Are Food Stocks a Defensive Play Amid Uncertainties?

Just as emperor penguins huddle together for warmth during cold weathers in Antarctica, investor communities tend to invest in similar themes to make up for the lack of confidence during harsh conditions. Amid uncertainty in the Chinese onshore and offshore markets, we noticed that investors are inclined to buy relatively macro-insensitive stocks that are perceived by them to have high degrees of certainty, such as food and beverage and other consumer staples. For example, one of food seasoning manufacturers was up almost +60% YTD and one of hot pot restaurants soared more than +100% YTD1. We understand the rationale of this behavior. However, are these food stocks really a defensive play at this juncture? 

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Chinese people spent 4.27 trillion yuan (USD 597 billion) on dining out in 20182, which is even higher than Sweden’s GDP (USD 551 billion3) and one type of cuisine dominates China’s restaurant industry – hotpot, eating almost 14% of the total market share1. With consumer sentiment weakening amid a sluggish economy, investors have been loading up on their perceived safe stocks, including the above-mentioned hotpot stock, as an old Chinese saying goes “Eating means the world to people” and they believe the company’s aggressive store expansion will increase revenue significantly.

In 1H19, the hotpot chain generated 11.7 billion yuan in revenue, up 59.3% from a year earlier4. Nevertheless, the company’s valuation, in our view, has been pushed to an expensive level, which could lead to the risk of a collective sell-off once risk appetite returns.

We think the current stock price has already baked in the scenario of rapid earnings growth in next three years, which may not turn out as the market expects. The current high valuation is based on the market’s hope that the chain will constantly break the ceiling on the number of restaurants locations and per store profitability maintains momentum. Notwithstanding, from its interim results for the first half of 2019, average income for single store slipped -8.89% YoY4 and  table turns for restaurants in Tier 1 cities declined from 4.9X in 1H18 to 4.8X in 1H194, indicating that new stores may cannibalize sales of existing stores. The stock is trading on a 12-month forward P/E ratio of 54.2x at the time of writing, an increase of 81% YTD, while its peers have much lower forward P/E ratios of 23.5x and 16.1x1.

In addition, some of its peers’ profit margin is catching up with this hot stock (see chart below5), with the valuation remaining at a reasonable level.

Despite that the hotpot chain’s strong brand and execution will support its earnings growth, we don’t think it provides a decent margin of safety.

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With the fear of missing out on a market rally, some investors may forget about disciplines and rush into an expensive investment. Instead of crowding to this space, we tend to focus more on companies that become undervalued during this round of market volatility. Although they might be perceived as more risky than defensive stocks at this moment, we believe that accumulating them at attractive valuations will drive medium to long term returns when the dust settles.

[1] Source: Bloomberg, as of August 2019

[2] Source:, as of July 2019

[3] Source: World Development Indicators database, World Bank, as of July 2019

[4] Source: Company Interim Report 2019, as of June 2019

[5] Source: Zeal Asset Management Limited, as of July 2019



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