This column is written by @J_Chou
-Jay has an interest in global macro trends, financial markets and equity research and enjoys applying a combination of the three in his investments. His eventual investing goal is to manage a risk parity portfolio and achieve true financial freedom.

Sakae Holdings Ltd. (5DO.SI) is engaged in the business of operating restaurants, kiosks and cafes, trading, sushi processing and operating as caterer and franchiser. It operates in two segments: Sakae Sushi, which includes the main brand in provision of food and beverages to retail customers from the general public, and other products and services, which includes other brands and services offered by the Company, such as Sakae Teppanyaki, Sakae Delivery, Hei Sushi, Crepes & Cream, Sakae Delivery, Sakae Express, Senjyu, Sachi , Kyo by Sakae and Novelle Events.

Sakae Sushi, Sakae’s flagship brand, is a quick service kaiten (conveyor belt) sushi concept.

Key Highlights

-Poor sales and earnings have plagued the company since FY15, with revenue down 12% year on year. Breaking down by geographical segment, Singapore, Malaysia and Others all experienced decreasing turnovers. The Singapore market which accounts for 60% of the company’s sales was the hardest hit with a 15% drop from FY15 to FY16.
-Company looking to consolidate in Singapore and expand into neighboring countries, with 3 restaurants to be launched in Myanmar.
-Consolidation of 16 Sakae Sushi non-performing outlets nationwide in 1Q17 from 46 to 30, with rationalisation of the outlets funded solely by Sakae’s cash holdings. Current cash holdings at 4.3M, down from 8.7M in 4Q16.
-No dividend payment announced in FY16, which will likely continue for the next few years given company’s dire financial position.

Only growth catalyst will be greater than expected turnover from Malaysia and successful expansion into regional markets.
It is highly unlikely Sakae will be able to generate the success the management is expecting given current management’s track record and that competitors from Singapore are entering or have already entered into the same regional markets, for instance Sushi Tei has already established a presence in Myanmar.
Key concern will be the competitiveness of their restaurants, with general consensus on their quality and pricing not as competitive as their peers such as Sushi Tei, Genki Sushi and Sushi Express who employ the same kaiten sushi concept.
Despite management attributing a big part of declining profits on increasing cost of rentals and operations, a closer look at their balance sheet will reveal revenue has declined significantly while operating and rental costs have not changed much from FY15 to FY16, indicating that the main reason for decline was more likely due to less demand for Sakae’s products and not operating inefficiencies. Peer comparison further confirms this theory as the restaurant industry in general is still able to generate profit growth despite facing the same issues of rising operating and rental costs.
Another issue will be Sakae’s 39.5M short-term debt, with current ratio at a dangerously low 0.42x.
It is a concern how Sakae will finance their promise of overseas expansion, with their low liquidity and strong possibility of more consolidation of non-performing outlets in the horizon.

Key Financials

Image Source from FY16 Annual Report
Conventional financial metrics are not applicable as the company is generating negative earnings for the past two years. Company has also seen declining profit margins and negative free cash flow over the past two years.

There is a huge red flag on their liquidity, as Debt/Equity ratio is at 1.6x with exponential increase in financing from debt for the past 5 years. Industry mean is near 0 given the restaurants in general are not capital intensive. Hence, Sakae having high amount of debt in the restaurant industry is unusual and which may signify poor capital structure decisions.

Valuation and Analysis
No valuation analysis as given current situation company has no clear growth drivers and is more likely to default in my opinion.

Sakae Holdings is a good case study of how a company cannot simply rest on its past laurels and continue to profit. A decade ago, the name Sakae Sushi was synonymous with Japanese food for Singaporeans. But the company has gradually seen its market share being eaten by competitors who offer higher quality Japanese food at lower price points. The lack of innovation in its menu and operations have seen standards across the restaurants becoming inconsistent and signs of cost-cutting and lack of attention detail have been noticed by the fast-changing taste of Singaporean consumers.

Sakae has also demonstrated poor management ability, with ill-advised capital decisions and a seemingly stagnant business model that is unable to adapt to current times resulting in overexpansion and inability to capitalise on its strong Singapore brand locally and overseas. One striking example that bothers me the most about the management:

Despite the company’s poor financial performance Directors remuneration has actually increased from S$1.05M to S$1.14M, with majority going to the founder/ chairman Douglas Foo and the CEO, his sister Ms Lillian Foo. Also, another S$174,000 to immediate family members of the CEO, up from S$169,000 the year before. Furthermore, if you look closely at the annual report there is a footnote on another payment of at least S$100,000 to their father with no justification. Yet employee benefits have fallen by 10%! It reflects badly on upper management as they seem to have shown disregard for employees and shareholders.

In conclusion, the influx of competitors offering Japanese food at higher quality and lower price points over the past few years have severely affected Sakae’s profits, and this trend looks set to continue given the company’s overexpansion and lack of innovation into catering to Singaporean’s demand for higher variety and quality of Japanese food over the past decade.

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