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Chinese Embrace Eating on the Go Growing Demand Has Investors Seeking Out Fast-Food Chains

June 25, 2008

By Joseph Chaney

With the stock market debut this month of the hot-pot restaurant chain Little Sheep, brokers are promoting a new theme for investors hungry for a slice of China’s consumer boom: home-grown fast food.

Chinese appetite for on-the-go burgers, fried chicken, pizza and noodles is expected to make fast food a $66 billion industry in China by 2009, up from $51.7 billion last year, according to the research firm Euromonitor.

The Chinese chains Little Sheep, Cafe de Coral and Fairwood, as well as Ajisen of Japan and the international behemoths KFC, Pizza Hut, McDonald’s and Burger King, are all catering to growing demand for fast food.

But food prices in China, the world’s fastest-growing major economy, are soaring, and experts say a lack of pricing power is squeezing firms in a crowded market, where scale is the key to long term success and profitability.

Food costs account for around a quarter of fast-food chains’ expenses, analysts say. Adding pressure is an extremely fragmented market where the five largest Chinese companies account for just 3 percent of the market.

That compares with the roughly 20 percent share controlled by top Chinese sportswear companies like Li Ning and Anta in that segment of the consumer market.

Despite the challenges facing the industry, their stock valuations are high as investors bet that the Chinese hunger for dining out and more modern lifestyles will not abate any time soon.

Shares in Ajisen, a specialist in Japanese-style noodles with stores throughout Asia, are trading at more than 28 times the company’s forecast earnings, more expensive than the price-earnings ratio of 24 for Li Ning.

Ajisen has gained more than 51 percent since its stock market debut in March 2007, but has shed over 7 percent in the past month amid market turmoil and general inflation fears.

Cazenove, the brokerage firm, has an outperform recommendation on Ajisen, while Merrill Lynch has a buy rating. But JPMorgan has an underweight rating on the stock, and ABN AMRO has a sell rating, citing difficulties in cost management.

“We remain positive on the long-term fundamentals of the company given its profitable restaurant concept and large proven market size,” Cazenove said about Ajisen in a research note on China restaurants.

Little Sheep’s stock has lost nearly a fifth of its value since its June 12 debut, racked by recent market volatility.

Companies are struggling to pass on costs to consumers in a year when inflation has hit 11-year highs, even though China’s per capita urban disposal incomes are expected to rise 13.6 percent this year to 15,663 yuan, or $2,272, according to Sun Hung Kai Financial.

“For department stores, they have high-end branding, margin expansion, they can pass on costs to consumers. But for fast-food companies it’s proving to be difficult especially when food costs are surging,” said Ebru Sener Kurumlu, a consumer sector analyst at JPMorgan.

As of now, global investors have limited options for getting in on the growth of Chinese fast-food chains: Ajisen; the Mongolian- style mutton specialist Little Sheep; and the Hong Kong-focused Cafe de Coral and Fairwood, although these two companies have only limited operations in mainland China.

Cafe de Coral, which had three dozen stores in China as of September, plans to have 500 by 2011, according to Kim Eng Securities.

And analysts say more market listings are in the works, as privately held chains seek to tap the markets for capital to expand and keep up with newly listed competitors.

The Shanghai-based Xiao Nan Guo is said to be considering a listing in Hong Kong this year, as is the higher-end restaurant chain South Beauty.

Ajisen, which combines fast food and traditional restaurants selling Japanese-style dishes, aims to have 1,000 restaurants in China over the next three to five years, a five-fold rise from the number it had at the end of 2007.

“We are acquainted with the catering culture and the taste of the customers” in China, said Alan Zheng, chief financial officer of Ajisen. “As such, we gradually penetrate towards second- or third- tier cities with strong growth potential.”

Despite vast growth potential, Chinese food companies are relative latecomers to the race to build widely known brands across the country.

Global fast-food companies long ago placed their bets on the country, hoping to hook locals on Western food.

Yum Brands, which owns the KFC and Pizza Hut chains, was the first foreign fast-food chain to enter the market with a KFC branch in 1987, and is leading by a wide margin.

Today, Yum operates more than 2,000 KFC stores in the country – more than double McDonald’s 900 outlets – and booked roughly 15.8 billion yuan of sales in 2007 for its mainland restaurants, which last year generated more than a quarter of the company’s operating profit of $1.36 billion.

That compares to Ajisen’s Chinese revenue of about $116 million and Little Sheep’s $105.4 million.

Yum has also tailored its KFC menu to satisfy local tastes, serving up preserved egg porridge, fried dough and other domestic foods alongside its traditional chicken offerings.

Shadow Lau, an analyst at Kim Eng Securities, said that he believed the ability for fast-food chains to cater to varying local preferences across the vast country would be a key to success. “One of the biggest questions is whether they can localize – every region of China has a different taste,” he said.

Originally published by Reuters.

(c) 2008 International Herald Tribune. Provided by ProQuest Information and Learning. All rights Reserved.




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