Financial Adviser: 5 Things to Know About the IPO of Fruitas Holdings Inc.

Food cart operator Fruitas Holdings, Inc (PSE: FRUIT) will be the fourth and last company that will go public this year after it recently obtained approvals from regulators.

FRUIT is planning to raise up to P1.01 billion by selling up to 602 million shares to the public at a price of P1.68 per share.

Earlier, FRUIT initially intended to offer its shares at P1.99 per share but despite the strong demand, the company decided to lower its price by 16 percent to give the investing public higher returns.

The offering period of FRUIT shares will be from November 18 to 22 with a target listing on November 29 on the main board of the Philippine Stock Exchange.

FRUIT will be the first food and beverage kiosk operator to be listed in the stock exchange with expected market capitalization of P3.6 billion.

Because of the risks that are associated with new stocks, it is always important to spend some time understanding the business and its growth prospects before you invest.

Once you have done your homework, you will have a better idea of what you are getting into in terms of potential loss and gain.

Here are the top five things every investor needs to know about Fruitas Holdings’ IPO:

1| Know the structure of the IPO offering

FRUIT is offering 533.6 million new shares, equivalent to 25 percent of the company, to the public at an offering price of P1.68 per share to raise P896 million.

The expected proceeds, which will amount to P820 million net of underwriting expenses, will be used for company expansion.

FRUIT is allocating about 65 percent of the proceeds for store network expansion and construction of new commissaries. The balance of the 35 percent shall be used for acquisition of new food concepts and debt repayment.

FRUIT is also offering overallotment shares of 68.3 million, equivalent to three percent of the company, to support its stock listing. The additional shares will come from one of FRUIT’s stockholders, Next Merchant Holdings.

In total, given full subscription of the IPO, FRUIT will sell 28.2 percent of the company with 602 million shares at P1.68 per share.

Early market indications show that the demand for the IPO is at least three times greater than the shares available.

2| Know the business prospects of the company

FRUIT is positioning to be the largest food and beverage kiosk operator in the country with its portfolio of market-leading brands.

The company has been expanding its store network aggressively in the past three years, growing by an average of 32 percent annually from 414 stores in 2016 to 949 this year.

FRUIT owns 81 percent of its total number of stores with only 18 percent of it franchised. This gives the company greater control of its operations that lead to higher margins.

About 78 percent of FRUIT’s stores are dominated by its top brands, namely, Fruitas (38 percent); Black Pearl (14 percent); Jamaican Pattie (14 percent) and Johnn Lemon (12 percent).

FRUIT’s emerging brands such as Buco Luco, Juice Avenue, the Mango Farm and Sabroso Lechon should further help the company strengthen its market position.

FRUIT’s market is largely focused on the northern part of the Philippines with 73.4 percent of its stores located in Luzon and the National Capital Region.

There is still a huge untapped growth opportunity for FRUIT to expand in the Visayas and Mindanao regions as the economy grows with more retail developments in the countryside.

With the company’s plan to use more than half of its proceeds to expand its store network, FRUIT can add at least 1,000 more stores in the next three years.

3| Know the financial track record of the company

FRUIT’s rapid store network expansion in the past three years have enabled its total revenues to grow by an average of 72 percent per year from P310 million in 2015 to P1.6 billion in 2018.

The strong growth in revenues boosted FRUIT’s net income to grow by almost 10 times from only P13 million in 2015 to Php100 million in 2018, or an average increase of 96 percent per year.

This year, FRUIT reported that its net income grew by 33 percent for the first six months of the year to P51.9 million from P38.9 million from the same period last year on the back of 29.6 percent growth in total revenues of P941 million.

Given historical growth of revenues, we can safely project that FRUIT will end the year with total revenues of P2.0 billion with net income of P130 million.

With the fresh capital from the IPO, FRUIT is expected to double its store network to 2,000 outlets in the next three years, which should further support its revenues to grow by at least 50 percent beginning next year.

4| Know the quality of the company’s earnings

Earnings are important drivers of share prices valuation.

Investors use earnings as basis to price a stock based on Price-to-Earnings (P/E) multiples, but earnings can be tricky because companies can use creative accounting to show positive results.

One way to detect the quality of earnings of a company is to compare its operating cash flows to its net income. The higher the ratio of operating cash flows to net income, the more reliable the earnings.

FRUIT’s operating cash flows have almost equal its net income for the past three years, which reflects the cash cow business of the company. Last year, its operating cash flow to net income ratio was 1.38.

Historically, PSE stocks with positive operating cash flow to net income ratios have 18.5 percent significant correlation with positive returns.

FRUIT’s high operating cash flow ratio translates to lower risks, which should merit premium on its share price valuation.

5| Know the prospective valuation of the company

It has been said that the value of a stock is determined by the growth of its earnings in the future.

The Price-to-Earnings (P/E) multiple that we pay for a stock represents roughly the present value of stock’s future earnings stream.

Let’s say we assume FRUIT’s total revenues to increase by a conservative growth rate of 20 percent next year from its existing stores to P2.5 billion, we can expect its net income to grow to P156 million.

But because FRUIT will also expand its store network next year, we can project that it will open 329 new stores that could generate additional revenues of P770 million and net income of P106 million.

In total, given the prospects of high growth next year, we can estimate FRUIT’s total revenues to grow by 54 percent in 2020 at P3.2 billion with net income of P293 million.

At these projected earnings, the prospective Price-to-Earnings (P/E) ratio of FRUIT’s IPO price is at only 12 times, which is 33 percent discount to market average of 18 times.

Now, let’s say FRUIT will add the same number of stores in the next three years, assuming minimal 20 percent growth per year, we can forecast that the company’s total revenues by 2022 will have compounded to P5.2 billion.

At this level of revenues, FRUIT’s net income by that time would have increased to P563 million.

Given normal pricing of 18x to 25x P/E ratio, FRUIT’s future market capitalization would range between P10 to P14 billion.

If we will discount this to present value at cost of equity of nine percent, we can derive the long-term target price of the stock at between P3.67 to P5.10 per share.