SINGAPORE Company Update Results SINGAPORE Company Report 10 March 2011

Initiating Coverage

MITA No. 010/06/2009 MITA No. 013/06/2010

BUY
Current Price: Fair Value: S$0.66 S$0.74

Breadtalk Group Ltd

Initiate with BUY on strong growth prospects
Local brand; regional success. BreadTalk Group Limited started out in 2000 as a local bakery chain best known for its signature floss buns, before firmly establishing its brand name and evolving into a major food retailer in less than 10 years. It currently operates in three main segments: bakery, food court and restaurants. It entered the restaurant segment in 2003 after acquiring the Singapore franchise rights to the renowned Din Tai Fung restaurant brand. The food court business soon followed in 2005. The group was listed on SGX in 2003. China - to spearhead the next growth phase. From Singapore, it moved to the rest of the region and China is currently one of its key markets outside of Singapore. Given the sheer size of the consumer market in China, we believe that it will be the future catalyst for BreadTalk's growth. While Singapore currently remains the largest revenue contributor to the Group, BreadTalk's diverse brands of various food offerings and established foothold in Beijing and Shanghai should allow it to take advantage of rising disposable incomes as well as react quickly to new consumer trends in China. In terms of number of outlets, China already outnumbers Singapore with 20 food courts, 3 Carl's Jr fast food restaurants, 3 RamenPlay restaurants and 184 bakery outlets. Rising costs, an issue, but manageable. We believe that BreadTalk will be able to maintain a gross profit margin of about 55%, which is in line with its margins over the past five years despite potential hike in food costs. Previous fluctuations in raw material prices had not resulted in any significant impact on gross profit margins, and the group also plans to improve its margins by shortening its supply chain and bulk sourcing globally for its supplies. Initiate with BUY and fair value estimate of S$0.74. We project revenue growth of 26% YoY for FY2011F on the back of outlet expansions and stronger sales from existing stores. Backed by strong sales projections, its growing brand recognition and its continuous commitment to review and enhance its offerings, we are initiating coverage on BreadTalk with a BUY rating and a fair value estimate of S$0.74 based on a discounted cash flow-to-firm valuation model with a WACC discount rate of 8.02%.This valuation translates to an upside potential of about 11.6% based on the last traded price of S$0.66.

3500 3000 2500 2000 1500 1000 Apr-09 Apr-10 Oct-09 Jan-09 Jan-10 Oct-10 Jan-11 Jul-09 Jul-10
Breadtalk STI

0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0

Reuters Code ISIN Code Bloomberg Code Issued Capital (m) Mkt Cap (S$m / US$m) Major Shareholders Quek Tong Meng Free Float (%) Daily Vol 3-mth (000) 52 Wk Range

BRET.SI 5DA BREAD SP 282 186 / 147 33.9% 44.0% 205 0.485 - 0.725

(S$ '000) Revenue EBIT PER (x) EPS (cts) PER (x)

FY09 246.5 16.3 16.7 3.9 16.7

FY10 302.9 16.6 16.5 4.0 16.5

FY11F 381.7 19.1 15.0 4.4 15.0

FY12F 450.8 20.3 15.5 4.3 15.5

Lim Siyi (65) 6531 9824 e-mail: LimSiyi@ocbc-research.com

Please refer to the important disclosures at the back of this document.

Breadtalk Group Ltd

Table of Contents
Page Section A Company Background 3

Section B

SWOT Analysis

Section C

Financial Highlights

10

Section D

Valuations and Recommendation

11

Section E

Disclaimer

14

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Breadtalk Group Ltd

Section A: Company Background Local brand; regional success. BreadTalk Group Limited is an investment holding company with subsidiaries that operate in three main segments: bakery, food court and restaurants. It started out in 2000 as a local bakery chain best known for its signature floss buns, before firmly establishing its brand name and evolving into a major food retailer in less than 10 years. It entered the restaurant segment in 2003 after acquiring the Singapore franchise rights to the renowned Din Tai Fung restaurant brand. The food court business soon followed in 2005 through the acquisition of Topwin Investment Holding's 13 Megabite food courts in China. The group was listed on SGX in 2003.

Exhibit 1: Geographical Distribution & Outlets

Source: Company

Exhibit 2: Brands under BreadTalk Group

Source: Company

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Consistent revenue contribution across business segments. Since the inclusion of the food court business in 2005, the percentage revenue contribution from all three segments has been very consistent. Franchising is classified together with its bakery segment. Staying true to its roots, bakery remains the main revenue driver for the group. Similarly, although its expansion into China has yielded substantial revenue growth for the group and will be the growth driver in the future, Singapore is still currently its largest market. As of year end 2010, it has 395 bakery outlets including franchises, 32 food courts and 21 restaurants spanning 12 countries and territories.

Exhibit 3: Segment Breakdown of Revenue

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2003
Bak ery

2004
Re s taurant

2005

2006

2007
Franchise

2008

2009

2010

Food Court

Source: Company

Exhibit 4: Geographical Breakdown of Revenue

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2003 2004
Singapore

2005
China

2006
HK

2007
Others

2008

2009

2010

Source: Company

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Business outlook and strategy. BreadTalk recently completed the restructuring of its management team to improve on operational efficiency. A Group CEO now leads three divisional CEOs for the respective segments, and each divisional CEO will take charge of the respective brands under the segment. Although the previous structure, which was based on geographical locations, had managed to grow revenues by a CAGR of 19% from 2006 to 2009, the new structure allows for a more effective execution of initiatives specific to each segment and the efficient allocation of group resources. With the new management structure in place, BreadTalk intends to focus on developing its existing brands and holding off on new brand creations for the time being. The Bakery segment will remain its core business with expansion targets of 176 outlets (60% franchises; 40% owned), 18 restaurants and 14-15 food courts planned for the year.

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Section B: SWOT Analysis

Exhibit 5: SWOT
Strengths 1. High visibility brand name & strong local presence 2. Dedicated and innovative R&D 3. Brand development & segment diversification Opportunities 1. Further growth and expansion into China; Regional expansion 2. Targeting the premium segment
Source: OIR

Weaknesses 1. Price-sensitivity of consumers 2. Impact of rising wages & food costs on margins Threats 1. Intense competition in food industry (local & overseas) 2. Over saturation in Singapore market

Strengths Highly visible & strong local presence. BreadTalk revolutionized bakeries in Singapore when it departed from the traditional layout and designs of the heartland bakery by incorporating an open concept theme to its bakeries and adopting glass shelves to display its bread offerings. It also standardized the design across all branches and utilized matching uniforms for its staff, and is now widely recognized for its attractive and eye-catching layout. BreadTalk also meticulously chooses each store's location to ensure high consumer traffic and visibility. In addition, the franchise model for its bakery segment has aided the Group's rapid expansion and increased its presence in its target markets. The number of franchise outlets has grown exponential over the past eight years (CAGR: 73%). Although BreadTalk's franchisee selection process is a rigorous one, where management reviews each application and successful applicants are required to undergo training before the outlet can be opened, BreadTalk will assist franchisees on location selection and outlet design as well as follow up with regular quality checks. As with other similar franchise models, recipes are tightly controlled and supplies are mandated to be procured from BreadTalk to ensure consistent quality standards. BreadTalk currently allows franchise agreements to be signed on a country basis (e.g. Indonesia), master franchise agreement basis for regions (e.g. Middle East), and on a city basis for China (with the exception of Beijing and Shanghai where BreadTalk operates its own outlets).

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Exhibit 6: Growth of franchise outlets

250 238

200 182

150

141

100 65 50 19 3 2003 2004 2005 2006 38

97

2007

2008

2009

2010

No. of Franchise Outlets

Source: Company

Dedicated, on-going and innovative R&D. BreadTalk's biggest strength is undoubtedly its creative and unique bread designs and flavours, which have helped raise its profile tremendously over the years. Its two specialized R&D teams (primary team in Singapore and the other in China) are devoted to creating and discovering new bread flavours and designs to keep abreast of the ever-evolving consumer preferences and taste. Prototypes that are developed undergo vigorous testing on the market to gauge consumer responses before full implementation into the outlets. With such strong commitment to creative innovation, BreadTalk has craved up a reputation of being a trendsetter, and is able to command a higher premium as compared to other bakeries. It also prevents brand fatigue and creates a sense of freshness in this industry where consumer tastes tend to change frequently. Brand development and segment diversification. With the success of its various brands, the group has demonstrated its ability to create and develop new products and diversify its revenue stream. The group's decision to cross over into the restaurant business with the Din Tai Fung franchise in 2003 and food court business in 2005 proved to be successful and allowed its revenue in percentage terms to grow by double digits each year. Leveraging on this track record, BreadTalk is likely to further develop its brands to meet growth targets.

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Weaknesses Potential margin squeeze. With 30% of its cost of sales attributed to raw materials such as vegetable oil, flour, eggs, etc, BreadTalk is inherently exposed to fluctuations in its gross margins if prices rise too rapidly or when costs are not managed effectively. Similarly, wage increases from rising expectations or government initiatives may also impact margins. Currently, staff costs account for about 30% of BreadTalk's operating expenses. Of its geographical segments, minimum wages in China have already adjusted gradually over the past year, and with the Chinese government's 12th five-year plan to raise the income of its workforce, there may be further wage hikes during the year. Although minimum wage workers account for only a small percentage of BreadTalk's workforce in China, the greater implication is that potential wage increases could spread across the broader Chinese economy. Given the nature of BreadTalk's line of products, where consumers are somewhat price sensitive, it will be difficult for them to pass on the full cost of any price increases on to consumers. Opportunities China - driver of growth. BreadTalk's plan to expand into China via acquisitions instead of starting up a new venture was a very prudent decision. By purchasing an established presence, it was able to reap benefits almost immediately without having to suffer any start-up losses. Given the size and increasing affluence of the Chinese, continued expansion into the Chinese market with an established base will allow BreadTalk to react rapidly to developing consumer demands in China and potentially seize market share. Regional expansion. In addition to China, BreadTalk has already made plans or is already in the process of expanding its businesses into Thailand and Taiwan. A Din Tai Fung restaurant in Bangkok's Central World Mall is slated to open this year, while Food Republic food courts are planned for Taizhong and Taipei. If these outlets and plans are successful, it will add to its revenue growth. Going premium - going for another segment of the market. Through modifications of its original line of products to create premium versions of its brands, BreadTalk has widened its audience by targeting higher-end and more affluent clientele. It currently has Bread Society and Tea Loft, which are situated in the prime retail property of ION Orchard. The success of both outlets is encouraging, as this opens up more opportunities for BreadTalk to compete in the premium segment if it chooses to.

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Threats Intense competition. Naturally in this industry, the biggest threat is competition and BreadTalk encounters it across all its segments. The business model, layout/location of outlets can be easily replicated and manufactured, and competitors can enter and exit anytime. Besides this, BreadTalk also faces competition from the small mom-and-pop bakeries, eateries, as these also compete with other more established bakery/food chains such as Koufu, Crystal Jade and Kopitiam. Over saturation in Singapore market. Currently, Singapore is still the main revenue contributor to the group. According to the Singapore Department of Statistics, there were 5,992 F&B establishments in 2009: 2,107 restaurants, 336 fast food outlets, 289 food caterers and 3,260 classified as others (includes cafes, coffee houses, snack bars, food courts, pubs, canteens etc). This reflected a 2.4% YoY increase in the number of outlets. However, operating receipts were up only 0.7% YoY over the same period. This compared with 2007-2008's outlet expansion of 10.7% YoY and increase in operating receipts of 8.8%. Although figures in 2009 could be affected by the economic slowdown, it could point to lower potential for future expansion in Singapore via outlet growth. Due to the smaller size of Singapore's market as compared to other regional countries, we believe that there will come a point when the market becomes saturated and growth in Singapore stalls.

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Section C: Financial Highlights

Exhibit 7: FY10 results

BreadTalk (S$m) P&L Revenue Cost of Sales EBITDA Operating Profit Pre-tax Profit After-tax profit (attributable to shareholders) Segment Revenue Bakery Sales Franchise Income Restaurant Sales Food Court Income
Source: Company, OIR

4Q10 83.3 -37.7 13.1 7.2 7.3 5.4

4Q09 68.2 -32.1 8.7 4.1 3.9 3.3

% Change 22.1% 17.2% 50.1% 74.4% 87.5% 63.5%

FY10 302.9 -137.6 38.2 16.6 16.7 11.3

FY09 246.5 -112.3 33.0 16.3 15.6 11.1

% Change 22.9% 22.5% 15.8% 1.9% 6.9% 1.6%

37.3 5.6 17.4 22.9

31.4 4.9 11.3 20.6

18.7% 15.9% 53.8% 11.4%

137.0 21.1 56.3 88.5

110.4 19.0 39.0 78.2

24.1% 11.3% 44.4% 13.2%

Net profit up. BreadTalk reported an increase in net income of 1.6% YoY for FY2010, which was aided by a gain of S$4.2m from property disposals. Excluding the gain, operating profit fell due to expansion costs in Thailand (Din Tai Fung) and Shenzhen (food court) as well as lower profit margins from higher food costs and wages in China. Revenue for the year rose 22.9% YoY to S$302.8m, while gross margins stayed consistent at about 55% of revenue despite rising costs experienced during the year. BreadTalk also reported same store-sales of -2% to 9.6% for Bakeries, 11.3% for Din Tai Fung and -3% to 10.9% for food courts. FY2010's diluted EPS was up 1.3% to 3.99 cents compared to 3.94 cents in FY2009. Store expansions. For FY2010, BreadTalk opened 12 restaurants, 38 owned and 56 franchise bakeries, with one net closure for its food courts, bringing the total number of outlets to 448. BreadTalk has a target of having slightly under 1,200 total outlets across all segments by end 2013. With the bulk of the targeted outlet increase coming from franchises, management is confident about reaching this goal. Outlook. Management will incur capex expenditure of about S$50m this year to fund its expansion targets for the year and undertake other strategic initiates such as focusing on high growth consumer markets such as Thailand and China. Management acknowledged concerns surrounding rising food costs and potential wage increases for FY2011, but stressed its ability to mitigate potential cost increases by shortening supply chain and also by purchasing directly from bulk suppliers. Due to the nature of its products and the price sensitivity of consumer, management is also more inclined to increase market share and cultivate brand loyalty via competitive pricing over passing on costs to end consumers although they will monitor costs and make segment specific price increases, if necessary.
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Section D: Valuations and Recommendation Dough, dough, dough. With the global economic recovery gaining traction, we are expecting BreadTalk to continue posting double-digit revenue growth for this year and beyond (FY2011 forecast: 26% YoY). Singapore and China will remain the two largest contributors to revenue with Singapore's sales staying strong - driven by its prime bakery locations as well as the highly successful Din Tai Fung restaurant chain - while the size and depth of China's consumer market and its citizen's growing affluence and corresponding bump in disposable income will provide the catalyst for increased expenditure on food. In addition, management's plan to more than double the number of outlets over the next three years not only signals its confidence in the group's future outlook, but also ensures that the desired revenue growth will be achievable.
Exhibit 8: Chinese expenditure on food vs. Disposable Income
3,500 20,000 18,000 3,000 16,000 14,000 2,500 12,000 10,000 2,000 8,000 6,000 1,500 4,000 2,000 1,000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -

Cash expenditure per capita on Food (LHS)

Annual Disposable Income per Capita Urban household (RHS)

Source: CEIC

Costs will remain consistent. We believe that BreadTalk will be able to maintain a gross profit margin of about 55%, which is in line with its margins over the past five years despite potential increase in food costs. This will come from its mitigation efforts in terms of shortening the supply chain by cutting out the middle man and bulk sourcing globally for its supplies. Even if average selling price increases become necessary, this is likely to be undertaken on a considerate and gradual basis, as seen from the previous experience during the Financial Crisis, resulting in negligible impact on sales. This is also supported by the lack of any significant impact on its margin during previous fluctuations in raw material prices.

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Exhibit 9: Raw material price changes vs. Gross profit Margins

60% 60%

40%

50%

20%

40%

0%

30%

-20%

20%

-40%

10%

-60% Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 FY2008 FY2008 FY2008 FY2008 FY2009 FY2009 FY2009 FY2009 FY2010 FY2010 FY2010 FY2010

0%

Palm Oil

Corn

Wheat

Sugar

Gross Profit Margin

Source: Bloomberg, Company, OIR

Initiate with BUY and fair value estimate of S$0.74. We project revenue growth of 26% YoY for FY2011F on the back of outlet expansions and stronger sales from existing stores. Backed by strong sales projections, its growing brand recognition and its continuous commitment to review and enhance its offerings, we are initiating coverage on BreadTalk with a BUY rating and a fair value estimate of S$0.74 based on a discounted cash flowto-firm valuation model with a WACC discount rate of 8.02%.This valuation translates to an upside potential of about 11.6% based on the last traded price of S$0.66.

Exhibit 10: Peer Comparison

Name Hsu Fu Chi International Petra Foods Ltd Super Group Ltd Cerebos Pacific Conscience Food Japan Food Holdings Auric Pacific Simple Average BreadTalk Group
Source: Bloomberg, OIR

Ticker HFCI SP Equity PETRA SP Equity SUPER SP Equity CER SP Equity CSF SP Equity JFOOD SP Equity AP SP Equity

Price (S$) 3.71 1.58 1.28 5.15 0.26 0.48 0.66

Mkt Cap (S$m) 2,941.50 977.85 764.10 1,613.21 97.08 37.51 86.08

P/E 20.5 16.3 12.0 13.3 5.8 9.3 13.0 12.9

FY11F PER (x) 19.4 14.8 17.3 13.6 6.8 8.3 11.5 13.1 15.0

FY12F PER (x) 16.6 12.7 12.2 12.9 4.3 8.6 11.1 11.2 15.5

P/Bk (x) 5.6 2.6 2.2 3.7 2.7 3.2 0.4

BREAD SP Equity

0.66

181.82

16.5

2.9

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BreadTalk's Key Financial Data EARNINGS FORECAST Year Ended 31 Dec (S$m) Revenue EBITDA Depreciation & Amortisation EBIT Net Interest Associates & JVs Pre-tax Proft Income Tax Expense Minority Interest Net Profit FY09 246.5 33.0 16.7 16.3 0.5 0.1 15.6 4.0 0.5 11.1 FY10 302.9 38.2 21.6 16.6 0.0 0.2 16.7 5.5 0.1 11.3 FY11F 381.7 44.7 25.6 19.1 0.6 18.5 6.1 12.4 FY12F 450.8 50.5 30.2 20.3 1.1 19.2 7.2 11.9 BALANCE SHEET As at 31 Dec (S$m) Cash Inventories Accounts Receivables Fixed & Intangible Assets Total Assets Debt Accounts Payable Total Liabilities Shareholders Equity Total Liabilities and Equity FY09 58.4 4.8 29.7 73.4 172.1 15.7 52.1 105.9 66.2 172.1 FY10 71.1 6.1 26.7 82.4 204.2 19.2 60.8 129.1 75.1 204.2 FY11F 92.9 7.6 36.6 107.1 262.2 50.3 76.3 176.7 85.5 262.2 FY12F 90.1 9.0 43.3 127.1 288.0 53.0 90.2 194.3 93.7 288.0

CASH FLOW Year Ended 31 Dec (S$m) Operating Profit Working Capital Changes Net Cash from Operations Purchase of PPE Purchase of Intangible Asset Investing Cash Flow Financing Cash Flow Net Cash Flow Cash at beginning of year Cash at end of year Source: Company data, OIR estimates FY09 46.6 11.3 42.6 24.0 0.4 29.9 2.2 10.5 47.9 58.4 FY10 43.8 5.9 39.7 21.7 0.5 27.8 0.8 12.7 58.4 71.1 FY11F 49.0 5.0 44.2 50.0 0.2 50.1 27.6 21.8 71.1 92.9 FY12F 54.3 6.2 48.1 50.0 0.2 50.0 0.9 2.8 92.9 90.1 KEY RATES & RATIOS Net Earnings Growth (% YoY) EPS (SG cents) PER (x) NAV per share (SG cents) Price/NAV (x) EV/EBITDA (x) Dividend Yield (%) ROIC (%) ROE (%) ROA (%) FY09 42.8 3.9 16.7 23.6 2.8 7.2 1.5 14.5 18.3 6.4 FY10 1.6 4.0 16.5 26.7 2.5 6.5 1.5 12.8 16.4 5.5 FY11F 10.1 4.4 15.0 30.4 2.2 6.1 1.5 9.5 15.5 4.7 FY12F 3.7 4.3 15.5 33.3 2.0 5.8 1.5 8.4 13.3 4.1

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SHAREHOLDING DECLARATION: The analyst/analysts who wrote this report holds NIL shares in the above security. RATINGS AND RECOMMENDATIONS: OCBC Investment Researchs (OIR) technical comments and recommendations are short-term and trading oriented. - However, OIRs fundamental views and ratings (Buy, Hold, Sell) are medium-term calls within a 12-month investment horizon. OIRs Buy = More than 10% upside from the current price; Hold = Trade within +/-10% from the current price; Sell = More than 10% downside from the current price. - For companies with less than S$150m market capitalization, OIRs Buy = More than 30% upside from the current price; Hold = Trade within +/- 30% from the current price; Sell = More than 30% downside from the current price. DISCLAIMER FOR RESEARCH REPORT This report is solely for information and general circulation only and may not be published, circulated, reproduced or distributed in whole or in part to any other person without our written consent. This report should not be construed as an offer or solicitation for the subscription, purchase or sale of the securities mentioned herein. Whilst we have taken all reasonable care to ensure that the information contained in this publication is not untrue or misleading at the time of publication, we cannot guarantee its accuracy or completeness, and you should not act on it without first independently verifying its contents. Any opinion or estimate contained in this report is subject to change without notice. We have not given any consideration to and we have not made any investigation of the investment objectives, financial situation or particular needs of the recipient or any class of persons, and accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the recipient or any class of persons acting on such information or opinion or estimate. You may wish to seek advice from a financial adviser regarding the suitability of the securities mentioned herein, taking into consideration your investment objectives, financial situation or particular needs, before making a commitment to invest in the securities. OCBC Investment Research Pte Ltd, OCBC Securities Pte Ltd and their respective connected and associated corporations together with their respective directors and officers may have or take positions in the securities mentioned in this report and may also perform or seek to perform broking and other investment or securities related services for the corporations whose securities are mentioned in this report as well as other parties generally. Privileged/Confidential information may be contained in this message. If you are not the addressee indicated in this message (or responsible for delivery of this message to such person), you may not copy or deliver this message to anyone. Opinions, conclusions and other information in this message that do not relate to the official business of my company shall not be understood as neither given nor endorsed by it.

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Carmen Lee Head of Research 10 March 2011