Jiumaojiu takes a taste of franchising

The restaurant operator said it will test out franchising for its popular Tai Er ‘sauerkraut fish’ chain in transport hubs and Western China’s Xinjiang and Tibetan regions

Key Takeaways:

• Jiumaojiu will trial franchising for a limited number of restaurants from its Tai Er chain, as well as for a new hotpot chain
• The restaurant operator is part of a growing number of food and beverage chains in China to try out franchising to boost their expansion

By Doug Young

Jiumaojiu International Holdings Ltd. (9922.HK) has become the latest to hop aboard the franchising bandwagon taking China’s restaurant scene by storm, announcing on Sunday it will experiment with the concept on a limited basis from this month. It seems quite suitable that this operator of a trendy restaurant chain would itself join one of China’s hottest catering trends that has ignited explosive growth for a number of startup chains.

Investors didn’t react too strongly either way about the company’s preliminary embrace of the franchising model. Jiumaojiu’s shares opened slightly higher when trading began on Monday, only to fall slightly by the end of the morning session. The stock certainly could use some good news these days.

It was once an investor darling, soaring as high HK$32 from its 2019 IPO price of HK$6.60, as investors gobbled up the strong growth story for its Tai Er restaurant chain serving up its signature “sauerkraut fish.” But then the pandemic hit, forcing restaurants to frequently close, and discouraging dining out in general. As that happened, Jiumaojiu’s shares plunged and fell below their IPO price for the first time last December.

The company’s business has actually rebounded quite strongly post-pandemic, meaning its shares now trade at quite a bargain-basement forward price-to-earnings (P/E) ratio of just 7.4. That’s about half the 14.7 for Haidilao (6862.HK), a former similar highflier that operates a popular hotpot chain. Even the more basic noodle shop operator Tam Jai (2217.HK) trades higher at 8.6, showing just how far Jiumaojiu has fallen from its glory days.

Jiumaojiu has been opening new stores at a relatively fast pace, with 621 stores in operation at the end of last June, up 31% from a year earlier, according to its interim results released last August. All of those were self-operated, and the company’s only previous experience with franchising involved one of its smaller chains, Double Eggs, which it later sold due to underperformance.

Jiumaojiu is taking a cautious approach to franchising, stressing it will use the model conservatively in the beginning. It said it will initially franchise new Tai Er stores in China’s thinly populated, less developed Western regions of Xinjiang and Tibet, as well as in transport hubs like train stations and airports. It will also use franchising to expand into offshore markets including Taiwan, Australia and New Zealand, extending its overseas network of self-operated stores that already counts outlets in Canada, Singapore and Malaysia.

In addition, the company said it will use the franchising model for what appears to be a new chain called Shandeshanwaimian Suantang Hot Pot. That brand will look for franchising partners to operate stores in shopping malls, the announcement said.

Jiumaojiu said it will continue to focus on self-operated stores, which are typically more profitable than franchised ones but require more resources.

“The company believes that the benefits conferred by the franchise and cooperative model include faster expansion and regional penetration of the brands; effective utilization of the partners’ entrepreneurial spirit, local expertise and business network, and reducing the operation risks of the group compared to the self-operated model,” it said.

Franchising fever

Restaurant franchising has been around for a while in China, but has only recently been embraced by major operators. That’s largely because the country’s modern restaurant industry only really began to take off after the turn of the 21^st century, at which time suitable partners from China’s young private sector began to emerge.

Still, most companies, especially major Western chains, were relatively reluctant to use the model in China over concerns about quality control. And even when they did, chains like Starbucks (SBUX.US) and McDonald’s (MCD.US) usually chose big master franchisee arrangements where they worked with a handful of major partners nationwide or in major regions within China.

But as China’s restaurant industry has matured and more qualified operators emerge, a growing number of chains are using franchising as a hybrid with self-operated stores, or in some cases are using franchising exclusively to record explosive growth. Yum China (YUMC.US; 9987.HK), operator of the KFC and Pizza Hut chains in China, has recently begun to use franchising, after insisting on self-operating its own stores for most of its more than three decades in China.

Others like bubble tea chains HeyTea and Nayuki (2150.HK) have also begun experimenting with the model to catch up with faster-growing peers. One of the most aggressive in that regard is Hong Kong IPO candidate Mixue Bingcheng, which has used a pure franchising model to become a behemoth with more than 36,000 stores inside and outside China.

Companies like Jiumaojiu are probably looking at those kinds of big numbers with envy, and hoping they can also bring some excitement back to their own stories by logging similar future growth using a franchise model.

Jiumaojiu’s own growth looks quite healthy already, even as investors seem to want more from the company. Its revenue increased 52% year-on-year in the first half of last year to 2.88 billion yuan ($400 million), and its profit roughly quadrupled to 222 million yuan over that period, according to its interim report.

But the company, like just about every business in China these days, is also facing challenges from the nation’s slowing economy. That slowdown is reflected in average spending per person at its restaurants, which fell at two of its three main chains as consumers become more cautious. Most notably, average spending per customer at the Tai Er chain, which accounts for about three-quarters of the company’s revenue, fell to 75 yuan from 78 yuan a year earlier.

One small upside to a slumping economy is easing labor costs, which appear to be plateauing and even falling in China after years of steady increases. Jiumaojiu said labor costs as a percentage of its revenue fell to 24.9% in the first half of last year, down more than three percentage points from the 28.6% of revenue a year earlier.

Overall, the picture looks broadly positive for Jiumaojiu, or at least for any investors who might want to take a chance on its undervalued stock. The company operates a relatively popular restaurant chain, and its careful move into franchising could provide some new growth momentum beyond its self-operated stores. The biggest question mark, of course, is the Chinese economy, which could lead to falling profitability for its stores if consumers continue to cut back their spending.

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