CCD-Something Wrong With This Coffee?

Something unique has happened in the last one month. The EROS LLC listing on NYSE bombed and the stock went down more than 50 per cent post listing, both in NYC and in India. The Cafe Coffee Day Enterprises stock too is sinking rapidly and is now below IPO price. Bringing high priced, high PE IPOs was believed to be a thing of mid 1990s and early 2000s. Alright stretch the logic to as much as 2013 but it is unthinkable merchant bankers will bring a CCD or EROS offering in an extremely weak market at extra-ordinary price. The Regulators have washed off their hands of the whole pricing process but it is the HNI and Retail clients which are getting the brunt of bad bankers and greedy promoters. Just read the note below, it explains why the CCD issue should not have been brought about. To me it reminds of the SKSMicro and MCX IPOs. Both stocks never regained lost value. Looks like CCD will settle much lower…

The coffee is frothy

Coffee Day Enterprises’ (CDEL’s) apparently strong coffee business of 1,518 stores across 219 cities is diluted in the myriad of other unrelated capitalintensive businesses; coffee retailing accounts for just 30% of capital employed. Despite being the largest coffee retailer, the coffee business has posted very little operating leverage—EBITDA CAGR of 14%, lagging revenue CAGR of 16%. Gross block turns of the coffee business have averaged 1x over FY12-15 with a near-negligible RoCE (pre-tax RoCE of 3%). The scope to improve RoCE (>10% excluding taxes) hinges on high like-to-like (LTL) growth, translating to higher LTL margin, which we believe has limited head room, as there are limited operating levers; fixed costs are already low and pricing growth has limited headroom given the target audience of the value- conscious youth segment rates this below average in metros (40% of stores).

Undisputed leader in café business with integrated back-end

CDEL through its subsidiary CDGL operates the largest coffee chain business with over 1,500 stores across 219 cities in India with a market share of 46%. The next largest coffee chain has just over one-tenth the stores of CDGL. The company has procuring, roasting, curing (60,000 MT) and roasting facilities which supplies consistent grade of coffee beans to its retail outlets. It also manufactures the vending machines used in its café outlets.

Where is the coffee?

CEDL is a holding entity with varied and diverse business interests, ranging from Café chains to logistics to real estate and financial services. The coffee business accounted for about 51% of CDEL’s turnover and 55% of EBITDA over FY13-15. The coffee business accounts for only 30% of the capital employed, with real estate, hospitality financial services and logistics business (Sical Logistics – Listed) accounting for the rest.

Is the coffee (business) strong?

The capital cost of store addition in the context of the business is high, as Gross block turns of CDGL have averaged at 1x over FY12-15. The company has added 730 stores since FY12 and closed 298 during the same period. Moreover, in FY15, it shut 411 (over 40%) of the Coffee Day Kiosks. The aggressive store addition over the years has seemingly diluted the store portfolio, as evidenced by the closures. Therefore, capital allocation in store openings has not been at its optimum. The average SSG over FY12-15 was 4% as per our calculations (ex of service tax which was introduced on eateries in FY13). As a corollary, the spike (11%) in average sales per day (ASPD) in FY15 in the absence of a similar spike in SSG (3%) is in our view due to closure of underperforming stores.

Moreover, the popularity of Café Coffee Day (CCD) outlets in Mumbai, NCR and Bangalore, which account for 40% of stores, is below average as per our analysis of the ratings on Zomato.

Use of Proceeds

The company is raising Rs11.5bn of fresh equity through its IPO. The company plans to use these funds for mostly repayment of debt and that too for the holding company which took on debt to acquire additional stakes in the coffee retailing business or other businesses such as Mindtree. Apart from repayment of debt in the coffee retailing business, nearly 25% of the fund raise will be used for setting-up of new café outlets (on highways), refurbishment of 240 cafes, manufacturing and assembling of vending machines and setting-up of a new coffee roasting plant facility, along with an integrated coffee packing facility and tea packing facility.