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3 Key Risks Facing Haidilao International

Haidilao International Holdings Ltd (SEHK: 6862) has been one of the hottest stocks this year. The fast-growing, premium hot pot company has seen its stock double in price this year, propelling its founder, Zhang Yong, to the top of Singapore’s rich list. 

But the company is not without risks that could derail its growth. And considering its stock trades at a rich valuation of close to 100x earnings, any slowdown in growth can have a detrimental effect on its stock price.

With that said, here are three risks that potential investors should be wary of.

#1 Risks that come with scaling

There are many potential bumps along the road as Haidilao grows its network of restaurants both in China and internationally. 

For one, safety issues become harder to contain as the company scales. For instance, Xiabuxiabu Catering Management Holdings Co Ltd (SEHK: 0520) saw its share price plummet last year when a video of a rat found in its hotpot soup went viral. As the number of outlets expands, Haidilao needs to ensure that the strict safety protocols are adhered to.

Haidilao also needs to ensure that it scales in a sensible and strategic manner. Cannibalisation of sales from existing stores or overexpansion leading to the cheapening of the Haidilao brand may have an unwanted impact where scale becomes detrimental to its business.

The landscape in countries outside of China is also very different. A part of its growth prospects is its ability to scale internationally, where average customer spend is much higher. Success will depend very much on the company’s expansion execution strategy. 

#2 Competition

The hotpot restaurant subsector is a highly fragmented market, with many players fighting for market share. Currently, Haidilao enjoys its status as one of the most recognisable restaurant brands in China and is well-known for its unique services such as free snacks and manicures while customers wait for a seat.

However, competition may arise as other F&B players begin to recognise the need to provide high-quality service to customers. Competitors can copy the “Haidilao model”, and possibly take customers away from it.

#3 Related party transactions

Lastly, a significant amount of Haidilao’s total purchases in 2018 was with related parties. The founders of Haidilao set up Yihai Group, Shuhai Group, Shuyun Dongfang and Weihai Consulting as separate companies to provide food and services to Haidilao. 

Related transactions include the purchase of processed food, human resource training and even the renovation of new stores.

However, it is worth noting that the transaction from related parties have been on a decreasing trend, which suggests that the founders are treating Haidilao shareholders fairly at the moment. Related party transactions have decreased from 61.7% of its total expense in 2015 to 38.4% in 2018.

Foolish bottom line

With its rich valuation, any slowdown in Haidilao’s growth can have a detrimental effect on its stock price. Investors should, hence, be acutely familiar with the key risks that could derail its growth.

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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.