Tang Palace (China) Holdings Limited

Tang Palace (‘Company’) operates 59 restaurants and 11 others under joint ventures across China.

It operates primarily under the ‘Tang Palace’ brand (30 restaurants; contributing 76% of revenues) along with ‘Social Place’ (9 restaurants; 14%), ‘Canton Tea Room’ (4 restaurants; 5%), ‘Pepper Lunch’ (14 restaurants, 3%), and ‘Tang’s Cuisine’ (1 restaurant, 2%).

The company was particularly hard hit during Covid-19, with revenues dropping by 46% over the year and generating losses. Restaurants in China were closed from the end of January to mid-March. The company reduced labour costs considerably in the six months to June. Lease liabilities, however, are a significant factor in the business and contributed to the losses despite rent concessions.

It reported TTM sales of $1.3b (2019: $1.7b), ebitda of $158m (2019: $311m), and net losses of $29m (2019: profit of $104m). Despite reporting losses, the company generated $18m in free cash flows in the six months to June.

The company’s balance sheet was healthy with cash balances sufficient to meet borrowings and lease liabilities. Also, the liquid assets were sufficient to cover current liabilities.

The adoption of relatively recent lease accounting rules resulted in higher depreciation charges from 2019. Since the company’s cash balances alone are sufficient to cover all lease liabilities, the company’s cash generating ability may provide a clearer understanding of business value.

The company generated over $150m/year in free cash flows over the last five years. On book equity of $393m, this represents a handsome cash return on invested capital of 38%/year.

This compares to a stock market capitalization of $860m, which is under 6x free cash flows or a 17%+ cash yield.

Management have been highly generous with dividend payouts, which averaged $147m over the last three years or over 80% of free cash flows. Despite poor operating conditions, they declared an interim dividend of $19m.

There’s no reason to believe this business won’t regain its former earning power. The current price provides a sufficient margin of safety against untoward developments – particularly considering the quality of the company’s operations. Furthermore, this is the sort of shareholder-oriented management team we like.