Gold Brands Investment (GBI) is best known for the Chesanyama brand, with over 300 stores in South Africa. They also own the Hot Chicks, Wild Wings and rapidly growing BlackSteer brands.
In the last week, they have signed a deal with the Casual Dining Group (CDG), which operates 300 mid-market restaurants including Café Rouge, Bella Italia, Belgo and Las Iguanas in the UK, to roll out their restaurants on a franchise basis in South Africa. Less than a week later, and geographically bizarre, they have announced that they will acquire 50% of the Hot-Hot Burger Bar chain, which operates 15 American style diners in Greece and Cyprus.
Whilst I openly admit that other than Chesanyama, I have never heard of any of these restaurants, I believe that there is a huge and growing market in Southern Africa and globally for Eating Out. This is supported by several trends including:
- Smaller apartments: As people live in smaller more centrally located apartments, they will be increasingly likely to entertain in restaurants rather than at home.
- Increasing affluence: The middle class in Southern Africa is growing rapidly and this additional disposable income is often translated into “spoiling yourself” with meal away from home.
- Economies of scale closing the price gap: As restaurant chains scale their supply chain and optimise their operations, their costs drop, which brings the costs of eating out closer to the costs of home cooking.
- Time: Demanding jobs, gym time, dual job households and long commutes all contribute to less available time for the preparation of meals at home.
- Less and later children: People with children are considerably less likely to eat out then those without kids. As people reconsider having children or have children later in life, demand for dining options increases.
For all these reasons, I am convinced that mid- and low priced restaurants represent a significant growth market in South Africa’s maturing middle class.
However, a specific investigation of GBI poses a weighty question, how are these deals being funded?
Their latest results paint a gloomy picture. Revenue was down 13% year on year, despite the opening of new franchises. Fortunately, costs were kept in check, but Trade and other Receivables have tripled in a year, from R11m to R38m, and now make up almost half of the company’s market cap. This means that reported profits did not translate into cashflow into the business. And cash flows were indeed negative to the tune of R8.5m in the previous 6 months.
The company was supported by the dilutive issue of 25m new shares. This has the effect that additional profit (up 16%) has translated into reduced earnings per share (down 10%). The share is trading at a modest PE of only 11, but that is only if you believe the receivables will materialise into actual cashflows in the future.
On 1 September 2016, cash on hand at the company was a mere R500k, a fraction of monthly operating costs. Worringly, the CDG deal requires approximately R1m in up front franchise fees and the additional large costs of opening-up the various restaurants (assume 5 restaurants at R1m apiece in the first year). The Hot-Hot Burger transaction comes at the hefty price tag of R11m. Therefore, while these new brands add “sex appeal” to the stable of restaurants, the costs in the short term are likely to be in the order of R17m or 20%-25% of market cap. Another dilutive rights issue is most definitely coming, and it is unlikely that this will lead to an increase in earnings.
I will stay far away from this company until cash flows are more established. It may be time to consider Taste Holdings or Famous Brands, which will make up the subject of future posts.