A free society cherishes nonconformity. It knows that from the non-conformist, from the eccentric, have come many of the great ideas of freedom. Free society must fertilize the soil in which non-conformity and dissent and individualism can grow. — Henry Steele Commager (1902-1998) Historian and author
In this issue
Reality Check: Jollibee’s Easy Money Financed Pacman Strategy Backfires
-Popular High Expectations and The Limits of Credit Finance Pacman Strategy
-As Foreign Assets Take Center Stage, JFC Now More Vulnerable to External Forces
-JFC Reaffirms a Saturated Domestic Market and the Peter’s Principle
Reality Check: Jollibee’s Easy Money Financed Pacman Strategy Backfires
Popular High Expectations and The Limits of Credit Finance Pacman Strategy
At the acme of its stock prices or before its share price meltdown, last March*, I wrote about the dramatic structural shift in Jollibee’s business model, which from my purview, had been laden by hazards.
Instead of pursuing organic growth in the market where it specialized in, the retail food chain boldly expanded overseas by devouring its competition.
The company’s monumental shift in its business strategy had been an outcome of the Bangko Sentral ng Pilipinas (BSP) low-interest regime, which encouraged the aggressive use of credit financing for its acquisitions. (bold and italics original)
In the recent past, JFC has expanded aggressively through horizontal integration. That is, JFC bought out and tacked into its fold, its domestic competitors. That’s JFC’s Pacman Strategy.
Now the thrust has been to expand also horizontally but externally.
JFC’s external recourse may be about the weak peso. As a means or a strategy to hedge against this, the company engaged in foreign FDI. However, JFC may be venturing into the unknown or to unfamiliar markets, where its competitive advantage may be deficient. It may not possess the same quality of knowledge and expertise in dealing with foreign consumers.
…
Jollibee’s aggressive use of credit seems to undergo a similar path. By aggressively taking on debt, not only does it remove the firms’ margin of safety, but it takes on unnecessary risks. JFC operates with little room for error.
…
And as I have been pointing out repeatedly, not only does artificially low-interest rates subsidize big debtors at the expense of the savers, but it also crowds out debtors of lesser degree. Firms with liberal access to credit can buy out competing firms, and therefore, result in the concentration of the industry.
…
And JFC’s monopolistic behavior, via its Pacman strategy, has been consistent with this.
The transformation of the firm’s operating model, from organic growth to a credit financed acquisition expansion, I named the ‘Pacman Strategy’.
*Jollibee’s Fantastic Paradigm Shift: From Consumer Value to Aggressive Debt-Financed Pacman Strategy March 3, 2019
Last May**, Jollibee surprisingly announced a steep drop in earnings, which sent its stocks in a downward spiral. Media attributed this shortfall to its recent acquisition of US-based burger chain Smashburger. Yet, a slowdown in domestic sales, as a result of the tight liquidity environment, was responsible for most of the damage.
Sorry, but domestic sales, which accounted for 73% of JFC’s top line, did most of the damage to its 1Q performance. Smashburger only exacerbated it.
But it comes as a surprise that mostly cash-based Jollibee’s sales had been affected more by the March collapse in consumer credit rather than retail enterprises dependent on credit cards.
The deterioration of JFC’s top line has massive implications on the consumer’s spending capacity. The impact from the ongoing liquidity crunch has begun to impact more on the middle and lower class.
Given Jollibee’s relentless overseas expansion, I warned…
Such point to JFC’s rapidly growing international exposure even when its competitive moat is here.
If JFC’s gambit of an aggressive credit financed external expansion should turn out to be unsuccessful, then it is likely to have a severe impact on the company’s balance sheets.
Smashburger wasn’t the only major acquisition in its campaign to expand internationally, an American coffee chain, The Coffee Bean & Tea Leaf, was added into the Jollibee’s portfolio last July, which deal was completed in September.
As Foreign Assets Take Center Stage, JFC Now More Vulnerable to External Forces
Figure 1
So in 9-months, while domestic sales still dominate, despite the downtrend, with a 73.26% share, the share of Philippine-based assets has shrunk to 42.84%! That is to say, because of the preeminence of foreign assets, foreign sales will have more impact on Jollibee’s balance sheet! (Figure 1)
That said, JFC has now become more exposed to foreign forces than where it specializes: the home market. Not only are developed markets intensely competitive that should place pressure on profits, but also, the external socio-political-economic environment may be more mercurial that could amplify the fragility of their investments.
To be sure, the company’s business risk most likely emanates from its aggressive acquisition side than promoting its organic (Jollibee) brand overseas to tap their captive markets: Filipino immigrants and OFWs.
Figure 2
As proof, the total sales growth of Jollibee’s 3Q and 9-month has plummeted to its lowest levels since at least 2012. 3Q sales growth was only at 7.01%, while 9-month revenue growth clocked in at 9.06%. (figure 2, upper window)
Interestingly, such lackadaisical sales growth occurred amidst JFC’s massive store expansions. Total stores grew by 34.7% as a consequence of the 7.83% growth in domestic stores and 94.4% in foreign outlets. Foreign outlets now account for 45% of the JFC’s aggregate stores of 5,863 as of September.
That said, like Shakey’s***, there was barely any growth from same-store sales.
***3Q CPI Fall to 42-Month Low as Divergences in Component CPIs Widen; Flawed CPI—the Shakey’s Pizza Evidence November 10
And speaking of domestic sales, since the preponderance of transaction payments in its retail outlets has been in cash, JFC’s 7.57% growth in domestic sales have almost resonated with the growth rate in the BSP’s cash in circulation, which has likewise tumbled to 2012-level. With a time lag, tightening bank and financial liquidity conditions have percolated into Jollibee’s domestic retail sales. (figure 2, lower window)
Figure 3
Dismal domestic sales growth was consistently seen in all three quarters of 2019: in pecking order 7.21%, 7.33%, and 8.3%. (figure 3, upmost window)
And here’s the thing. While the inclusion of Smashburger boosted international sales from 2018 into the 1Q 2019’s 19.31%, the pace of growth dropped substantially to 5.2% in the 2Q and 3.75% in the 3Q! (figure 3, middle window) Remember, because of the shift in the balance sheet weighting towards foreign assets, foreign sales would have more impact at the present.
Strikingly too, after the smoothing out of data to include the acquisition, Smashburger’s sales haven’t boosted its aggregate overseas revenues!
And with the slowdown in both domestic and international sales, JFC posted the lowest total sales growth in the 2Q’s 6.72% and 3Q’s 7.01% with 1Q’s 10.15% sales outperforming slightly 2015’s 9.5%. (figure 3, lowest window)
JFC Reaffirms a Saturated Domestic Market and the Peter’s Principle
To preserve its high-income growth expectations, JFC opted for the overseas campaign foray in the hope of attaining scale in revenues and or maintain its profit and operating margins.
Unfortunately, hardly any of these expectations have borne fruit for now. Both gross profit and operating margins suffered significant declines in the 9-months of 2019, the lowest since 2012. (figure 4, upmost window)
Figure 4
And of course, the tilt in the balance sheet towards the foreign exposure has been due to the unmatched surge in leverage used to finance the acquisition of US food chains.
The repercussion of which has been to swell interest expenditures to unprecedented rates. Interest expenses flew by 69.2% in 2019, in a follow up to 2018’s 102.12%, rates eclipsing the top and bottom line. (figure 4, middle window)
So in the face of a record pileup of debt, debt servicing has likewise been rocketing, adding immensely to JFC’s financial burdens!
And the interesting part, Jollibee has been undertaking such a bold expansion overseas campaign at a time when the global economy seems to teeter on the edge of a recession!
Oh by the way, a reminder from the BSP-led Financial Stability Coordinating Council’s 2018 Financial Stability Report (p.13): “Based on the audited financial statements of the 148 Philippine Stock Exchange (PSE)-listed non-financial corporations (NFCs), the growth of interest expense (IE) has outpaced the rise of earnings before interest and taxes (EBIT)…The same companies have also reported lower profitability with respect to return on assets”
Rings a bell?
And based on demonstrated preferences through the company’s actions, and subsequently, its performance, Jollibee reaffirms the growth limitations of the Philippine market.
As noted in August****:
And the “home market is getting saturated”? Well, has this been so hard to notice? JFC has been aggressively expanding horizontally through Mergers and Acquisition (M&A) financed by debt, benefiting from the BSP's easy money regime. And aside from falling margins, perhaps they have come to realize that the pockets of Filipino consumers have limits, and so the overseas M&A gambit.
****An Update of Jollibee’s PacMan Strategy: In the Lens of 2Q and 1H Financial Performance August 25, 2019
That said, net income grew by 4.5% in 3Q but hemorrhaged 22.2% in the 9-months (figure 4, lowest window)
JFC would have to pray that the USD peso firms up significantly to cushion their setback.
Peter’s Principle—where people tend to rise to their level of incompetence—appears to have plagued Jollibee.
Here’s a prediction: should such dicey overseas projects fail to work out, because of an unstable economic environment (e.g. recession) or the inability to transpose their expertise abroad or unwieldy growth of debt burden or a combination of these, JFC will cut loses by selling some these investments.
Figure 5
And a reality check, for a stock which has been priced to perfection, can be harsh. Newton’s law has been emphatically asserting and spreading its presence at the PSE.
And yes, JFC confirms the old axiom, “Past performance does not guarantee future results”!
But who knows, a twist of fate may occur if JFC manages to pull rabbits out of the hat!
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