More Dough from Dunkin’ Donuts

Since its IPO in July 2011, Dunkin’ Donuts has performed strongly in the US in the particularly unforgiving environment of the financial crisis. Their share price has equally grown from its IPO price of $22 to $49.76 currently. Their rise fits within the pattern of the greater trend of superbrands pulling away from their average competitors and into a league of their own. Dunkin’ Donuts will continue to provide more dough, but not just from their donuts.

Dunkin’ Donuts is headquartered in Canton, Massachusetts and runs itself as one of the world’s leading franchisors of coffee, donuts, baked goods and ice-cream under the Baskin-Robbins brand. With over 16,000 distribution points in 57 countries, and the number one position in the USA in terms of brand awareness for coffee, breakfast sandwiches, donuts, bagels, and ice-cream, Dunkin’ Donuts are in a strong position to continue to grow their superbrand, particularly when their low capex strategy and franchise model are taken into account.

Around 75% of their global sales of around $8 billion come from the USA and 75% of sales are generated under the Dunkin’ Donuts brand. The Dunkin’ Donuts USA division has achieved revenue growth of 7-9% over the past few years and this is expected to continue. Dunkin’ Donuts has high market penetration in its core New England market with one distribution point per 9,700 people. It is in the West of the USA and parts of the East USA that Dunkin’ Donuts has very low penetration of one store per 1,200,000 people and this is where growth opportunities can be leveraged. This is evident when compared to their competitors such as Starbucks with 1 distribution point per 20,600 people and McDonalds with 1 distribution point per 21,700 people. Moreover, Dunkin’ Donuts began leveraging their brand through K-Cups rolled out nationwide in August 2011, before competitors such as Starbucks (who only began to do this in November 2012). Having stolen a march on its competitors in this market, Dunkin’ Donuts are in a strong position to maintain market leadership over the next few years and to consolidate its 6% market share of all K-cups sold (roughly 7 portion packs per day per distribution point).  

Additionally, Dunkin’ Donuts’ defensive business model is facilitated by its low operating leverage. By the end of 2017, Dunkin’ Donuts will be fully unlevered as a US$1.5 billion floating rate term loan ends. Moreover, their franchise model means that 100 new distribution points in the USA is valued at roughly 3% increase to its Earnings per share.

On the international scene, there is also plenty of room for the superbrand to expand. Dunkin Donuts and Baskin Robbins are already saturated in Japan and South Korea. However, they also expanded by roughly 300 stores a year internationally during the financial crisis, demonstrating the business’ resilience. The strategy is now to focus on Russia, India and China as well as expand in the Middle-East. They had an agreement with Jubilant Foodworks in 2012 to open 500 distribution points in India, which has helped progress their international strategy. With the brands’ presence currently skewed towards Japan and South Korea (at 75% of revenue), there is excellent potential growth opportunities for this superbrand internationally, especially in Asia, Russia, and Latin America.

Therefore, buy Dunkin’ Donuts at its share price of approximately $50 as this is a long-term growth stock. Our hypothesis is for superbrands to continue to grow their market share and consequently their shareholders’ wealth, particularly in a globalised world. It is also evident that other competitors, such as Dominos and Chipotle, have taken the same growth trajectory – based on the same principles of lower operating leverage, franchise strategy and a defensive business model. With a market capitalization of around US$5.4 billion, there is significant growth to be achieved both in Western USA and internationally – over the next 10-15 years expect to see that market capitalization expand to around US$15 billion with a consequent rise in share price.

French Institutions at Discount on Euronext Paris

Paris' NYSE Euronext Exchange

The view that the European stock market is cheap has been propagated for several months now. When scrutinized, the European debt crisis really has reduced the value of some stocks for the sole reason that they are headquartered and listed in Europe. On Euronext Paris - Total, Sanofi, Louis Vuitton Moet Hennessy (LVMH) and Danone – four French institutions accounting for roughly 31% of the CAC-40 index’s market capitalization and doing most of their business abroad have been affected by the European debt crisis merely by being listed in Europe. This is apparent particularly when comparing them to similar US companies.

Total is a French multinational oil and gas company with a market capitalization of close to EUR 87 billion. Total counts as one of the 6 “Supermajor” oil conglomerates globally and obtains 3% of its profits from France. Its price to earnings ratio (P/E) is around 8.5 currently, compared to the USA’s ExxonMobil trading at 11.5 times. Moreover if we employ another comparison statistic - the prices per barrel of oil held in reserves, Total’s enterprise value is around 11 times total reserves compared to Chevron with 21 times. A simple analysis of this comparison would be that the markets judge each barrel of oil Chevron extracts to be worth roughly twice as much as each barrel for Total. This seems erroneous based on the fact that before the global financial crisis and the eurozone’s own crisis, the two companies traded on an almost identical multiple.

Sanofi Lab

Secondly, Sanofi is the world’s fourth largest pharmaceuticals company by prescription sales and has a current market capitalization of EUR 102.88 billion. Despite only deriving 5% of its profits from France, they trade on a multiple of 14 times earnings compared to 16 times for their competitor Johnson & Johnson.

Meanwhile, LVMH is heavily dependent on Asia rather than Europe for its growth. This is a continuing trend as the Asian middle-class swells. It has a market capitalization of around EUR 66 billion, with its most well-known brands including Dior, Celine, DKNY, Fendi, Givenchy, Kenzo, Marc Jacobs, Loewe, Guerlain, Bulgari, De Beers Diamond Jewellers, Tag Heuer, Sephora, Belvedere, Dom Perignon, Hennessy, Glenmorangie, Krug, Chateau d’Yguem, Moet & Chandon, and Veuve Clicquot. In line with most luxury companies that have high PE ratios relative to other industries, LVMH trades at 18 times earnings compared with 21.5 times for US’ Tiffany.

Lastly, Danone is a leading French food products manufacturer focused on fresh dairy products, bottled water, cereals, baby foods, and yogurts. Their current market capitalization is EUR 34.4 billion. 10% of its profits come from France and 50% of its profits from emerging markets. Danone trades at the same P/E ratio to Coca-Cola despite being much faster growing, which suggests that they are trading at a discount to Coca-Cola. This can be seen by juxtaposing its earnings per share growth since 2007 with Coca-Cola – 95% compared to 70%.

An active stockpicker's portfolio

Therefore, it may be good to take a look around Europe’s stocks and compare them to comparable companies across the Atlantic. These discrepancies are a result of a top-down model of investment run by most major asset managers and hedge funds whereby investment decisions are made based on geography of where they are headquartered and listed. This is why billions of dollars have left Europe since 2007, which may be justifiable from a risk management perspective but is also indiscriminate and has created anomalies. Hedge funds and quantitative trading housing supposedly exist to arbitrage away these anomalies, but having not done so, it is left to the active stock pickers and common individual investors to correct these discrepancies and profit.

Against a Stereotype: Tingyi Noodles

Tingyi Instant Noodle Shelves

Who said the Chinese loved noodles? As often happens, when stereotypes are closely scrutinised they are found to be only half-truths. The Chinese consume 3 kilograms, or 30 standard packets, of instant noodles per person. Meanwhile its neighbours are consuming far more on a per capita basis: Indonesians and Vietnamese eat around 5.6 kilograms or 56 packets of instant noodles per person, Hong Kongers consume 5 kilograms or 50 packets of instant noodles per person, and Japanese consume around 3.9 kilograms or 39 packets of instand noodles per person. It may be down to the working week. For example Hong Kongers work an average of 49 hours a week compared to 43 hours in China and so instant noodles are an excellent quick hot meal. Whatever the reasons, data suggests the Chinese are currently less keen on noodles than its neighbours.

Nevertheless, China is the largest instant noodle market in the world with 44 trillion packets of instant noodles produced in 2013, far higher than second place Indonesia with 14 trillion packets and Japan and Vietnam with around 5 trillion packets. As China develops a larger service economy, expect instant noodle sales to increase as the Chinese work longer hours with a clear trend being that its neighbouring countries have followed the same path.

Within the Chinese instant noodles market, we would look to Tingyi Holding Corporation as the incumbent monopolist to capitalize the most on these growing trends.  Founded in 1991 and listed on the Hong Kong stock exchange in 1996, Tingyi currently controls an over 50% share of China’s instant noodles market. Their flagship instant noodle brand is Master Kong or Kang Shi Fu, which was voted the second most valued brand in China for the past two years (behind only Sony). In the era of big brand augmentation, expect their brand to propel Tingyi’s sales growth. The Master Kong noodles are famed for their salty and oily flavour.

Tingyi Logo

Tingyi reported sales of US$9.21 billion, making 7% growth year-on-year in 2013, down from their five year average growth of 20%. They were forced to lower their profit margins due to the onset of a price war in the mainland Chinese instant noodles market. Far from being a warning, this intimates Tingyi’s adaptability – after all it is the companies most adaptable to change that succeed. This should bode well for Tingyi’s decision to start selling its instant noodles in Taiwan for the first time in 2013. Its major competitors in mainland China are Want Want China and Uni-President. Uni-President is the market leader in Taiwan with 50% share of the US$300 million market.

Tingyi’s various strengths ensure that we remain optimistic about their future outlook in both their major markets, both mainland China and Taiwan. Tingyi have an excellent brand, production base and retail channels in China. Moreover on the macroeconomic level, China’s rising average income and massive urbanisation trend will continue to deliver healthy sales growth to Tingyi’s operations.

The company also produces soft drinks, bottled water, and baked goods. Tingyi gets over half its revenues from beverages, 43% from instant noodles and 2.5% from baked food. Tingyi is PepsiCo Inc’s Chinese partner. Tingyi is the second largest soft drinks company in China’s 67.5 billion litre market, with a 13% share after Coca Cola’s 16%. Meanwhile, Tingyi’s bottled tea products are market-leading in China, with 44% share, whilst its juice products come in second with a 20.5% market share. Moreover, China now consumes the largest amount of bottled water in the world, however they are still below the global per capita bottled water consumption average of 30 litres per person. The top three water brands in China are Tingyi’s Master Kong, Zhejiang Nongfushanquan Water Co, Ice Dew from Coca-Cola and Yibao from China Resources Enterprises. With increased consumer health consciousness in China, bottled water is the lion’s share of the non-alcoholic beverages market constituting 42% of sales. Thus we can expect continued hegemony for Tingyi in terms of its beverages products.

Despite the ongoing tensions between the Chinese and Japanese governments, Tingyi have found bedfellows that are able to assist them R&D-wise in their hegemonic endeavours.  Tingyi formed a joint venture in April 2012 with Japanese trading house Itochu Corporation and Japanese snack maker Calbee to produce snack foods in China. More recently, Tingyi agreed to a joint venture with Japanese beverage producer Asahi and Itochu to further expand their share of China’s US$15 billion soft drink market. This market has grown at a consistent rate of 15% since 1995. The new venture will make tea, fruit juice, health drinks and coffee. Tingyi is banking on Asahi’s strong R&D capabilities and Itochu’s outstanding information collection ability and supply of inexpensive materials to surmount the rapidly changing Chinese beverage market.

Divestiture arbitrage opportunity?

Tingyi is currently trading at HK$22.4 within a 52 week range of HK$18.2 to HK$24. At the current price, it is a good long-term buy. However there may be a divestiture arbitrage opportunity with rumours afloat that Tingyi may consider divesting its food or beverage business with the intention of listing the divested business in order to improve operational efficiency and maximize shareholder wealth.

Bright investments often come down to a combination of luck and discerning patterns. The pattern for consumer staple foods is that a market goes through a boom phase, a slowdown phase, and then there is a fight for consumers centered on marketing spend. We live in a world where control often dictates success. I’m betting Tingyi, with their current market capitalization of US$15 billion and 79,300 employees, will win that marketing war. 

A New Theory for the Residential Property Asset Class

Globalization has deepened complexity and allowed seamless investment across the world. This has enabled investors to diversify into ever more asset classes. Our focus here is on the residential property asset sub-class. Typical avenues of investment into property are:

·         Direct investment into commercial property;

·         Direct investment into residential property;

·         Investment in property ETF or listed property company via purchasing shares;

·         Investment in a real estate investment trust.

Property as an entire asset class has historically delivered risks and rewards halfway between equities and bonds. Its benefits include its ability to keep pace with inflation and its usefulness in a portfolio of investments as global property returns have demonstrated a moderately low correlation to North-American and European equities. Its drawbacks are that the asset class is susceptible to bubbles and property can be illiquid.

It is the residential property asset sub-class which we are focused on as it has historically been the most lucrative of the sub-classes. It is not only the largest property asset sub-class, but also the largest out of all investment asset classes, with residential property just in the UK worth over GBP4 trillion. Its benefits include:

·         On a risk-adjusted basis, residential property has outperformed all other assets over the long-term, with a 10-year average weighted return of 10.6%;

·         More liquid than commercial property;

·         Good to be used in diversification strategy as it has low correlation with commercial property (0.70), bonds (0.04) and equities (0.09), as measured by the Pearson product-moment correlation coefficient over the past 40 years;

·         Residential property has the lowest volatility of all asset classes over the long-term;

·         It can be used as a hedge against inflation, partly due to the ability of landlords to adjust rent upwards and partly due to the uptrend of property valuations over time;

·         Depending on the area and type of property, there are chronic supply/demand imbalances;

·         Residential property has intrinsic value through being a tangible investment;

·         Favourable tax treatment of residential property and debt finance has also made it attractive.

However there are some drawbacks to investment in the residential property sub-class:

·         Low liquidity if compared with bond or equities markets trading;

·         High transaction costs and cumbersome settlement and clearing process compared to stocks or bonds as residential property transactions generally require exchanges of physical documents prepared by lawyers;

·         Lack of pricing transparency as most price information comes from prior transactions that may be weeks or months old by the time they are published;

·         Asymmetric price movements as historically residential property prices tend to move up more readily than down (pricing stickiness). This is due to the tendency for sellers who don’t receive offers in their desired price range to resist selling;

·         Significant holding costs of residential property including maintenance expenses and property taxes;

·         Rents are outstripping average incomes, which is sustainable short-term but will be a constraint in the long-run.

More recently within the residential property sub-class, I believe we can discern more distinctions between certain types. This is supported by the difference in price increases between the various market segments – for example prime London property prices have increased 53% since Q1 2009 and 10% just since Q1 2012, whereas comfortable property prices have increased 15% since Q1 2009 and 7% just since Q1 2012. There are several factors propelling this divergence of residential property:

·         The market is now global;

·         Investors hunting for yield have turned to residential property as an inflation-matching income;

·         The wealthy have increased their share of the world’s wealth whilst the middle-class (associated with comfortable and affordable property) have suffered a decrease in their share over the past five years;

·         The advent of larger knowledge economies have continued to consolidate and create more global financial and business hubs.

This divergence can be extrapolated onto the below matrix:

Residential Property Demand Elasticity Matrix

	Super-Prime	Prime	Comfortable	Affordable	Low-Cost
Global City	Perfectly Inelastic demand	Perfectly Inelastic demand	Inelastic demand	Inelastic demand	Elastic demand
Transnational City	Perfectly Inelastic demand	Inelastic demand	Inelastic demand	Elastic demand	Elastic demand
Developing Global City	Inelastic demand	Inelastic demand	Elastic demand	Elastic demand	Elastic demand
Developing Transnational City	Inelastic demand	Elastic demand	Elastic demand	Elastic demand	Elastic demand
National City	Elastic demand	Elastic demand	Elastic demand	Elastic demand	Elastic demand

Looking vertically, city allocation is based on the total capital flows through a city, as the assumption used is that the more international the city the larger amounts of capital that will pass through. However there are many exceptions, such as the Channel Islands, Cayman Islands, Luxembourg, and many more which would feature as global cities if solely based on total capital flows. Therefore, city allocation is a function of total capital flows + population size. The rise of the knowledge economy renders population size for cities an important factor as a greater population can (hopefully) provide a greater number of highly skilled knowledge workers. So for instance:

·         Global City – London, Hong Kong, New York, Tokyo, Zurich, Amsterdam

·         Transnational City – Beijing, Frankfurt, Mexico City, Chicago, Boston

·         Developing Global City – Paris, Shanghai, Moscow, Mumbai, Sao Paolo, Dubai

·         Developing Transnational City – Lagos, Istanbul, Buenos Aires, Jakarta

·         National City – Chongqing, Calcutta, Bogota, Dhaka

Meanwhile looking horizontally, Super-Prime property is property valued at or over US$10 million, Prime property is property valued at US$2 million to US$10 million, Comfortable property is property valued between US$1 million to US$2 million, Affordable property is property valued between US$250,000 to US$1 million, and Low-cost property is property valued up to US$250,000. Low-cost property is that often associated, globally, with the lower-middle class and working classes. Conversely, the middle-classes are associated with affordable and comfortable property, whilst the upper middle-class and global 1% would be associated with prime and super-prime property.

There has been a trend over the past 50 years as a result of a growing world population against a finite supply of land. Super-prime property has increased by 2,690% since 1975 and prime property has increased by 2,580% in the same period. This trend and rising prices will continue, as demonstrated by the demand elasticity matrix.

More specifically, there are several desirable locations to invest in residential property. Using a net of gilt yields measure which compares government bond interest rates to rental growth to demonstrate a comparison of where investors may put their money, suggests there is potential for 30% growth in average New York residential capital values and 40% in Tokyo property by 2016. Moreover, it is suggested that the average price of prime London property will increase to GBP 6million by 2045, up from GBP 1.5 million currently. Rising prices will be most keenly exhibited in the global cities with their favourable legal protection, quality of life, attractive tax regimes, lifestyle, and world-class schools. Research also forecasts London’s average per capita income to grow by more than any other world city between now and 2025, from US$66,000 currently to US$95,000 by 2025, mainly due to booming financial services and increased tourism. By 2025, London will have the fourth-largest city economy in the world (US$821 billion), despite the fact that its population size will remain stagnant. Tokyo will have the largest economy of any urban city (US$1.98 billion), followed by New York and Los Angeles. The other developed city to demonstrate meaningful growth during this period would be Hong Kong, which would also benefit from its world-class financial services industry. These factors will continue to facilitate rising prices for residential property in these global cities.

Ultimately, residential property is a composite good providing many different functions to a buyer – it is an investment asset, a utility as people live in these properties, and as a Veblen good where lifestyle and luxury play a role in the decision. Perhaps the residential property demand elasticity matrix can help illuminate market movements and facilitate investment decision-making in this asset class.

The Ibis Budget of China – Home Inns

The Ibis budget hotel chain, owned by the Accor Group, consists of over 380 basic-service hotels across Europe, Indonesia and Israel. There is a Chinese competitor with a similar model that is beginning to look at overseas markets.

Basic Comforts

Enter Home Inns Group, both the largest hotel chain in China and the first budget chain within China. Founded in 2001 by Ji Qi, this hotel chain managed from Shanghai has swiftly grown to operate 1,682 hotels across 243 cities in China. Much like Ibis Budget, they focus on providing the basics – comfortable beds, free in-room wifi, air conditioning, hot water, and modern bathrooms. The company initially garnered investment from several private equity funds before financing their aggressive expansion through an IPO on the USA’s NASDAQ stock exchange in October 2006. Over the past 12 years, Home Inns have consolidated their hegemony over the domestic budget hotel market by acquiring other major budget hotel chains, including Top Star in 2007 and Motel 168 in October 2011. Home Inns Group have also ventured into the middle and upscale hotel market by launching Yitel brand of hotels in November 2010. Their strategic plan over the next five years is to continue expanding within China to ensure they are domestic tourists’ number one choice as well as selectively expanding into overseas markets.

Hoome Inns' extensive network

Not only is the company itself a good investment, it makes sense to invest within China’s travel industry. China’s hotel market is demand-polarized; this means that consumers are more interested in either the bottom (so-called Starless) market or the top luxury hotel market. There are now around 10,000 starless hotels in China, 9,000 1 & 2 & 3 star hotels, and 2,200 4 & 5 star hotels. Even more stark is the relative growth between these segments over the past 8 years: starless hotels have risen from 200 hotels to 10,000 hotels, the 1 & 2 & 3 star hotel segments have lost roughly 2,500 hotels since 2005, and the 4 & 5 star hotel segments have added around 500 new hotels over the last 8 years. This growth in starless hotels is the result of a variety of factors:

·         More hotels opting out of the China National Tourist Association stars system;

·         Construction of new properties, spurred by rising Chinese domestic income and a greater propensity for travel domestically; and

·         Chinese demand for value for money

Home Inn, Nanjing

These economy hotels roughly correspond to a 2 or 3 star hotel in quality, but have opted not to be classified as they have stripped away many of the hotel extras in order to focus on cleanliness, safety, convenience and value for money. These starless hotels tend to favour a model where they lease property or adopt a franchise model, which lowers their costs and enables them to expand their chains more rapidly.

Home Inn - Wuyi Mountain Resort

Last year starless hotels filled 80% of their rooms, compared to an occupancy ratio of 60% for star-rated hotels. Within the starless hotels segment, Home Inns is the market leader in China with 22% of the number of rooms, followed by 7 Days with 14%, Han Ting with 12%, and Jin Jiang with 8.5%. Moreover, there is still room for growth as nearly 50% of China’s cities have only one hotel and there are only 0.6 hotel rooms for every 1,000 Chinese people compared to 2.5 hotel rooms for every 1,000 American people. With the additional prospect of 221 cities with over a million residents by 2025, buy into Home Inns Group’s shares now and hold for the long-term. Their shares are at US$40.72 currently and have had a stellar performance since January when its shares were around US$24. So buy into Home Inn so that your home can be wherever you are.

All that Glitter Does Not Buoy Gold

The world gold market has undergone a fundamental shift over the past year. This year marks its official end of a 20 year bull run.

 

The last two times the gold market fundamentally shifted were when vast gold deposits were discovered in South America in the 16^th century leading to a sharp drop in gold prices, and when Richard Nixon announced the abolition of the Gold Standard in 1973 as a response to the USA running out of enough gold supply to back all the USD it was printing.

Here is the problem – the supply of gold depends on what can be mined whereas if we use gold to back the economy it needs to bear some relation to the world’s economic needs. Thomson Reuters GFMS produces an annual gold survey with their latest suggesting there is 171,300 tonnes of gold. All this gold would be valued at around US$950 billion totally. We won’t run out of gold anytime soon. Estimates suggest there are 52,000 tonnes of minable gold still in the ground and more is likely to be discovered.

This suggests that the gold price will continue its downward trend. It had been on a bull run from 2011, rising from US$260 to a peak of US$1,920 in September 2011. Since then it has steadily shed more than 30% of its value by falling to US$1,230 currently. The gold price is still well above its price if adjusted for inflation of circa US$900. With no shortage of gold supply in the near future, we would expect the gold price to converge with its price adjusted for inflation. This is a view shared by some notable funds, such as PIMCO, Third Point (run by Daniel Loeb) and Baupost Group (run by Seth Klarman), who have continually cut their gold ETF holdings.

John Paulson up to his eyes in Gold

That is not to say that the gold price won’t, in the long term, revert back to its typical use as a hedge for inflation. The solution for governments troubleshooting most economic problems is to print more money, the corollary of which is inflation. There has always been a strong link between inflation and gold, which no doubt will bring the gold price up over the long term. One of the world’s highest-profile gold proponents is hedge fund Paulson & Co, which made billions correctly predicting the 2009 US housing crash. They have accumulated large quantities of the metal since 2009 and have retained their faith despite the 30% price drop over the past year, backed by the assertion that inflation will raise gold demand.

Therefore the gold price may, historically, move in a cycle in direct correlation to the boom-bust business cycle. As the global economy booms, gold prices diverge from their inflation adjusted price. Conversely, as the global economy contracts, gold prices converge with their inflation adjusted price.

Gold used in USB Flash Drive

The one x factor that may shift the current demand and supply dynamics for gold is one of its relatively new uses. Until now, gold has never gone away but has always been recycled. 12% of the world’s current gold production is being used in the technology industry where it is used in such small quantities in each individual product that it may no longer be economical to recycle it. If this percentage should rise, beware the ramifications for long-term gold prices.

In the extreme short term, gold prices are highly sensitive to expectations of US Federal Reserve tapering. Any reduction in Federal Reserve bond purchases will sharply decrease gold. However, with Janet Yellen taking over from Ben Bernanke as head of the US Federal Reserve, she is likely to err on the side of inflation as she has a penchant for supporting the Federal Reserve stimulus plans, which will provide some short-time support for gold prices. On the other hand, easing geopolitical tensions in the Middle-East have caused demand for gold as a safe haven to decline. Meanwhile, the S&P 500 index’s 30% increase this year has incentivized investors hunting for yield to switch from other asset classes into shares. There is also debate as to whether investment demand is determining short-term gold prices or whether physical demand for jewellery, coins and bars particularly from China, India and the ASEAN nations is driving gold prices.