BreadTalk: Unaffected by food inflation (OCBC)

Slew of activity in June. Breadtalk had an eventful month in June as it announced the establishments of three joint ventures. The announcements were expected as BreadTalk seeks to accomplish its expansion plans in China and Taiwan for its bakery and food court segments. For the bakery segment, BreadTalk will enter into a JV via its Shanghai BreadTalk subsidiary to manufacture and sell frozen dough for bread and Danish pastries to bakery outlets in China. The partnership will seek to take advantage of its partner's manufacturing technology to complement its existing store development expertise and brand power to cultivate a strong value chain in China's bread market. For its food court segment, the company entered a JV to establish and operate food courts in Guangzhou under its "Food Republic" and "???" trademarks as well as firmed up a JV to oversee its food court operations in Taiwan. All three joint ventures are not expected to have any material impact on the earnings per share and net tangible assets of BreadTalk Group for this financial year.

Food inflation continues to climb but BreadTalk's key ingredient unaffected. With 30% of its cost of sales attributed to the cost of raw material such as vegetable oil, wheat, flour, eggs, etc, rising food inflation will have an impact on BreadTalk's margins. A broad gauge of 55 food commodities as measured by the United Nations' Food and Agriculture (FAO) showed an increase of 1% for the month of June as prices of sugar, meat and dairy increased. Although June's levels are about 1.6% lower from its all-time peak in Feb, the FAO expects prices to remain elevated over the next few years with agricultural output growth slowing to 1.7%/year through to 2020 versus 2.6% over the previous decade. Fortunately, there has been some temporary reprieve for BreadTalk. Prices of wheat, one of its key ingredients, declined 21% over June due to a higher-thanexpected increase in output production.

Margins should remain relatively intact; maintain BUY. With the reduction in wheat prices, we anticipate an offsetting effect on raw material costs from the general increase in prices of other ingredients. As such, we do not foresee any deviations from our gross margin forecasts of 54-55% and continue to put faith behind BreadTalk's management ability and its growing brand recognition. Furthermore, its recent JV announcements have reiterated its continuous commitment to expansion as well as enhance its operational capabilities. We maintain our BUY rating for BreadTalk but pared our our discounted cash flow-to-firm fair value estimate by 10% from S$0.74 to S$0.66 on account of its lack of trading activity.