Haidilao International Holding Limited was founded in 1994 and trades under the ticker symbol: 6862.HK on the Hong Kong stock exchange.

The company operates a chain of hot pot restaurants under the name of Haidilao Hot Pot and is the largest hot pot chain in China. The company has begun expanding overseas with chain restaurants in the likes of London and New York.

Like all restaurants and physical businesses, the company has suffered from the coronavirus pandemic. However, the stock gained 90% in 2020 and moved to all-time highs in February of 2021. Since then the stock has dropped almost 70% after the Chinese crackdown on tech companies rocked Chinese stocks. This article will study the investment opportunity at Haidilao.

Business Overview

Haidilao was founded in Sichuan province in 1994. By the end of 2020, Haidilao Group operated over 1200 restaurants in China and 93 restaurants outside China. Key to the company’s popularity over other hot pot brands is exceptional customer service, fresh ingredients and creative marketing campaigns.

Rather than just a fast-food chain, the Haidilao business model is aimed at providing experiences with the Chinese seeing hot pot restaurants as a social event. This can often sees diners waiting in line for an hour or more. The company provides free entertainment and other distractions, such as a free nail bar and massage. Haidilao covers every small detail at the tables and in the bathrooms to cater to its customers. This has helped the chain excel at customer service and become the biggest hot pot brand in China ahead of rivals Jiumaojiu and Xiabuxiabu.

“Visitors often have to wait up to an hour or more for a table at the popular restaurant and so Haidilao provides free entertainment to keep customers satisfied, including a nail salon, board games, a screen protector service, as well as snacks, drinks and H++aagen-Dazs ice cream! When the customer is finally seated, staff provide hair ties, wipes for glasses, aprons and protective bags for mobile phones to ensure that the customer and their accessories don’t become doused with spicy red hotpot broth. The company’s focus on customer service is what differentiates it from other hotpot restaurants, and even restaurants more generally. Haidilao’s brand name has become unanimous with the smooth service, luxurious bathrooms and entertainment provided before and during your meal.”

- Dao Insights

Rapid Expansion

A stock market listing in 2018 raised nearly $1 billion and helped Haidilao embark on a domestic and international expansion push. This helped to drive revenue growth from 17 billion RMB in 2018 to 26 billion RMB in 2019. Revenue growth prior to the coronavirus outbreak was clocking in at 45% per annum and still managed to advance by 12% in 2020 despite the pandemic.

In 2018, the company created a DIY recipe challenge for TikTok fans which eventually had over a billion views. This helped to increase brand awareness at no cost and is one example of the company’s adept use of new technology.

Haidilao During The Coronavirus Pandemic

Haidilao did what many could not in 2020 and embarked on an aggressive expansion plan. The company expanded its network in 2020 with the opening of over 540 new restaurants in spite of the virus disruption. It now operates over 1,200 restaurants with 93% located in mainland China and has moved into 14 new countries globally. The company’s founder, Zhang Zhong, said of the move:

“It’s better to scale fast and be everywhere instead of having a single towering presence”.

- Company CEO, Zhang Zhong.

But the expansion came at a price for Haidilao in the near-term as the company reported profit that fell 87% to 309 million yuan in 2020. The company also faced a labor shortage in the second half of the year. Labor shortages come as many workers have been displaced from cities, unable to support themselves during economic lockdowns.

Some of the other headwinds that have faced the company are rising ingredients costs and the outlay for coronavirus sanitization and protective equipment. This led to a first half profit warning and in July of 2021, the stock had the unfortunate title of being Hong Kong’s worst-performing stock of the year.

But despite the headwinds there are signs of potential with table turnover recovering to more than three-quarters of pre-pandemic levels by the second half of 2020. Full-year sales have also increased with the Chinese consumer not facing the brunt of a second lockdown as many western countries did. Unfortunately, the virus has returned in August of 2021 and seen the country push more draconian lockdowns. This situation is still ongoing and is another reason why Haidilao stock has been punished.

Lockdowns and changes to socializing during the pandemic have also brought some positives to the business. Average spending per guest has been rising as eating out has become a less frequent, but more appreciated event. Sales from the company’s delivery business have also increased by 60%. One of the benefits of the company’s strong brand is that the hot pot restaurant market in China is highly fragmented. The company garners over 96% of its sales from the industry, but accounts for less than 3% of the market, leaving a lot of room for expansion.

Future Growth Opportunities

One of the biggest opportunities for Haidilao could come through technology. The company already utilizes efficient self-ordering via tablets but also began to make further breakthroughs in using new technologies in 2020.

“We have built and reconstructed more than 50 new-technology restaurants, further promoting various equipment and techniques such as dish supplying machines and direct allocation of finished dishes from central kitchens. Intelligent soup bases preparation machines have been applied in some restaurants, allowing more customers to taste more personalized hotpot soup bases in Haidilao. Robot waiters have been deployed in more than 900 restaurants to enrich dining experience of our customers. Various kinds of kitchen cleaning equipment have been deployed in more than 1,000 Haidilao restaurants globally, making our employees’ work easier and enabling them to better serve our customers.”

– Haidilao Annual Report 2020

The other potential for growth is international expansion and although the company has opened new restaurants in foreign countries, they will need to make efforts to increase brand awareness in those territories.

As the revenue numbers from the annual report highlight below, international restaurants lag the revenue performance of China by a great deal. This will be largely driven by the home country’s affection for hot pot eateries, but there is still room for the overseas businesses to improve. On the cost of revenue there were increases driven by the rapid expansion and coronavirus:

“Our raw materials and consumables used increased by 9.1% from MB11,239.0 million in 2019 to RMB12,261.5 million in 2020, primarily due to the expansion of our business and the increase in the disinfection and sterilization materials used for anti-epidemic purpose. As a percentage of revenue, our raw materials and consumables used increased from 42.3% in 2019 to 42.9% in 2020.”

– Haidilao Annual Report 2020

Staff costs also increased by 20% which was a management decision to tackle staff shortages and boost morale.

Risk Factors

One headwind affecting Haidilao is the financing costs of new debt used for expansion. According to the company finance costs increased by 88.2% from RMB 236.8 million in 2019 to RMB 445.6 million in 2020. This was primarily due to the increase in interests on lease liabilities resulting from business expansion and the increase in interests on bank borrowings. Despite this, the company had a debt-to-equity ratio of 39.8% at the end of 2020 which is a fairly standard level for large corporations.

Expansion can generally be viewed as both a positive and negative. While increasing the number of restaurants worldwide can grow brand awareness and revenues, it is also expensive. Haidilao clearly operates a popular and lucrative product in China but exporting that product overseas, where tastes are vastly different, could be more difficult. Having said that, the large numbers of Chinese consumers overseas means that Haidilao should be able to find customers in most areas.

Perhaps a bigger risk is the volatility associated with Chinese companies generally and continued government antitrust measures. Chinese financial misconduct is well known and was recently highlighted by the case of Luckin Coffee which filed for bankruptcy in February 2021.

As for the government crackdown, this could actually prove to be an investors advantage. As reported by the Financial Times, the hospitality sector in China has historically been immune to government intervention. The fact that Haidilao is being lumped in with monopolistic tech stocks takes the valuation of Haidilao to a more reasonable level for long term investors.

“The Chinese catering industry has historically carried low regulatory risk. Amid changing government policy, this is rapidly becoming one of its greatest selling points.”

- Financial Times.

Inflation has been a problem for economies in 2021 and this would be detrimental to Haidilao’s growing business footprint. Central bank’s are assuring investors that the inflationary effects are ‘transitory’ and the company should be able to raise prices in restaurants to compensate. This would not be popular with customers, but it would be an industry-wide phenomenon. However, that could hurt table turnover and visitor numbers.

The obvious headwind for the company is simply the coronavirus. The Chinese consumer was resilient in 2020 as the country shrugged off the virus, but the return of lockdowns in H2 of 2021 are a worry as variant mutations could undo the work done by governments to vaccinate large portions of their population. For Haidilao, their business revolves around China and that will be the focus. The company seems to be weathering the storm well in revenues and other metrics, so a larger international expansion can happen later.

Back Of The Envelope Valuation

According to Seeking Alpha, Haidilao holds around $451.6 USD million cash and $1.86 billion in total debt giving the company a USD enterprise value of $20.39 billion. With 2020 revenues of USD $4.41 billion that means the stock is trading at 4.6 times 2020 revenue. As the chart below shows, that’s the lowest valuation since the stock listed in 2018.

There are at least two conclusions to make from this chart. The first is that the stock is capable of high valuation multiples as exemplified by the +12 multiple seen in February 2021. This is good news for any investor who hopes the stock can ever return to high levels of investor sentiment.

Second, the stock is currently trading at a historically cheap level and likely to see a significant rerating if the restaurant business comes back strong.

If you consider some other restaurant related chains in developed markets, McDonalds has more than 30,000 stores for a market cap of $178 billion, Domino’s has more than 18,000 stores for a market cap of $19.1 billion, Wendy’s has over 6,500 restaurants for a market cap of $5.31 billion and Shake Shack has 275 stores for a market cap of $3.56 billion.

On the table below, Haidilao not only has the lowest revenue multiple of the list but the highest revenue growth as well.

Looking ahead, analysts expect Haidilao to generate revenues of $7.47 billion in 2021 and $10.35 billion in 2022. That puts 2021 ev/sales at 2.7 and 2022 ev/sales at 1.97. EBITDA multiples are more stretched at almost 40 times. However, EBITDA has been growing just as strongly as revenue and should get a boost from expansion and the reopening of economies.

The Story So Far

Haidilao Hot Pot was running full steam into the coronavirus pandemic and, like others globally, has suffered from lockdowns and changes in consumer behavior.

The company did what many others couldn’t in 2020 and aggressively expanded their business footprint. In the short-term this was a risk and has obviously caused problems for the company this year. As the virus drags on Haidilao will have to dig deep for the duration of the pandemic. But the company has been able to see some positive metrics in customer traction.

The stock has been hit with a near 70% drop in 2021 but this could be a short-sighted panic move by investors. An important area that will be missed by many investors who are focused solely on the numbers is the company’s attitude to technology. The company has built 50 new-technology restaurants. These are obviously prototypes but as efficiencies grow out of these locations, they can be expanded to the over 1,200 outlets. The effect from this will be that Haidilao can continue its expansion with a lower cost base.

Domestic growth is still possible despite the company being a well-known and respected brand. With only 3% market share making up 96% of the company’s revenues, even a 1% market share improvement is almost 33% of the current revenues. There is also room to improve sales at overseas restaurants as countries look to reopen their economies.

Final Thoughts - What’s Going On Here?

An investment in Haidilao balances an appealing growth story with some high level risks. I’m not smart enough to know if Haidilao’s financials are 100% in order or if the Chinese government will spare the company from future crackdowns. I also don’t know how well the Haidilao brand is going to do overseas. These are perhaps the biggest risks for investors going forward.

But I do like the growth story of Haidilao and the company’s focus on customer service, technology and staff. These are important signals of durable business strength and competitive advantage. You cannot argue with the recent growth of the business and the huge opportunity that exists across China. At some point the bearishness against Chinese equities will turn and Haidilao looks like a good option.

After a huge price drop, the valuation is reasonable and the company has plenty of runway ahead. With US markets at all-time highs I am having to look further afield for opportunities. I like the opportunity in Haidilao and have purchased a small position in the Hong Kong listed shares. I inted to hold for the long term.

Thank you for reading Unexpected Value.

Disclosure: I/we are long 6862.HK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This post expresses the opinions of the writer and is for information, entertainment purposes only. Joe Marwood is not a registered financial advisor or certified analyst and does not purport to tell or suggest which securities customers should buy or sell for themselves. The reader agrees to assume all risk resulting from the application of any of the information provided. We strive to provide accurate data and analysis, however, mistakes and errors do occur. Financial investing is risky and not for everyone. You should not bet more than you can afford to lose. Past performance is not indicative of future results.