Ginger Beef (“GB. V”) operates as a franchiser of Chinese food restaurants located primarily in Calgary, Alberta. The company franchises takeout and delivery units, full-service restaurants, and food court concepts under the Ginger Beef Bistro House, Ginger Beef Peking House, and Ginger Beef Express(“Express”) names. It also manufactures fresh and frozen Chinese food items for wholesalers primarily in Canada.
Express (franchisor of Chinese food restaurants) was about 13% of total sales and the Ginger Beef Choice Ltd (“Choice”) was 87% of total sales (federally inspected manufacturer of fresh and frozen Chinese food items for wholesalers in Canada). Choice had 4 customers who are 82 to 86% of the total whole sales.
Over the 5-year period GB generated an +8% CAGR in its top line. In 2016 sales were 5.43 million dollars and at end of 2020 sales reached 8 million. In the last 12 months the company has been able to generate close to $9 million in sales continuing this “explosive” growth. Although the top line is looking all rosy the same hasn’t happened with the profit margins due to the pandemic.
The lower profit margins were primarily resulted from significant meat cost increases due to COVID-19, such as shortage of labor for meat suppliers and reduced output capacity due to COVID restrictions. An article by business insider stated that:
“Prices are on the upswing for many goods, and people could start feeling the pinch at their next grocery store visit. In particular, beef saw a large increase in prices over one month compared to some other food items.
The price of beef rose by 4.5% in June compared to May, per new data from the Bureau of Labor Statistics (BLS) released on Tuesday. That was largely in tandem with increases for the cost of eggs (3.0%), pork (3.1%), and ham (3.1%). Compared to a year ago, however, the price of beef was down by 2.8%.
Other food prices also rose but not to a similar extent. In June, the price of milk rose by 0.5% and potatoes increased by 1.5% compared to May. It will likely increase grocery store costs for many shoppers.”
This increase in the cost of significant factors in production have caused the operating earnings of the franchisor and wholesaler to decrease as well. In 2015 they generated $50,000 in operating income and then at the end of 2020 they had $750,000. In the last 12 months they were able to generate $730,000 in operating income. Majority of the costs are taken by the manufacturing of the fresh and frozen Chinese food items for the wholesaler. The bulk of the non-manufacturing costs are general and https://equity.guru/wp-content/uploads/2021/10/tnw8sVO3j-2.pngistrative expenses and interest payments that the company must make. This means on average over the last five years they’ve been able to generate about $340,000 in free cash flow, which is money that is potential left over for their business owners, and they had close to $600,000 in debt. This means if they were able to generate the same amount of cash flow that they did over the last five years it would take them two years to pay off their total debt.
If we continue analyzing the balance sheet, we notice that majority of their assets are tied up in inventory and accounts receivables. the bulk of the inventory is in food items about $350,000 to be exact. They also have $70,000 in packaging material and $16,000 of cleaning chemicals. this obviously fluctuates with the demand of the food items and packaging materials so you can expect their inventories too very depending on volume.
Since they are a manufacturer, they generate account receivables from purchase orders. The bulk of their accounts receivables, $998,000, are due to be paid in less than 30 days compared to the account’s payables, about 400,000, that are due in less than 360 days. this sort of mismatch between the accounts payables and the accounts receivables could cause the business to have cash flow problems but the company is able to generate on average $300,000 of free cash flow after paying for its working capital which means the balance sheet is somewhat protected.
This unknown enterprise with its meteoric rise in the stock market also has a 62% owner. Stanley Leung owns 8.2 million shares or 62% of the outstanding common and over the last few years has used excess cash to buy back stock. The total shares outstanding went from 13.6 million to 13.3 million which is a reduction of about 4% over the last five years. This might not mean much to people who own individual shares between majority owner like Stanley this could increase your net worth with no need of extra capital from your own pocket.
Honestly, I don’t blame him for a company generating positive free cash flow with very little need of maintenance expenditures outside of the manufacturing conducted by Choice it seems like a very nice business to own. In 2016 the company generated 2.2% return on invested capital and in 2020 that number shot up to 17%. Due to inflationary pressures in the meat market the return on invested capital has dropped by two percentage points to 15% but the long-term average is still high. most investors look for a return on invested capital that is above 9% to 10%.
Mr. Stanley Leung has also been able to generate a return on assets of 10% (the benchmark is usually 5% and above) and a return on tangible equity of 26% (Mr. Warren Buffett himself is happy of his companies have a return on tangible equity of 10% and above).
So, what we have here is a business that is owned by the operator, meaning the bulk of the economic cost is exposed to both the managers and the private owners. The company has a high return on invested capital, return on equity and return on assets. if these numbers are true what we have here he’s one of the mysteries of capital allocation at work. such a simple business model can generate high returns on equity especially if the operator is a 62% owner. The real question is now figuring out how good this ‘ginger beef’ is and am I able to get a meeting one on one with Mr. Stanley Leung. I want to meet him because I have a few questions on how he can generate such a high return with such a simple business model and in such a fragmented industry.
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