This Market-Beating Small Stock Is Doing the Right Things for Future Growth

Credit: Simon Cunningham

Eating is one of Singaporeans’ favourite past-times and I’m proud to say I belong to that majority too. It’s for this reason that I particularly like shares involved with the Food & Beverage industry – what better way to research a potential profit-making opportunity than to tuck into a hearty meal?

An F&B champion

One small stock in Singapore that has not only delivered great meals but outsized returns as well is Neo Group Ltd (SGX: 5UJ). The catering and F&B retail outfit got listed in July 2012 at S$0.30 per share and has since gained more than 200% in price to S$0.905; in comparison, the SPDR STI ETF  (SGX: ES3) has grown by only 14% in the same period. The SPDR STI ETF is an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index  (SGX: ^STI).

As an example of how the company’s catering fare attracts customers, the most recent Chinese New Year in February 2014 saw the firm serve more than 220,000 guests through its catering brands over the entire 16-day festive period. In the previous Chinese New Year, only 195,922 guests were served. The company’s upscale Orange Clove catering brand has also managed to grow its corporate client base from “a handful when it started in 2008, to 4,500 for FY2014 [financial year ended 31 January 2014].”

Along the way, such achievements and more has helped the firm to nearly triple its revenue in four-plus years from S$22.7 million (in FY2010) to S$57.3 million (over the last 12 months). Neo Group’s bottom-line has also shown commensurate growth, jumping from S$2.2 million to S$6.15 million. Such corporate growth has also likely been the basis for the company’s market-beating returns that it has earned so far.

But, the F&B industry is a highly-competitive one. So, who’s to say that Neo Group’s growth potential would be similar to how it has done in the past?

Paving the way for further success

On that note, one telling aspect on the possibility of Neo Group being able to continue growing its business comes from a recent profile of Neo Kah Kiat, titled “An appetite for good food and business expansion,” which was published in The Straits Times. In the article, Neo, who’s the founder, chief executive, and majority owner of Neo Group, said (emphasis mine):

“I started out from the kitchen. I’m a food man, so I know everything about my food – I can tell you what type of fish is nice, where it is from…

The kitchen is a passion. You must love it. Before, I would do R&D (research and development) on the ground, but now I supervise and do more planning, strategy.”

For me, his quotes convey a real passion for cooking and for making great food. And that is reminiscent of one of America’s great recent success stories in the F&B industry, Chipotle Mexican Grill. The fast-casual restaurant owner went public in the U.S. in January 2006 and has seen its stock explode with a 1,540% gain so far.

Learning from success

Chipotle’s phenomenal returns has come on the back of equally stunning business success. In 2005, the company clocked US$628 million in revenue and US$38 million in profit. Over the last 12 months, the two figures have come in at US$3.88 billion and US$404 million respectively. Chipotle has also managed to grow its restaurant count from less than 500 to 1,724 over the same period.

And in an impressive feat, Chipotle has been able to achieve all that through the use of minimal or zero borrowings since its listing; the firm has been financing all its growth through the generation of copious amounts of cash flow from its operations.

In the company’s latest quarterly results for the third quarter of 2014, it reported a breath-taking 19.8% increase in same-store sales while McDonald’s saw a decline of 3.3% in comparable sales for the same period in the U.S. The difference in the growth rates of the two companies’ existing restaurants is actually a microcosm of how Chipotle is winning the war against fast-food companies.

But what is it that makes Chipotle such a stunning success? Steve Ells’ comments in the company’s latest conference call is telling (emphasis mine):

“While our performance has been particularly strong this year, our results have been solid throughout our history as a public company, even through the depths of the recession, and I am often asked how we continue to perform so well.

The fact is there is no great mystery to it. Our ability to generate such strong sales growth is the result of our commitment to serving the best tasting food we can. Food that is made with ingredients from more sustainable sources and prepared using classic cooking techniques, and our commitment to having teams of top performers in our restaurants who are empowered to provide an extraordinary customer experience.”

Ells’ other comments on why his company is crushing the competition is also instructive (emphasis mine):

“The traditional fast food sector has traded food quality and taste for low cost and ease of preparation. It has aggressively marketed low prices to entice customers to visit more often which has resulted in the need to reduce cost by cheapening ingredients and by compromising the overall dining experience. We have not made these compromises because our fundamental belief is that in order to provide an extraordinary customer experience you cannot take shortcuts.

The gimmicks that have driven the fast food sectors for years, dollar menus, limited time offers, and merchandising partnership are not producing results like they used to as consumers simply want better tasty nutritious food at a more compelling experience, not gimmicks.

In some cases, these other companies are looking to revamp their branding efforts to change their customer’s perception but not the food. Fundamentally these are short sighted reactions that seem out of touch with what customers want, better food and a more compelling dining experience. This is exactly what we offer at Chipotle and we think it’s replicable with other kinds of cuisines.”

From the comments above by Ells, it seems obvious to me that the core underlying theme driving Chipotle’s success as an F&B outfit is a love of producing great food.

A growth star with warts

Neo Group’s leader, from his comments given above and the company’s ability to get its customers to stick with its services, seem to embody the same kind of love for preparing great food.

But this does not necessarily give Neo Group any certainty when it comes to generating great future returns for shareholders. The financials of a firm matter too. And this is where Neo Group has its warts despite healthy top- and bottom-line growth (as mentioned earlier).

The firm’s balance sheet has deteriorated as it has to take on debt to expand its business (such as the building of a new centralized kitchen). At the end of FY2013, Neo Group was in a net-cash position (meaning it had more cash than debt) but as of 31 July 2014, the company’s carrying S$19.5 million in total borrowings while having only S$9.2 million in cash.

Neo Group's operating cash flow

Source: S&P Capital IQ

In addition, Neo Group hasn’t shown the ability to generate consistent growth in operating cash flow so far, as seen in the chart above.

A Fool’s take

Chipotle’s success can prove to be an instructive lesson for F&B companies when it comes to the important factors that determine their success – as Chipotle has shown, the love of great food from the firm’s leaders (which can then permeate throughout the organization) is a crucial recipe.

Neo Group has displayed the same kind of qualities thus far through the company’s actions and Neo’s quotes. But although that’s an important contributor to the firm’s future success, the financials play a role too and in that aspect, there’s certainly room for improvement for the company.

It’d be interesting for investors to watch how it all plays out for Neo Group.

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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 owns shares in Neo Group and Chipotle Mexican Grill.