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Haidilao International: Are the Hotpot King’s Shares Overpriced?

Haidilao International Holdings Ltd (SEHK: 6862) has been one of the hottest stocks in Hong Kong. Barely a year since its listing, the stock has already doubled its initial public offering (IPO) price, propelling its founder, Zhang Yong, to become the richest person in Singapore.

But with the popular hotpot company’s stock trading at an eye-popping 100x its earnings, are investors getting ahead of themselves?

Growing fast

A high price-to-earnings (PE) ratio may be justified if sales growth is similarly high. In the first half of 2019, Hadilao reported a 59.3% increase in revenue, driven by a (1) an increase in the number of restaurants and (2) sales growth in existing stores.

Both of these metrics are likely to continue to rise over time. The biggest drivers to same-store sales growth are likely to be in Tier-3 cities in China and in restaurants outside of China, which grew 12.5% and 9.7% respectively.

There is also room for growth in the average table turnover rate in restaurants outside of China. The average table turnover rate for restaurants outside of China was only 4.3 times a day, which is some way behind the table turnover of 5.1 times a day for restaurants in Tier-1 cities in China.

Expanding its footprint

Besides organic growth in existing restaurants, the hotpot chain is also expanding its network of outlets rapidly. In the first half of 2019, Haidilao opened 130 restaurants, expanding its network of restaurants by 27% to 593.

The group currently operates 550 restaurants in China, which, in my opinion, is still relatively few compared to the sheer size of the China market. Based on a DBS analyst report, the largest casual dining chains in the US have around three to five stores per million population. Given China’s population of around 1.4 billion, that would translate to around 4,200 stores on the low end of that range.

The group also only operates 43 restaurants internationally, which means there is a huge market opportunity outside of its core market in China.

Valuation justified?

So the big question ends up being “is the growth fast enough to justify its rich valuation”? I think so.

Haidilao has a tremendous runway for growth and we could easily see the company’s sales grow by more than 50% every year for the next five years at least. On top of that, the group’s restaurants are highly profitable and cash generative, which means it can rely on internal cash generated to fund its expansion.

As its restaurants mature, same-store sales will grow too. This could also improve net margins, which means more of that growth could trickle down to earnings. Although there are risks involved, such as the possibility of new premium hotpot brands or changing consumer behaviour, the risk that Haidilao’s competitive edge gets significantly eroded is thin.

All things considered, if Haidilao is able to grow its sales by 50% or more for the next five years, I believe investors who are willing to play the long game, will be well-rewarded.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Jeremy Chia doesn't own shares in any companies mentioned.