Cooks Global Foods — Update 5 September 2016

Cooks Global Foods reported a lower than forecast audited result for FY16, complicated by the shareholder restructure and recapitalisation plan, which took management focus away from the business and resulted in a lower than target store roll-out. The company, which owns the Esquires Coffee brand globally, reported a normalised net loss of NZ$4.9m, compared with a normalised net loss of NZ$3.5m in FY15 and our forecast for a loss of NZ$2.6m. The company ended FY16 with 87 stores versus its target for 120 and up from 71 stores in the previous year. Revenue was higher than forecast due to the full year effect of the wholly owned stores in China, which were acquired in the final quarter of FY15. Exhibit 1 highlights the FY16 results versus our forecasts and the previous year results.

The composition of revenues had also changed on the prior year and was different to our previously forecast FY16 revenues. As Exhibit 2 shows, while overall revenues increased 39% y-o-y, revenues from the company’s owned coffee houses increased 142%, due predominantly to the increase in wholly owned stores in China. Fees from the redesign of stores in the UK, together with store openings globally, resulted in a 145% uplift in revenue year-on-year.

The company’s auditor PwC added a disclaimer to its signoff on the accounts on the basis that it was not able to obtain sufficient audit evidence to determine the viability of CGF’s funding initiatives and management’s future cash flow assumptions. This underscores the need for CGF to raise sufficient capital to fund its roll-out plans. The company has noted that to meet its forecast operating and cash flow projections up until 31 October 2016, it needs additional funds of NZ$2m to NZ$4m.

The board has, in the short term, addressed this by arranging a convertible note facility of NZ$2m from its two largest shareholders, Cooks Investment Holdings (CIH) and Shandong Jiajiayue Holding Co Ltd (JJY). It also is seeking an outstanding amount of NZ$2.8m from shares underwritten by Cooks Investment Holdings and is seeking to renegotiate the repayment of loan commitments that fall due between July, when the company issued its annual report, and October 2016. CGF has said it will also delay capital projects until funds from the equity raising are confirmed.

Shareholders approved a NZ$9m capital raising last November as part of a NZ$18m package to restructure and recapitalise the company. To date, NZ$9m has been spent by JJY and CIH (although as at 31 March 2016, CIH was still to provide the final payment of NZ$3.1m) to acquire the shareholding previously owned by the Deek brothers, who founded the company. The restructure of the company’s shareholding base in November 2015 has strengthened the company’s register. According to management, CGF now has a register of shareholders that have the capacity to support the company until it is generating sufficient cash flows to finance itself.

CGF has reported total store sales and transactions for Q117 versus Q116 and demonstrated 10.2% growth in transactions year-on-year and 2.7% growth in average transaction values on a constant currency basis.

On a same store basis, average transaction values rose 3.6% y-o-y to NZ$9.80, but transactions declined 1.5%. These results are set out in Exhibit 3. The company plans to report these metrics on a quarterly basis going forward.

CGF is budgeting for 650 stores by FY21, but has noted that management has set a target for 800 stores.

The company, however, has also noted that there are uncertainties in achieving its budget growth in store numbers including:

The final risk is particularly relevant to China, where CGF expects its greatest store growth, as Exhibit 4 demonstrates. By FY21, CGF anticipates that at least 220 of its 650 budgeted stores will be in China, up from 29 today. Since balance date, CGF has opened seven new stores and closed two underperforming stores.

We have adjusted our FY17 and FY18 earnings forecasts following the lower than expected FY16 result. Our forecasts are based on the assumption that the company will be able to secure the funding it requires to continue as a going concern.

We anticipate that by the end of FY17, CGF will have 167 stores in operation. We are forecasting revenue of NZ$18.9m. The significant increase in revenue from our previous forecast takes into account the wholly owned stores in China and the joint venture arrangements, which will report total store sales rather than our previous expectation of royalties revenue. Offsetting this is the expectation that the revenues from the more mature UK and Irish markets will be generated from master franchise fees and royalties. We have also reduced our expectations for the food processing businesses in the group as these delivered a lower than forecast FY16 result. As a consequence, we have increased our forecasts for gross profit by 15% in FY17 and 26% in FY18, but anticipate that overhead costs will be higher, resulting in an increased EBITDA loss of NZ$0.5m (previously NZ$0.1m) in FY17. Our EBITDA forecasts for FY18e are largely unchanged but we anticipate higher depreciation charges from the wholly owned stores and higher interest costs. This has resulted in a 45% reduction in our FY18 EPS forecast to NZ$0.25/share.

Given CGF’s early stage in its lifecycle, we use a DCF valuation methodology to value CGF. The increased risk to the business due to going concern issues necessitates a higher discount rate. We have increased the discount rate (WACC) to 12.0% (previously 10.7%) and this, together with our earnings downgrade, has resulted in a reduction of our DCF valuation to NZ$0.145/share (previously NZ$0.245/share). If we keep our discount rate at 10.7%, our DCF valuation, following our earnings adjustments, would be NZ$0.167/share. Our valuation parameters and DCF valuation are set out in the following exhibit.

We have also undertaken a scenario analysis, shown in the sensitivity matrix below, to demonstrate the impact on valuation from different terminal growth rates and WACCs. As Exhibit 7 highlights, a higher discount rate would result in a lower valuation. Based on our estimates, the current share price of NZ$0.09 implies a discount rate (WACC) of c 16.5%. A WACC of 20% implies a valuation of NZ$0.07/share.

Cooks Global Foods operates in a dynamic space in the consumer foods industry. Its peer group of listed coffee houses is trading on a median EV/revenue of 3.8x and EV/EBITDA of 15.2x. On an EV/revenue basis, CGF is trading on 2.1x 12-months’ forward revenue, which is at a 44% discount to this group average. While a discount for its relative size might be justified, we are of the view that CGF’s growth profile should enable this gap to close.