They also have lots of complimentary services which helps them to stand out. From providing manicure services while guests are waiting for a table, to changing screen protectors and giving out ziplock bags to prevent the soup from spilling onto your phone. It is this care and attention to the entire customer journey that I believe has made it so successful.
It is also due to this pampering that has created a name for the company.
Skin in the Game
If the Chairman or the CEO of a company owns more than 50% of shares in the company, but not more than 70%, their interests are more likely to be more aligned with the shareholders.
That is because they are unlikely to take actions to harm their own wealth and would look towards improving the prospects of the company
In Haidilao’s case, the ownership disclosed by the annual report looks like this:
There have been cases whereby owner-cum-management shortchanged the minority shareholders by offering a very low price to buy up the remaining shares and delist the company. To minimize this risk, we can consider investing in stocks where a controlling shareholder does not own more than 70% of the company. However, due to the fact that the stock has recently IPO-ed such a prospect would be relatively low.
So, Is Haidilao International still worth investing?
The main reason we are not interested in buying Haidilao International is that the company’s dividend yield is not attractive enough (D3 not D5) and unsustainable (its average free cash flow is less than the dividend distribution). We listed several other growth dividend counters available in HKEX which have much more promising metrics as compared to HDL.
So we would not be investing in Haidilao International, for now.
The Expansion of Haidilao
Not all hope is lost for the hotpot star, as its growth prospects and expansion plans look pretty promising. This might potentially drive up the company’s gross profitability, dividend distribution, and sustainability through increased free cash flow.
Automation and Artificial Intelligence
In October 2018, one of Haidilao’s restaurants began introducing robots to take orders and deliver raw meat and vegetables to customers to cook in the simmering pots of soups placed at their tables.
According to GoGo News, Haidilao has said that after implementing automation and analyzing its supply chain, the new intelligent restaurant lowered labour costs by 37%. Should intelligent robots begin to expand and take over more Haidilao Restaurants, profits could possibly see an increase with the savings in labour.
“McDonald’s, Coca-Cola and Starbucks are all a reflection of American culture, as the Chinese economy grows and the world starts to put more focus on China, I believe there’s a chance for Chinese restaurants.”Mr Zhang Yong, the co-founder, and chairman of Haidilao
This is especially true as seen in the rise of the Korean wave which caused a crazed influence in people’s fashion and diet choices internationally.
In 2018, they opened 200 new restaurants, and its global restaurant network increased from 273 to 466.
For the international market, Singapore has the most number of outlets followed by Taiwan, South Korea, the United States, Japan, Hong Kong and London.
They stated that they would continue to strategically expand our restaurant network by further increasing their restaurant density and further expanding geographical coverage.
This expansion would allow Haidilao to capitalize on the international markets thereby possibly improving both their top and bottom lines substantially.
The purpose of this article is to share our investment approach to capture the Profitability Factor on dividend-paying stocks. It is not meant as a recommendation to buy or sell this stock.
To learn more about the GPAD strategy, along with a suite of other investing strategies, we hold regular introductory courses to share our structured investing course called “Intelligent Investing Immersive Programme”. You can get a free seat here.
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