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Fast food a $66b industry in China by 2009

(Agencies/China Daily)
Updated: 2008-06-30 15:05

With the stock market debut of hot-pot chain Little Sheep on June 12, brokers such as Cazenove are touting a new theme to investors hungry for a slice of China's consumer boom: home-grown branded restaurants.

But food prices in the world's fastest growing major economy are soaring, and experts say a lack of pricing power is squeezing firms in a crowded market where scale is the key to long term success and profitability.

Little Sheep, Ajisen (China), Cafe de Coral, Fairwood, and international behemoths Yum Brand's KFC and Pizza Hut, McDonald's, and Burger King are all catering to growing demand for fast food.

Chinese appetite for on-the-go burgers, fried chicken, pizza, and noodles is expected to make fast food a $66 billion industry in China by 2009, up from $51.7 billion last year, according to research firm Euromonitor.

Despite the fast food industry's challenges, valuations are high as investors bet that Chinese hunger for dining out and more modern lifestyles won't abate any time soon.

Shares in Ajisen, a specialist in Japanese-style noodles, are trading at roughly more than 28 times forecast earnings, pricier than Li Ning's 24 times. Ajisen has gained more than 51 percent since its March 2007 debut, but has shed over 7 percent in the past month due to market turmoil and general inflation fears.

Cazenove has an outperform recommendation on Ajisen, while Merrill Lynch has a buy rating. But JP Morgan has an underweight rating on the stock, and ABN AMRO has a sell rating, citing difficulties in cost management.

"We remain positive on the long-term fundamentals of the company given its profitable restaurant concept and large proven market size," Cazenove says about Ajisen in a research note on China restaurants.

Little Sheep's stock has lost nearly a fifth of its value since its June 12 debut, racked by recent inflation-driven market volatility.

Firms are struggling to pass on costs to consumers in a year when inflation has hit 11-year highs, even though China's per capita urban disposal incomes are expected to rise 13.6 percent this year to 15,663 yuan, according to Sun Hung Kai Financial.

"For department stores, they have high-end branding, margin expansion, they can pass on costs to consumers. But for fast food companies it's proving to be difficult especially when food costs are surging," says JP Morgan consumer sector analyst Ebru Sener Kurumlu.

"They are not able to raise prices. The problem is they have a few flagship products the consumer knows so they will keep those products at the same price. They renew prices on the remaining parts of the menu, but not by that much."

Food costs account for around a quarter of fast food chains' cost structure, analysts say. Adding pressure is an extremely fragmented market where the top five Chinese players account for only 3 percent of the market.

That compares to the roughly 20 percent share controlled by top Chinese sportswear firms such as Li Ning and Anta in that segment of the consumer market.

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