Can This Winning Share Continue Winning?

Food & beverage retail outfit BreadTalk Group Limited (SGX: 5DA) has been a great winner since the start of 2006 with its shares climbing by some 576% to S$1.295 today. Those returns have significantly outpaced Singapore’s market barometer, the Straits Times Index’s (SGX: ^STI), which gained only 36% in the same period.

A winning share

Can BreadTalk continue doing well though? To help answer that, we can take a look at the company’s valuation, keeping in mind the idea that shares with lower valuations are generally favoured over those with high valuations.

Breadtalk PE ratio

Source: S&P Capital IQ

At its current price of S$1.295, BreadTalk’s valued at around 27 times its trailing earnings. As you can see from the chart above, which plots BreadTalk’s price/earnings (PE) ratio since the start of 2006, the company’s current valuation is significantly higher than its average PE ratio of 18 over the past eight years.

This might suggest that BreadTalk isn’t cheap. In addition, the company’s PE ratio also does not compare favourably with that of the SPDR STI ETF (SGX: ES3), an exchange-traded fund which mimics the Straits Times Index; the SPDR STI ETF is currently valued at around 13 times its trailing earnings.

But, looking at the PE ratio without context of the company’s corporate future can’t give us the full-picture. As investor Ric Dillon once said:

“On the behavioural-finance side, one of many inefficiencies comes from people anchoring on the past. People assume something is cheap, say, just because it hasn’t traded at such a low valuation for five or ten years. But that doesn’t matter, what matters is what will be [emphasis mine].

What Dillon meant is that a share which looks expensive in relation to its own historical standards need not actually be pricey if its future warrants a rosier outlook.

The way forward

And with BreadTalk, there is some room for optimism. Last year, BreadTalk’s founder and current Chairman, George Quek, laid down the company’s goal of having S$1 billion in revenue by 2016 and 2,000 bakeries, food courts, and restaurants by 2018.

BreadTalk, which runs its namesake BreadTalk bakery outlets and other F&B brands like Din Tai Fung and Carl’s Junior, brought in S$570 million in revenue over the last 12 months. The company also had 844 F&B outlets in total (751 bakeries, 59 food courts, and 34 restaurants) around Asia. From BreadTalk’s current position, it’s evident that there’s massive room for growth if the company were to hit its targets.

Some risks to consider

That said, it’s not a sure thing that BreadTalk can meet its lofty aspirations. For one, the company needs to drive revenue growth at much faster pace – in the second quarter of 2014, sales grew by only 10.5% year-on-year. In order to hit that S$1 billion target by 2016 (which is only two years away), growth needs to accelerate.

The company’s pursuit of top-line expansion also brings with it a number of risks. The first deals with declining margins, which are shown in the chart below.

Breadtalk Profit Margin

Source: S&P Capital IQ

With declining margins, there might come to a point in time where growth becomes unprofitable and that would be something for investors to note.

BreadTalk’s ambitions have also led the company to borrow increasing amounts of capital in order to fund its growth. This has caused the company’s net-debt position (total borrowings minus total cash) to increase tremendously over the past three years as seen below, increasing the financial risks faced by the firm.

Breadtalk balance sheet

Source: S&P Capital IQ (The year 2014 equates to the first half of the year)

The company’s operating cash flow hasn’t grown too much either, as the figure had only increased from S$38.9 million in 2009 to S$59.7 million over the past 12 months. This could be taken as a sign that the company has not made full use of its borrowings to generate growth in cash flow.

Foolish Bottom Line

There are certainly things to like about BreadTalk’s future with Quek’s goals for the company. But, the risks of declining margins and increasing leverage are something investors have to note with the company. Also, if the growth in BreadTalk’s bottom-line and cash-flow fails to catch up with its increase in sales eventually, the company’s high valuation might yet come back to haunt investors.

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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 Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.