CAF DE CORAL HOLDINGS LIMITED

AC4304 Advanced Financial Accounting Group Project

Lam Wing Yi, Emily Lai Hei Man, Carmeny Lai Hiu Kwan, Kathy Kurnia Jessica Adharana

52203894 52046626 52189729 52064830

S01 S01 S01 S03

We declare that this report is wholly our own work and that all referenced work from other people has been properly cited and documented on the reference list.

Contents
I. Business Expansion and Acquisitions ......................................................................................................... 2 II. Company Profile and Portfolio .................................................................................................................. 2 III. Control VS. Ownership ............................................................................................................................. 5 IV. Return on Assets (ROA), Return on Equity (ROE) and Return on Capital (ROC) ...................................... 5 V. Financial Ratio Analysis ............................................................................................................................. 8 VI. Implications and Limitations of Current Accounting Practices .............................................................. 10 VII. Groups Reflection ................................................................................................................................ 11 VIII. Reference List ...................................................................................................................................... 13

I. Business Expansion and Acquisitions

Most of the large and successful companies will inevitably expand their businesses for various reasons. When a company is doing well, it will expand its profitable business as a sign of growth. A company may expand either by external or internal growth. External growth means the company is expanding by purchasing a collection of assets in the form of an established business or a controlling interest in other companies. Business combination comes in several different forms: merger, acquisition, amalgamation, consolidation, absorption and takeover. Business combinations provide some benefits to the acquirer, such as: Economies of scale Elimination of competition Diversification of risk Acquisition of expertise

As companies have grown in size, they often develop a complex group structure. According to the newly amended HKFRS 10 Consolidated Financial Statements, a group consists of a parent and all its subsidiaries. A parent is an entity that controls one or more entities (subsidiaries). A subsidiary is an entity that is controlled by the parent. Based on HKAS 28, an associate refers to an entity over which the investor has significant influence and that is neither a subsidiary nor a joint venture. Based on HKFRS 10, control of an investee refers to an investor which controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Meanwhile, Non-controlling interest (NCI) is the equity in a subsidiary not attributable, directly or indirectly, to a parent. Consolidated financial statements are the financial statements of a group presented as a single economic entity. Complex group structure is adopted by a large organization because of various reasons: Acquisitions of other business, i.e. subsidiaries Setting limited liabilities to avoid chain reaction For some countries, to maintain separate legal entities For management purposes (e.g. easier to control company in smaller scale) For tax reasons

II. Company Profile and Portfolio

Caf de Coral Group (0341) is the largest publicly listed Chinese fast food restaurant group in the world, with over 24.8% market share in the Quick Service Restaurant segment and 4.6% of

the total dining out industry in Hong Kong. Its business operation spans over 2 continents with more than 300 operating units in Hong Kong, over 100 outlets in China as well as more than 140 units in North America. For the simplicity of this report, Caf de Coral will be referred as the Group hereafter. The Group is principally engaged in the operation of quick service and specialty restaurants chain, with vertical and horizontal diversification in institutional catering and food processing businesses. Other than the core brand Caf de Coral, the Group also operates Super Super Congee & Noodles, The Spaghetti House, Spaghetti 360, Ah Yee Leng Tong, Bravo le Caf, ME.N.U, Mix, Manchu Wok and some institutional catering services (Asia Pacific Catering and Luncheon Star). Relating to the benefits of business combinations, here are the reasons as to why the Group acquired its subsidiaries. 1. Economies of scales There are two Central Food Processing Plants, which are located in Guangzhou Yonghe Development District, Mainland China and Tai Po, Hong Kong. Both of them are fully operational. As mentioned in the Financial Report, the CEO stated that the two plants not only improve the food quality and safety, but also the capacity and the cost of the production. Scanfoods is focusing in the food processing and distribution industry and as one of the leading processed meat suppliers in Hong Kong, Scanfoods owns a 40,000 square feet production base in Dongguan city, which processes and distributes ham, sausages and bacon products to over 1,000 institutional customers in Hong Kong and China. By acquiring Scanfoods in 1997, it led the Group towards further upstream integration into the food manufacturing and distribution business in the Greater China region. 2. Elimination of competition The group started its expansion by acquiring Ah Yee Leng Tong in 1990. Afterwards, it had acquired many other businesses in the food and beverage industry. This is because the Group wanted to expand their market, to not only focus on quick service restaurant (QSR) but also create development in the Specialty restaurant business. As all of the acquirees are food and beverage businesses, it is no doubt that such expansion can eliminate the intense competition in the restaurant industry. The development of The Spaghetti House since its acquisition and the recent development of Spaghetti 360 series enable the Group to achieve a more diverse earning base through wider market exposure, as well as assuming a leadership position in the pasta segment. Since there is an emerging market for healthy and nutritional lifestyle and rapid growth of health-conscious customers, the Group acquired Olivers Super Sandwiches and Mix. Olivers

Super Sandwiches is considered to be the market leader in the niche market of sandwich specialty restaurant while Mix is the first and largest healthy concept restaurant chain in Hong Kong. The Group acquired Manchu Wok in 2000. Manchu Wok is the largest national brand of Chinese quick service restaurant chain in Canada and the second largest in U.S.A. and is now a wholly owned subsidiary of Caf de Coral. The Group also acquired China Inn, a regional Chinese restaurant chain in California, U.S.A., in 2002. These acquisitions allow the Group to expand its business to North America and successfully transformed from a small home grown enterprise into a diversified global corporation. Other acquisitions are Dennys Bakery, a bakery manufacturing and distribution business in Hong Kong, in 2000 and New Asia Dabao, the largest Chinese quick service restaurant in Shanghai, P.R.C., in 2003. In 2007, the Group made a strategic investment in Tao Heung group and established a joint venture to operate an exclusive franchise under the brand of Espressamente illy to penetrate into the high-end coffee market in Hong Kong. 3. Setting limited liabilities to avoid chain reaction and management purpose As shown in the table below, the Group clearly has invested a lot in the catering business. By investing in other companies, it can reduce the risk of the chain effect which means that if a company faces a loss or financial difficulties, it will not affect other companies.

III. Control VS. Ownership

Control is different from ownership. Control means that the investor has the power over the investee or rights to variable returns from the involvement with the investee and has the ability to affect its benefits from its activities. The total net assets controlled by the parents company is equal to the total equity minus the investments in associates (HK$ 3,250,269,000-18,505,000=HK$3,231,764,000). The effect of jointly controlled entities shall be ignored for this calculation. The total net assets owned by the parents company is the total equity minus the sum of the investments in associates and the non-controlling interests (HK$3,250,269,000-18,505,0001,271,000= HK$3,230,493,000). The difference between the amount of total net assets controlled by the parents company and the amount owned is the non-controlling interests which participate proportionally in the risks and rewards of an investment in the subsidiary. The shareholders would like to know both because they can get different information from them. The controllership can indicate the extent to which the Group has the right to make use of the entitys assets for operation and maintenance of the entitys business. For ownership, the shareholders can calculate the share of profit associated with each individual share and know how much they can get back when the firm goes liquidated. The book value per share is equal to the book value of net assets divided by the number of outstanding shares. The share of non-controlling interests should be excluded from the calculation because of the matching concept. The total net assets owned by the parents company should be used and be divided by the number of shares outstanding (HK$3,230,493,000/569,557,000=HK$5.67 per share). It shows the worth of each share of stock per the books based on historical cost. Common shareholders would get HK$5.67 per share if the company liquidates.

IV. Return on Assets (ROA), Return on Equity (ROE) and Return on Capital (ROC)
Return on capital of associates = _Profit of associates__ Investment in associates Return on capital of associates of 2012 Return on capital of associates of 2011 , =, =, =1.68% =12.43%

Return on capital of the parent = _Net income__ Equity +Debts Return on capital of the parent of 2011 Return on capital of the parent of 2012 514,322 473,483 3,067,419+0 3,250,269+0 =16.77% =14.57% Return on capital is the measure of how well the company uses its money (borrowed and owned) to generate a return. The return on capital of associates (ROCA) represents the Groups ability to generate returns by using its capital (Equity and Debts). In 2012, the ROCA is very small, which means that the associates have a loss on its operating activities. When compared to 2011, the ROCA decreased a lot, from 12.43% to 1.68%. For the return on capital of the Group, in 2012, the return on capital is 14.57%. When compared to 2011, it decreased from 17.77% to 14.57%. In the two financial years, the return on capital of associates is lower than the Groups. In 2011, the Groups ROC is 16.77% but associates ROC is 10.10%. In 2012, the Groups ROC is 14.57%, but the associates have a negative return. The above analysis indicates that it is not a wise decision to invest in these associates because the return is not only below the Groups, but it is also a loss. Net profit margin = Operating profit + Finance income Revenue Net profit margin of 2011 Net profit margin of 2012 ,+, ,+, = ,, = ,, =11.57% =9.53% Profit margin is a measurement of profitability. It is mostly used for internal purposes. Profit margin is also an indicator of a company's pricing strategies and how well it controls costs. Revenue represent the income that a company (only the parent and its subsidiary, but not including the associates) receives from its normal activities, therefore the operating profit should not include associates portion, which means the operating profit should be used instead of the profit after tax.

The financial income is separately disclosed, shown under the operating profit. The financial income represents the interest income therefore it should be included in calculation. The net profit margin of associates cannot be calculated because the associates do not provide the required information, such as the income statement. From the above calculation of 2011 and 2012, it can be concluded that the net profit margin of 2011 is higher than 2012, which means in 2011, the price strategy and the controllership of the cost is better than 2012. Return on Equity Net Income____ Shareholders equity Return on Equity of 2011 Return on Equity of 2012 , , , , , , , , , , =14.99% =17.37% = The return on equity shows how well the company uses invested fund to generate earning. However, this is not suitable for analyzing the groups performance as the equity included in the calculation is only the equity hold by the parent company. These ratios will only show the performance of the parent company. According to the ratio, we can see that the ROE is reduced from 17.37% to 14.99%. The performance of using the invested fund to generate earning is worse than last year. Return on Assets = Net income____ Average Total Assets Return on Assets of 2011 = 514,322 3,781,383 =13.06%

Return on Assets of 2012 = 473,483 4,073,757 =11.62%

The ratios (Return on Equity and Return on Assets) both show a trend that the groups performance of 2012 is worse than 2011. The Return on Assets (ROA) measures how many dollars of earnings is derived from each dollar of assets controlled by the company. The above figures show that ROA decreased from 13.06% to 11.62%. Unlike the Return on Capital, the Return on Equity and Return on Assets cannot be calculated on the associates prospective. For the return on capital, the return and the cost of investment can both be found in the consolidated income statement and consolidated financial position.

But the assets and the equity of the associates cannot be found therefore the Return on Assets and Return on Equity of associates cannot be calculated.

V. Financial Ratio Analysis

1. P/E Ratio A stock's P/E tells us how much investor is willing to pay per dollar of earnings. The figures are the reflection of the market's optimism of the investors concerning a company's growth prospects. A stock with a higher P/E ratio suggests that the investors are expecting a higher earnings growth in the future. The investors are willing to pay more today in anticipation of future earnings growth. On the other hand, a stock with a lower P/E ratio suggests that the investors have a mode expectation for its future growth when comparing to the whole market. To conclude, a high P/E ratio stock will be more attractive to investor then the one with a low P/E ratio.

Caf de Corals P/E ratio of 27.09 ($22.7/$0.838) suggests that the investors are willing to pay $27.09 for every $1 of earnings that the group generates. This ratio is more useful when comparing valuation of peer companies in similar sector. We have chosen Fairwood as comparison.

The P/E ratio of the Fairwood is 15.61. The P/E ratio of Caf de Coral is 73.54% [= (27.0915.61)/15.61] higher than that of Fairwoods.

Based from the above data, the industry average is 21.4%. From the figures, it shows that the investors have a higher expectation on the growth of the Caf de Coral when comparing with the similar corporation Fairwood and the whole industry. Thus, Caf de Coral is more attractive to invest. Although P/E ratio can mostly draw investors attention, investors should not solely depend on this ratio to make their decisions as this ratio has a problem. The problem is that its denominator (EPS) is based on the determination of earnings and it is susceptible to assumptions, interpretations or management manipulation. This means that the quality of the P/E ratio is based on the quality of the underlying earnings number. 2. M/B Ratio M/B Ratio is an indication of how much shareholders are paying for the net assets of a company. It provides investors a way to compare the market value, or what they are paying for each share, to a conservative measure of the value of the firm. [HK$22.7/(HK$3,250,269,000/565,517,000) =HK$3.95] The ratio is over 1 hence it tells the investors that the market believes the asset value is understated. The investors do not need to worry about holding the companys shares because there is only little chance that the asset value will face a downward correction by the market and bring a negative return to the investor. 3. Dividend Yield Investors investing in shares always look for two types of returns. One is capital appreciation which is the increase in share prices. Another is the dividend income. Companies will declare dividends to the shareholders from their profits so the dividend yield ratio is also a good indicator for the investor in accessing which equity share to invest. Dividend yield measures how much dividend income the investors can get for each dollar invested in an equity share. Retirees and those who want to live on their money and are no longer able to work always look for a minimum stream of dividend income from their investment portfolio. They will focus on investing in stocks which have a relatively high or stable dividend yields.

For Caf de Coral, there are 26 consecutive years of uninterrupted dividend payment since public listing. It is favorable for those investors who want to have a regular income by way of dividends. To compare the industry as a whole, the dividend yield of Caf de Coral is 2.73% while Fairwood is 6.14%. Although the dividend yield seems to be rather low when compared with Fairwood, still the investors will be worth to invest in Caf de Coral. For long term, this can help them to gain from the capital appreciation, i.e. increases in the market value of the share, rather than the dividend they might receive. As Caf de Coral is spending more resources on expanding their business in the PRC regions, the growth of the company will have a positive effect on the share price in the future. 4. Debt Ratio Debt ratio is a ratio that can show us how much the company relies on debt to assets. A high debt ratio means that there is a high risk associated with the firm's operation. The chance of getting bankrupt will increase because the company is financing with more debt. It can help the investor as well as the owner keep an eye on possibility that the company will go to bankruptcy. Debt ratio of Caf de Coral is 20%. The Companys debt is quite low and it is more solvent and will have a lower chance of getting bankruptcy. The risk of failing to get the return is lower which is favorable for the potential investors to invest in Caf de Coral. Based on the ratios mentioned above, the investor will be more likely to invest on Caf de Coral as it will be more beneficial for them from their point of view.

VI. Implications and Limitations of Current Accounting Practices

The consolidated financial statements are the financial statements of a group presented as those of a single economic entity with the objective to enhance the reliability, relevance and comparability of the information in accordance with HKFRS10. With the consolidated financial statements, shareholders are able to see the whole picture of group activities. It can save their time as they do not need to view all the single financial statements of the subsidiaries. The group financial statements can also give a true and fair view of the position of the group as a whole and of its earnings which can show the appropriate earnings per share for group shareholders.

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The group accounts show the total assets at work in the group and the return earned by those assets and the proportion of minority shareholders. The shareholders can know the control and also the ownership from the group accounts. On the other hand, there are some limitations. When preparing the group accounts, a group of companies is viewed as one entity. Because of this nature, the details of the individual companies will not be shown. The amalgamation of financial results may lead to the losses by some subsidiaries will be masked by profits elsewhere and shareholders are not able to find where the profits or losses come from. The shareholders can only know the profits or losses for different segments which disclosed in the notes. While the company in whole may be performing well, consolidated statements may not show the entire picture. Some companies in the group may be in an insolvent situation but the group accounts will not disclose this fact because current assets and liabilities are aggregated. So the shareholders cannot use the group account to measure the liquidity of the companies within a group. In a large complex group, the parent company and the subsidiaries maybe in different business sectors so it is difficult to value the assets in uniform basis. The information in consolidation may be misleading. Also disclosures under the current accounting practices may not be adequate enough to show users all the relevant information. Users may have short term or long term perspectives on their investments. People may not be able to identify which information is useful for their analysis.

VII. Groups Reflection

Since the project do not appoint a particular company for us to analyze, our group have to discuss on which company we should analyze. We think that whichever company we do, we believe that we can learn many things during the process. If we choose a group which has a complicated structure, it will be a challenge but we may fail to finish our project. So we decided that we first analyze a group with a simpler structure and can help us to learn on how to analyze a consolidation financial statement. We finally choose Caf de Coral to analyze as we are familiar with the Group, so we will be able to mainly focus on trying to do analysis based on what we have learned during the lesson. To do the project, we need to have the ability to read the financial statement. The meaning of able to read is to know the underlying message hidden in the information in the Annual Report. When we were doing the analysis, we found that some of the skill that we need in the project was not directly mentioned in class. We need to think backwards. What we have learnt is how to make a consolidated statement. So we have also developed a new ability on how to use the

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information in the annual report to determine particular useful ratio and number for us to analyze the Group. During the project, we faced many problems but we managed to get the final result of our analysis. Now we can generate the information we need from the annual report and calculate the ratio of the group, the parents company, subsidiaries and associates. Besides, as we have done the analysis on Caf de Coral, we know more information about the Group and even some things that we didnt know before, like the subsidiaries of the Group.

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VIII. Reference List

1) Industry data http://biz.yahoo.com/p/712conameu.html 2) AAStocks

http://www.aastocks.com/en/LTP/RTQuote.aspx?symbol=00341 http://www.aastocks.com/en/LTP/RTQuote.aspx?symbol=0052 3) Caf De Coral

http://www.cafedecoral.com/ 4) Return on Asset

http://en.wikipedia.org/wiki/Return_on_assets 5) Return on Capital Employed

http://en.wikipedia.org/wiki/Return_on_capital_employed 6) Caf de Coral Holdings Ltd (341:Hong Kong)

http://investing.businessweek.com/research/stocks/financials/ratios.asp?ticker=341:HK

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