How well do you know luxury goods?

LVMH is one of the biggest luxury brand in the world. Under its stable, you’ll find the likes of Louis Vuitton, Rimowa, Loro Piana, DFS and Sephora. In 2016, it had annual sales of €37.6bn and as I write this its market cap stood at €122bn.

Today, I came across its 3Q results and it was interesting.

To see if you know luxury as well as you thought, take the following quiz. The answers are posted after the various photos. Don’t peak.

1. Which region contributes the most to LVMH’s revenues through the first nine months of 2017?

  • A) Asia,
  • B) Europe,
  • C) US,
  • D) Others

2. Which region had the strongest revenue growth rate in 3Q 2017?

  • A) Asia ex Japan,
  • B) Japan,
  • C) Europe and
  • D) US

3. Rank the revenue contribution by product segment from largest to smallest?

  • A) Wine and Spirits,
  • B) Fashion and Leather Goods,
  • C) Perfume and Cosmetics,
  • D) Watches and Jewellery and
  • E) Selective Retailing (i.e. DFS and Sephora)

4. Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

  • A) Wine and Spirits,
  • B) Fashion and Leather Goods,
  • C) Perfume and Cosmetics,
  • D) Watches and Jewellery and
  • E) Selective Retailing (i.e. DFS and Sephora)
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Which region contributes the most to LVMH’s revenues through the first nine months of 2017?

  • The answer is Asia. Combining Asia ex-Japan (29%) and Japan (7%), Asia contributed 36% to LVMH’s overall revenues in 9M 2017. Europe was the second largest region with 27% of sales (9% France and 18% Europe ex-France). The US was the third largest region at 25%.

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Which region had the strongest revenue growth rate in 3Q 2017?

  • The surprising answer was Japan and Asia ex-Japan. Both regions saw top line sales growth of 21% in 3Q 2017. For the year-to-date, Asia ex-Japan was still stronger at 19% while Japan is only at 11%. However, given all the talk about Japan still struggling with its lost decades, a 21% YoY growth was most unexpected.

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Rank the revenue contribution by product segment from largest to smallest?

  • This question should be the easiest one. I’m pretty sure that 90% of you knew that Fashion and Leather Goods would be the biggest category (at 35.5%) but how many knew that Selective Retailing (i.e. DFS and Sephora, etc) would be the second largest category at 30.6%. Perfume and Cosmetics was third at 13.3% while the Moet-Hennessy part of LVMH was only fourth largest at 11.5% of revenues. Watches and Jewellery was the smallest segment at 9.1%.

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Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

For the first nine months of 2017, LVMH’s largest segment was also its fastest growing. The Fashion and Leather Goods segment (35.5% of sales) grew 14% YoY in 9M 2017. AS Perfume and Cosmetics also grew 14% (with 17% YoY growth in 3Q 2017), this suggest that luxury branding is very strong. On the flip side, although wine and spirits grew 8% YoY, 3Q growth of 4% YoY made it the slowest growing segment in the group.

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Key Takeaways – Japan and Asia might be getting its Mojo back

As a generalist data point gatherer, the most interesting takeaways were:

1) The very strong performance out of Japan and Asia ex-Japan. Japan was supposed to be struggling to show inflation while Asia was supposed to be still dealing with the anti-corruption curbs. For both regions to show 21% YoY growth in 3Q and 11% and 19% YoY growth in 9M 2017 suggest that Asian consumers seems to have found their mojo and are back to their happy spending ways.

2) Branding remains effective. Usually with the law of the large numbers, as sales reach a certain critical mass, growth would inevitably slow. However, in the case of LVMH, although Fashion and Leather Goods is its largest segment at 35.5%, it growth has remained the strongest among the categories. Further, as many perfumes and cosmetics are branded along the same lines, the strong growth in those two categories suggest that consumers still love the luxury brands.

On point 1), if Japanese and Asian consumers have indeed gotten their mojo back, then the recent catch up of Japanese equities might have more room to go.

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Source: Yahoo Finance




Mass Consumption Part 6B – How do you build the FedEx of China?

Last week, we discussed the economics of China’s express delivery industry. This week, we review their balance sheet to gauge who is likely to become the next UPS/FedEx of China.

Last week we discussed China’s rising express delivery market and how it has grown together with China’s massive online retailers. As a quick recap, in 2016, online retail sales made up 14.30% of China’s overall retail sales and for the express delivery industry, it delivered 27.9bn parcels and generated overall revenues of US$59.8bn.  chart (29)

With China’s express delivery market expected to double in the next five years, everyone is vying to become the UPS or FedEx of China.

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When we reviewed the economics of China’s top express delivery companies and compared their margins and profitability to the top US operators like UPS and FedEx, we came away with mixed feelings (see full discussion here). While we were very positive about the express delivery market’s overall growth, we are concerned that competition from new operators vying for market share would compress margins.

Crunching the balance sheet

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After having some time to digest our initial thoughts, we are still scratching our heads. Something is missing. Why is there such a big divergence in valuation?

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One could argue that the high PE ratio of SF Express and Best (net loss) was because of companies sacrificing near-term earnings for long-term market share. But in order to emerge from this fight, you need to either have (1) strong underlying cash flow or (2) a strong balance sheet to sustain you for the long haul.

A look at another conventional valuation metric, price-to-book, shows an even greater divergence. To me, the 3.1x-7.0x price-to-book ratio that ZTO, FedEx, STO and YTO are trading at would be within my range of expectations. But what about UPS at 81.6x and SF Express at 11.3x PB?

chart (40)

Although labour costs is a major component of the express business but there are also a lot of hard assets as well. What about the trucks, the planes, the computer systems, the conveyor belts, not to mention the drones?

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PPE make up 50% of US express company assets and only 13-28% for China

This is where we see one of the big differences between the US and China express companies. For UPS and FedEx, property, plant and equipment (PPE) was the largest component of their assets. Even after accumulated deprecation, PPE still made up around 50% of UPS and FedEx’s total assets. For the Chinese express companies, SF, ZTO and YTO have PPE around 26-28%. Best and STO’s PPE are only 13-15% of assets.

chart (41)

Since some companies sometimes classify their software as intangible assets, we further consider intangible assets and goodwill. Again, we see that UPS and FedEx are fairly close with intangible and goodwill making up around 14% of assets. Grouping PPE and intangibles together, we see that these make up around 65% of the US express companies’ asset base.

Need to buy more trucks and build more sorting facilities

For the China express companies, SF, ZTO and YTO are hovering around 39-45% but STO and Best are only around 20-22%. This suggest to me that if these companies want to institutionalize their business and expand their market share, more investments and capex is needed. They must buy more trucks, more planes, build more sorting facilities and build out their logistics network.

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On this basis, it is no surprise that SF Express and YTO have higher PPE and intangible assets. Their revenues have already started to scale.

chart (33)

Capital structures reflect the early stages of investment

For the China express sector, one silver lining is that they appear to have anticipated this need and have already tapped the capital markets. As of June 2017, four of the five China express companies are sitting on net cash. Although SF Express had US$73mn net debt, its 2% net-debt-to-equity ratio suggest there is lots of scope for it to borrow.chart (42)

In comparison, given the relative maturity of FedEx and UPS business, their capital structure is optimised to boost ROEs.

Incumbents best positioned to become China’s UPS/FedEx

If we apply the filter of (1) normalised margins and (2) high PPE-intangibles, this would suggest that the two largest incumbent operators, SF Express and YTO, best resemble FedEx and UPS. That said, one would still have to decide whether the current PE ratios of 52.8x and 37.2x is too high a price to pay for that potential future.

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Mass Consumption Part 6 – Getting your online purchases from Point A to Point B

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Online shopping. This is the trend behind massive internet companies like Alibaba and Amazon. The picture above is from last year’s “Singles’ Day” sales event where Alibaba pulled in Rmb120.7bn of online sales just within 24 hours on November 11, 2016.

But behind the glamour of online shopping, there is a less glamorous but equally important service that drives this mega trend – express delivery. I have often wondered how the heck do they manage to ship goods so quickly. Didn’t I just click confirm payment yesterday and bam the goods are already at my home.

Here is a picture of how it happens.

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China’s e-commerce expected to rise from US$2.8trn in 2016 to US$5.9trn in 2021

According to iResearch, the gross merchandise value (GMV) of China’s e-commerce market has increased 3x from US$988bn in 2011 to US$2,825bn in 2016. In the next five years, it expects the GMV of China’s e-commerce market to double to US$5,785bn by 2021.

chart (28)

Source: iResearch.

In terms of online penetration, online retail sales now account for 14.3% of China’s overall retail sales, a higher penetration rate than the 11.7% in the US.

chart (27)

Logistics and shipping are the new landlords

Intuitively, we know the draw of online shopping, namely, cheaper goods and greater convenience. But why are goods cheaper? One big reason is the removal of rental costs from the retail equation.

A while back, I came across an interesting illustration in the WSJ. Using a pair of US$150 jeans as example, the offline “bricks-and-mortar” retail sales would net US$24 after the various operating expenses, a net margin of 16%. By comparison, through the online sales channel, the residual profit is almost double that at US$45, or a 30% margin

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What was interesting in the illustration was where the two channels differ. As you can see from the above, there is no difference in Cost of Goods Sold and there is also no difference in Marketing expenses. Although there is no “Store Payroll” in the online sales channel, one could argue that the software maintenance operating costs is almost the same. Similarly, freight to retail store has been replaced by warehouse/fulfilment.

The key difference is Rent and other retail operating costs being replaced by free standards shipping and return. In the traditional model, rent accounted for 15% of sales and other retail operating costs made up 8%. In the online model, free shipping and return make up 7%.

What this cost comparison suggest to me is that in the new online environment, the shipping and logistics companies are the new landlords in the virtual distribution channel.

China Express Delivery Market – 27.9bn parcels and US$59.8bn

While China’s e-commerce has tripled in size over the past five years, its express delivery market has grown even faster. The number of parcels delivered has increased 7.5x from 3.7bn in 2011 to 27.9bn in 2016.chart (29)

In dollar value, China’s express delivery market has quintupled from US$12bn to US$59.8bn in 2016. According to iResearch, in the next five years, the number of parcels are expected to double, reaching 60bn parcels and US$124.5bn by 2020. Although these numbers may seem big, they are actually quite conservative if one were to consider that FedEx and UPS each generated revenues in excess of US$60bn last year.

chart (30)

Business model – Network Partner Vs. Direct Model

Unlike the US where express delivery is dominated by two players (FedEx and UPS), China’s express delivery market is more fragmented.

China’s express delivery companies tend to follow one of two business models, namely the network partner model or the direct model.

  • Under the direct model, the likes of SF Express and EMS (related to China post) manage the entire delivery channel from parcel collection to sorting to transportation to delivery.
  • Under the network partner model, companies like ZTO, YTO, STO and Yuanda only manage the centralise sorting and transportation. The last mile pick-up and delivery is left to smaller local network partners to handle.

chart (31)

Growing pie but profitability being squeezed by rising competition

Looking at the financials released by five express delivery operators, the pie is clearly growing. Among the likes of SF Express, YTO, ZTO, STO and Best, their collective revenue increased by 29.7% in 2016 to Rmb103bn and in the 1H of 2017, their revenues has grown another 30.6% to Rmb60bn.

chart (33)

Among these five operators, SF Express is the clear leader. In 1H 2017, SF Express earned Rmb32.2bn revenue, giving it a 54% market share among these five operators. YTO Express was the second largest revenue earner at Rmb8.2bn with Best Inc a close number three at Rmb8.1bn.

chart (34)

As with most things in China, if there is money to be made, competition will sniff it out. When we compare 1H 2017 revenue growth with 2016, only SF Express and Best Inc were able to accelerate sales growth. It is clear that Best Inc’s market share gain is coming at the expense of the other operators.

chart (35)

More worrying is the manner by which Best Inc is going after market share. In 2016, Best Inc’s gross margin was -6%, some 25pp lower than SF Express’s 19% gross margin.

chart (32)

With competition aggressively going after top line growth, profitability has suffered with four of the five operators showing a decline in 1H 2017 gross and net profit margins.

chart (36)

The other key notable from the above gross and net margin chart is the dispersion among operators. Gross margins range from ZTO’s 33% to Best’s -0.6%.

Comparison to FedEx and UPS

In order to gauge what longer term sustainable margins may be like, we turn to the US operators. As we alluded to earlier, FedEx and UPS generated revenues of US$60.3bn and US$60.9bn in their last financial year. This is roughly 7x larger than SF Express’ US$8.6bn 2016 revenues. From a market capitalisation perspective, UPS is nearly 72% larger than FedEx and 2.86x the size of SF Express.  chart (37)

From a profitability perspective, in their last financial year, UPS and FedEx recorded operating margin around 8.3%-9.0% and net margin around 5.0-5.6%. Among the Chinese operators, SF Express and YTO Express’ margins most resemble the US operators. SF Express had operating margin of 6.8% and net margin of 7.2% (it had some non-operating gains) while YTO Express generated operating and net margin of 10% and 8.1% respectively.

chart (38)

China express sector – Strong sales growth but margins likely to compress further

Based on the, we would come away with the following initial impressions:

  • (1) Strong top line growth for China’s express operator – China’s top express delivery operator, SF Express, currently only generate sales that is one-seventh that of UPS and FedEx. Given the expected rise of China’s overall economy and e-commerce, there should be ample runaway before China’s express delivery sector’s growth peaks.
  • (2) Margins likely to come down – Normally, in a fragmented market, one would expect strong competition and low margins to be the norm. However, in this case, China’s express delivery sector margins are much higher than the US duopoly. As new operators vie for a piece of the express action, margins are likely to come down. Among China’s express operators, only the two larger operators of SF Express and YTO Express have margins that resemble those of the mature US operators.



Mass Consumption Part 4 – Whassssup? Watching the game, having a beer

Whassup? During the summer, when it is scorching outside, there are few things better than an ice-cold beer. In Part 4 of our Mass Consumption series we review the state of the beer industry. But unlike the previous post, the Chinese beer industry outlook is not “whassup”. In fact, after peaking in 2013, Chinese beer consumption has fallen for three straight years and operating margins are less than half of global peers.



For those unfamiliar with the term, Whassup was an iconic beer commercial from the late 1990s. The commercial was so successful that for quite a while, everyone went around saying “Whassup?”. To truly appreciate the fad at the time, you have to go back and watch the commercial. (Youtube link here). It may appear silly now, but admit it, you said your fair share of “Whassup” back then.

As promised from my “Fried Chicken and Coffee” post, I was planning to do some work on the Beer industry but I did some initial reading, I I really did not feel a sense of urgency, hence the lateness of this post. To put it simply, the beer industry is not “Whassup?”

China beer production peaked in 2013

chart (9)

According to data from the National Bureau of Statistics, in 2016, China’s beer production was 450.6mn hectolitres. Beer production had peaked in 2013 at 506.2mn hl and has now fallen for three straight years and are now down 11% from the peak. This is very different from the other mass consumption themes that we had been talking about (i.e. ageing population, travel and fast food).

Volumes down across most major breweries

Looking into the numbers, this is not just a China phenomenon. Across the major international breweries, Heineken was the only one to report a growth in beer sales in 2016 (up 6.3%). The largest brewery, AB InBev (owner of Budweiser, Stella Artois and Corona) saw sales volume drop by 0.4% in 2016. Carlsberg’s sales volume fell by 2.8% while Tsing Tao’s declined by 6.6%.

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Craft beers and premium-ization

With overall beer consumption flat, in order to grow revenues, breweries have turned to craft and premium beers to try to boost overall ASPs. Next time when you order a Leffe or Camden Town, you are in fact ordering a cousin of Budweiser (so to speak). Here’s a table of the family of beers.

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For instance, did you know that Budweiser, Corona, Hoegarden, Boddington’s and Pure Blond are from the same family. Similarly, the Carlsberg family of beers include Grimbergen and Brooklyn Lager. And in the Heineken family, this includes Moretti, Sol, Anchor and Tiger.

Alcohol-Free and Ciders

In addition to premium craft  beers, another focus area for the breweries is the “low and no-alcohol” beer segment. AB InBev has set a goal to have low-and-no alcohol beers represent 20% of its global beer volumes by 2025. For Carlsberg, although Craft and Non-alcoholic beer only represent 5% of its beer volume, they make up 10% of net revenues. As for Heineken, the low-and no-alcohol segment represented 12mn hectolitres in 2016.

Margins are all over the place

While the beer industry’s growth profile is very different from the other mass consumption industries that we have reviewed, there is one aspect that is similar: Low China margins.

At 29%, AB InBev has the highest EBIT margin among the breweries. Heineken and Carlsberg are at 17% and 13% respectively. By comparison, the two Chinese breweries’ operating profit margin of 6% is less than half of their international peers.

chart (13)

Looking at the international breweries’ segmental results, China’s lower margin is not obvious. For AB InBev, although its Asia Pacific profit margin of 16% is well below those of Latin America, North America and EMEA, it is still more than double that of Tsingtao and CR Beer.

chart (12)

Interestingly, for Heineken and Carlsberg, their Asian operating margins are actually higher than those of Europe and the America. Of the three, Heineken’s 32% operating margin in Asia is the highest among our comparison group.

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Need to diet before I have a pint

Although overall volume growth has been anaemic, the sector has not done too poorly over the past 12 months. On a blended basis, the five beer stocks above are up 27% against their 52 weeks lows. But with current price only 8% below their 52 week highs, I feel that similar to my own situation, the stocks may need to go on a diet before they become attractive again.

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Mass Consumption Part 3 – Coffee and Fried Chicken

I love coffee and I love fried chicken. Normally, I wouldn’t mix these two together but in Part 3 of our mass consumption series, we look at the economics of feeding China’s 1.3bn mouths.

I know, I know, coffee and fried chicken don’t go well together. I wish the title could have been Beer and Fried Chicken but I have yet to do work on the beer industry so for this week, we will have to focus on the two strange bed fellows of Coffee and Fried Chicken.

I love coffee and I love fried chicken. Every morning, regardless of whether it is a weekday, weekend, rain or shine, I always start my day with a Grande Black Coffee. If one were to talk about an industry with a defensive moat where consumer stickiness is very high, coffee is it for me. If my local Starbucks were to raise prices, I’m stuck.

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On the other hand, although I love fried chicken, I eat it sparingly. When I was a teenager, I could devour a whole bucket of KFC by myself but nowadays, I try to limit myself to splurging once every 6-12 months. It taste good but I feel very guilty afterwards and the indulgence shows up immediately on the scales.

What do they have in common? Making money in China

But what do Coffee and Fried Chicken have in common? They are two of the food companies that have been able to make money in China. Yes, I’m talking about Starbucks and KFC.

In part 3 of our Mass Consumption series, we turn to the largest consumption category. At Rmb1,535, food and tobacco make up 32% of the average spending of the Chinese consumer. Although its growth rate of 4.6% is the second slowest among the various categories, it is still growing nonetheless.

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A Starbucks around every corner?

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Although it may seem like there is a Starbucks around every corner, the actual penetration is still limited, especially in overseas market. At the end of September 2016, including both company operated and licensed stores, there were 15,607 in the Americas. China and Asia Pacific is one of the fastest growing regions but the 6,443 stores is still only 41% that of the Americas. In percentage terms, the America’s have 62% of total stores, China/Asia Pacific 26% and EMEA 11%.


(Source: Company data for all charts)

In terms of revenue, the skew is even higher. The Americas contributed US$14.8bn or 69% of total revenues. China and Asia Pacific grossed US$2.9bn of revenue or 13% of the total while EMEA made US$1.1bn revenue or 5.3%. Although it may not seem obvious from the below chart, China and Asia Pacific had the fastest revenue growth in FY2016 at 22%, nearly double the 11% growth rate experienced in the Americas.

chart (1)

By product, beverages make up 58.1% of total revenues. Food make up 16.4% and packaged and single-serve coffees and teas made up 13.4%. From a growth rate perspective, in FY2016, food sales grew 13% y/y, slightly faster than the 11% beverage sales growth.

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The trick is in growing profitably

As we have written previously (see here and here), China’s allure has always been its massive 1.3bn population. But the big pitfall for many companies is how to grow in a profitable manner especially when it is faced with hyper competition.

Starbucks profitability in Americas and China / AsiaPac

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In this regards, Starbucks appears to be successfully juggling between growth and profitability. In absolute terms, Starbucks made US$632mn from the China and Asia Pacific region. This represented a margin of 21.5%, roughly 4pp below the 25.3% operating margin that it makes in the Americas. Even if one were to exclude the 5.1pp by way of income from equity investees, the operating margin of 16.4% is still pretty respectable.

Looking at the cost breakdown, the obvious areas of variance between the Americas and China/Asia Pacific would be in the (i) cost of sales including occupancy costs and (ii) store operating expenses. While the store operating expenses in China / Asia Pacific is much lower than the Americas (26.5% Vs. 33.2%), this is more than offset by the higher occupancy costs (35.6% Vs. 44.1%).

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Last but not least, while China and Asia Pacific’s 22% revenue growth is obviously important, don’t count out the Americas. If we were to consider same-store-sales growth, The Americas are actually doing better at +6% versus China / Asia Pacific at +3%. Notably, the key distinction is in the change in ticket size. In FY2016, the average ticket in the Americas increased by 5% while the average ticket in China / Asia Pacific only rose by 2%. In both cases, the number of transactions within the stores only rose by 1% but that is understandable as more stores are being added around every corner.

Finger licking good

If we are talking about tapping into China’s mass consumption wave, Starbucks was actually pretty late. It opened its first store in 1999 at the China World Trade Building in Beijing. McDonald’s opened its first store in Shenzhen in 1990. The first global brand to go into China was in fact Kentucky Fried Chicken. Yes, Colonel Sanders was the first one to “make a run for the border”  when he opened the first KFC in Beijing back in 1987 (Note: two points if you can tell me where the quoted slogan is from).

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Including sister restaurants like Pizza Hut, Taco Bell and Little Sheep, Yum China now operates 7,562 restaurants in China. This is 14% more than Starbuck’s 6,443 stores in the China / Asia Pacific region.

Over the past five years, the number of KFC and Pizza Huts have increased by 32%. Company operated restaurants make up nearly 80% of restaurants with franchisees and unconsolidated affiliates making up the other 20%.

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Between fried chicken and pizza, KFC is more popular. At the end of 2016, there were 5,224 KFCs, nearly 3x the number of Pizza Huts. Incidentally, both KFC and Pizza Hut have added about 400 stores over the past two years.

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While the number of KFCs outnumber Pizza Hut 3:1, at the top line revenue level, KFC’s US$4,696mn revenue is only 2.6x that of Pizza Hut’s US$1,774mn. Perhaps due to some food scare issue, KFC’s revenues have actually fallen slightly from US$ 4,893mn to US$4,696mn while Pizza Hut’s revenues have increased by 4.5% from US$1,696mn to US$1,774mn.

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What KFC appears to have done much better over the past two years is in boosting its profitability. According to the segmental data, restaurant margins at KFC has increased from 11.4% in 2014 to 15.9% in 2016. By comparison, Pizza Hut’s margins have oscillated from 14.3% in 2014 to 12.3% in 2015 before rebounding to 14.0% in 2016.

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Similar to Starbucks, occupancy costs and other operating expenses are the biggest cost items, eating up around 33.5% of revenues. Interestingly, “Food and paper” is the second largest cost item, accounting for around 28.4% of revenues. I suppose fried chicken is quite greasy and you do need lots of napkins to clean your hands afterwards.

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So what will it be? Chicken or Coffee?

Hmm, that’s a hard one. In nominal terms, although Yum China’s revenue is more than double that of Starbuck’s China / Asia Pacific revenues (US$6,752mn Vs. US$2,939mn), as Starbuck’s China / Asia Pac 21.5% operating margin is double that of Yum China’s 9.5%, their nominal operating profits are actually very comparable. For the fiscal year 2016, Yum China had operating profit of US$640mn while Starbuck’s China / Asia Pac segment earned US$632mn.

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While Starbuck’s US$87bn market cap is much higher than Yum China’s US$15bn, from a valuation perspective, the two are in fact quite similar. Starbuck is currently trading at 30x trailing twelve months PE. Yum China is at 28x. Although both company’s PE may appear high, one must decide if China’s 1.3 billions mouths to feed are worth it.

Decisions, decisions….

Mass Consumption Part 2 – The best travel deals around

There are Chinese tourists everywhere. Whether you are in Sydney, Hong Kong, London or LA, I think that statement holds some relevance. Well, the fact is that in 2016, Chinese outbound tourists numbered 135mn and with only 4% of its population holding a passport, that number is likely to rise further. In this second part of our mass consumption series, we look into the economics of the online travel agency business and see where the best travels deals are.

China is big. It’s 1.3bn population makes any kind of consumption trend a potential huge opportunity. However, as we illustrated last week in Part 1 of our Mass Consumption series, the winners might not be the obvious candidates.

In this second instalment, we look into the economics of the travel business, specifically, the online travel business. I’m not sure whether travel falls into the (i) education and recreation services or (ii) transport and communications but these are the second and third fastest growing spending categories for the typical Chinese consumer.

Average spending by Chinese population

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(Source: National Bureau of Statistics)

While China does have a rapidly ageing population, those between the age of 14-64 had been one of the fastest growing segment that currently number nearly 1bn persons or 73% of the overall population.

Chinese population between 14-64

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(Source: World Bank)

4% of Chinese hold a passport vs. 37% of Americans

According to the United Nations World Tourism Organization, Chinese tourists spent US$261bn overseas in 2016, up 12% y/y, while the number of outbound tourists rose 6% y/y to 135mn. Although those numbers are big, they could get even bigger since the percentage of Chinese that hold a passport is only 4%, compared to 37% for Americans (source: China Daily).

The spending by Chinese tourists on things like cosmetics and luxury goods have been well documented but what about the very act of travel itself?


Say what you will about commercial jingles but I think they are effective. To this date, when I think about online travel portals, I usually think of trivago or Expedia.

Travel agencies were among the first industries to be disrupted by the internet. Nowadays, for anyone planning a holiday getaway, their first port of call must be to comparison shop with an online travel agency (OTA). While most of these sites come with some sort of price match guarantee, exactly how good are their deals? And how do they make money?

Travel – a US$1.3trn market with 50% online presence

As I read up on the OTA industry, I came across a couple of interesting findings.

First, let’s check out the current OTA landscape. According to a presentation from Expedia, the total travel market is estimated at US$1.3trn in 2017. Of this EMEA (Europe, Middle East and Africa) is the largest market at US$456bn, followed by Asia Pacific at US$392bn and the US and Canada at US$383bn.

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(Source: Expedia presentation)

But if one were to consider the online penetration, the US is the most advanced at 67%, followed by Europe at 50%. Asia Pacific and Latin America are at 37% and 34% respectively. For the overall market, online penetration is at 50%.

Multiple brands, different niches

The second detail that I found interesting was how the brands are affiliated. I don’t know whether it was because of historical mergers and acquisitions but many of the big travel websites are owned by the same parent.

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(Source: Company data)

In the case of some of the Priceline websites, the company actually does a good job of explaining how each company fits into the different geographic niches. For instance, Priceline is a leading site in the US, whereas agoda caters primarily to consumers in Asia Pacific.

Screen Shot 2017-05-31 at 2.39.30 pm

(Source: Company data)

From a market cap perspective, Priceline is the largest one by far. But despite having a market cap that is 3x that of Ctrip, its price-to-earnings ratio is the lowest at 42x (still quite punchy by non-internet standards. Note: No PE for Ctrip as it made a loss in 2016).

How much commission do they charge?

In terms of amount of business, Expedia is currently the leader with about US$72.4bn of gross booking done in 2016. Over the past three years, Expedia and Priceline have actually been very close while Ctrip has begun to catch up with 2016 GMV at around US$63.2bn. For Ctrip, it targets total GMV to surpass US$150bn by 2020 or even a year or two earlier. If this is met by 2020, this would suggest a CAGR of 24%. If this is met by 2018, then the CAGR would rise to 54%.

Screen Shot 2017-05-31 at 2.46.47 pm

(Source: Company data)

Perhaps due to their different business and geographic mix, the three companies’ commission rate (i.e. gross revenue divided by  gross booking) vary quite a bit. At first glance, Priceline appear to have the highest take at around 15.1% of gross bookings. Expedia is around 12% but Ctrip is very low at only around 4.6%. Since some of the overall gross booking numbers are not broken down by segments, this could be a case of a higher transport-to-hotel mix for Ctrip dragging on the overall gross commissions rate.

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(Source: Company data)

I won’t go into the full details but the companies do report on their revenues slightly differently depending on whether they run a merchant or agency model. In the case of Priceline, there is little difference between its gross profit and its gross revenue whereas for Expedia and Ctrip, their gross profit margin range from 67-82%.

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(Source: Company data)

Advertising and marketing eat up 30-50% of overall revenues

As the OTA are a service based business, there is hardly any significant costs of goods sold. Instead, the key costs are those related to advertising, sales and marketing which help to differentiate these very similar product offerings.

Of the three, Expedia spends the most on advertising and marketing at around 50% of overall revenues. Priceline is also high at around 40% of overall revenues. Perhaps due to less competition within China’s on-line travel market, Ctrip only spends about 30% of revenues on marketing and advertising (Note: Ctrip also spends about 30-40% of revenues on Product Development).

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(Source: Company data)

With advertising eating up nearly 30-50% of revenues, it is little wonder that those travel deals keep popping up on the banner ads on various websites.

Net margins explain reason behind Priceline’s high valuation

Net of all the other personnel, depreciation and miscellaneous expenses, Priceline’s operating margins stands heads and shoulders above the other two. For 2016, Priceline had written off US$941mn in goodwill. Excluding this amount, Priceline’ operating margin would have been around 37%.

Screen Shot 2017-05-31 at 3.59.40 pm(Source: Company data)

A bird in hand or two in the bush

So, where are we going on this? I think the bottom line is what is the better deal?

If one were to simply consider the profitability issue, there is no comparison between Priceline and the other two operators. It’s operating margin of 37% is just that much higher. And if we assume that top line revenue growth can be translated into profits, Priceline should be in the best position. That said, we are also confronted with the reality that over the past three years’, Priceline’s fully diluted EPS had been fairly stable, fluctuating between $45.67 to $49.45 to $42.65. The other two operators also do not seem to have fared much better. Clearly, somewhere along the line, the very strong top-line growth in bookings and revenues have not translated to bottom line earnings.

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(Source: Company data)

On the other hand, if we were to take a more forward-looking perspective, one could argue that Ctrip may have greater potential. The Asia Pacific market is already the second largest travel market after EMEA, yet it has the third lowest online penetration at 37%. Furthermore, with Ctrip’s commission rate of only 4.6% versus Priceline and Expedia’s 15% and 12%, there is the potential for this to converge with the other two operators.

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Now for the end user. If you are still  planning your summer or Christmas holidays, you better try to lock in the lower rates before Ctrip starts raising its commission levels from the current 4.6% and you wind up paying more.

Mass consumption Part 1 – Ageing population

Imagine selling a billion pairs of sneakers and a billion frapuccinos. China’s massive population has always been the holy grail for consumption plays. With a rapidly ageing population where those above aged 65 already number more than 131mn, we look into the economics of assisted nursing care.

A billion pair of sneakers and a billion frappuccinos

For as long as I can remember, China’s 1 billion plus population has always made for a compelling investment case. This is especially the case, when you hear about China’s rising middle class and the growing affluence of its consumers. As the following chart shows, in the six years between 2009 and 2015, China’s per capita GDP has more than doubled from US$3,838 to US$8,069.

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(Source: World Bank)

But first some caveats…

While the Chinese population is definitely richer and consuming more, the winners (from a stock perspective) are far from intuitive. Consider the case of the life insurance companies. The logic was supposed to be that as China’s middle class became more affluent, they would buy more insurance products, benefiting the likes of China Life. Well, since October 2010 (note that this is already after the bursting of the 2007 China bubble and also the 2008 Credit Crisis), China’s Life share price has declined by 30%. In sharp contrast, another life insurance company, AIA, has seen its share price rise more than 130% over the same period.

Insurance – China Life versus AIA
Screen Shot 2017-05-24 at 1.26.47 pm

(Source: Yahoo Finance)

Similarly, the rise of mobile penetration has also not translated into higher share prices for the incumbent operators. Since October 2010, China Mobile’s share price has remained largely unchanged while Verizon in the US has seen its share price rise by 37%.

Telecom – China Mobile versus Verizon

Screen Shot 2017-05-24 at 1.26.56 pm

(Source: Yahoo Finance)

Now, if this were the case of traditional retailers losing market share to the internet, I can totally understand that. But even in the irreplaceable bricks and mortar play of home builders, share prices have greatly lagged behind the rise in consumption. Over the past five years, one of China’s largest developers, China Overseas Land, has grown its top line revenue nearly three fold from HK$57bn in 2011 to HK$164bn in 2016. Yet its share price is only up by 48% and has in essence been stuck in a range since 2013.

Property – China Overseas Land – Share price versus EPSScreen Shot 2017-05-24 at 1.53.27 pm

(Source: Yahoo Finance, Company data)

There are many possible explanations behind this apparent decoupling between trend growth and share price growth but I think it is safe to say that in many cases one has to be very careful in selecting the right stocks that can “profitably” benefit from this trend.

How are the masses spending their money?

Be that as it may, the long-term rise of the Chinese consumer is still compelling enough that we should do more research around it.

In the latest data release from the National Bureau of Statistics, it showed that (1) Food and tobacco and (2) Residence are the two largest spending categories for Chinese consumers, accounting for 32% and 20% of total spend. However, if one were to consider the rate of growth, the fastest rising spending categories are (a) Healthcare and (b) Education and Recreation Services at 15.8% and 13.5% y/y growth.

Average spending per head

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(Source: National Bureau of Statistics)

131mn people above age 65

In this first instalment, we start by looking into healthcare. Although China’s 1.3bn population usually grabs the headlines, there is another very significant aspect to China’s population. It is ageing rapidly. Over the past 10 years, the percentage of the population above age 65 have risen from 7.5% to 9.6%. At the same time, those below age 14 have dropped from 20.1% to 17.2%.

China population – Those above 65 and those below 14

Screen Shot 2017-05-24 at 2.44.47 pm

(Source: World Bank)

In absolute terms, the number of seniors have increased from 97.7mn in 2005 to 131mn as of 2015. By comparison, those below the age of 14 have dropped from 261.9mn in 2005 to 236.3mn in 2015.

Part 1A – Nursing care

Although I like the healthcare concept, there are two practical issues to overcome. The first is the absence of a sector leader. Among the 50 Hang Seng constituent stocks, there are no healthcare stocks. Within the Hang Seng Healthcare Index, the largest constituent, only has a market cap of US$8.9bn and most of them are pharmaceutical companies. The second problem is that Pharma is a highly specialized industry. For the average layman, it is near impossible to see which medicine has better efficacy and predict which drug may be the next blockbuster.

Instead, we turn to the hospital and healthcare providers. We still have the problem of a lack of sizeable comparables but let’s do some homework anyway. Below, we look into the economics of nursing care in Hong Kong.

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(Source: Census and Statistics Department)

In 2016, 16% of Hong Kong’s population is aged 65 or above. According to the Census and Statistics Department, this ratio will rise to nearly 23% by 2026 and 29% by the year 2036.

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(Source: Company data)

As those with older family members can attest, regardless of how well we try to live and how much we exercise, our bodies eventually break down. Even though today’s medicine has greatly reduced the invasiveness of certain procedures and shorten recovery periods, there are times when assisted nursing care is necessary. According to a study done back in 2014, the gross fees from healthcare staffing solutions was HK$290.6mn back in 2013. This was projected to grow to HK$437.1mn by 2019, a CAGR of 7.0%.

Screen Shot 2017-05-25 at 11.45.38 am(Source: Company data)

In terms of service hours, personal care workers (PCW) make up nearly 53% of total demand. They are followed by health worker and healthcare assistants (HCA/HW) at 23.6%. Registered and Enrolled Nurses (RN and EN) make up 9.8% and 8.2% of service hours.

Screen Shot 2017-05-25 at 11.47.30 am(Source: Company data)

Based on data from June 2016, the average hourly charge out rate for RN and EN was HK$270/hr and HK$226/hr respectively, roughly double the rate charged by the HCA and PCWs.

In organising and matching the supply and demand for healthcare and nursing providers, the platform take a cut around 20-25% of the gross fee charged.

Screen Shot 2017-05-24 at 4.19.24 pm

(Source: Company data)

As the service is mainly one of matching supply and demand, overhead and PPE is minimal, with the resultant operating and net margin generally around 60% and 50%. Even though the margins appear very favourable, the main barriers of entry is just word of mouth and the availability of the nursing database.

Screen Shot 2017-05-24 at 4.20.03 pm

(Source: Company data)

With the right “app”, one could easily see the matchmaker being dis-intermediated from the process. If one were to look ahead, this matchmaker ought to take advantage of its strong database and uber-ize its service before someone else does it for them.