HFFG is an over-valued, over-levered food distributor with an unparalleled level of related party transactions that just wrote down most of its latest deal. Moreover, its focus on the Chinese independent restaurant industry positions it poorly in a post COVID world. We believe HFFG is worth $1.50-$3.00 or 60-80% lower vs. current price.
HF Food Group Inc. (HFFG) is a leading food distributor that focuses on Chinese restaurants that mainly serve non-Chinese Americans. The business model is very similar to the likes of USFD, SYY, etc. with the distinction being that HFFG is solely focused on a very niche market segment of the foodservice distribution industry. The business operations of procurement, storing, distribution, inventory management are similar to its peers, but HFFG’s comparative advantage comes from a) Chinese management team and employee base that has a deep understanding and appreciation for the Chinese culture, b) has better selection that is more integrated with Chinese food suppliers, and c) call centers based in China + bilingual capabilities offering unparalleled support to their customer base. The uniqueness of the Chinese restaurant industry means that the larger players do not spend the time and effort in growing their Chinese business. Furthermore, most of HFFG’s customer base is comprised of independent, family-owned restaurants which are not as large of a focus for the larger distributors who tend to focus more of their efforts of large casual/QSR chains.
HFFG was originally created as a SPAC that officially began to trade in the summer of 2018. However, on November 4, 2019, HFFG acquired B&R Global (“B&R”). B&R was founded in 1999 and supported nearly 7,000 restaurants across 11 Western States. The combination created the largest food distributor focused on Asian Restaurants in the United States. The newly created HFFG has 14 distributor centers, 340 refrigerated vehicles, nearly 1,000 employees and is supported by 2 call centers in China. The combined entity now serves over 10,000 restaurants in 21 states. The total acquisition price was $577mm and HFFG issued 30.7mm shares of its common stock to B&R shareholders. Goodwill was $406mm of the $577mm acquisition. Based on HFFG’s disclosure, we estimate the acquisition was done at nearly ~30x EV/EBITDA.
We believe a short is compelling at these levels for the following reasons:
1.The B&R Global deal was presented as this revolutionary deal that transformed the company into a leading food distributor. While Covid is clearly playing a role, within 7 months of deal closing HFFG took a $338 goodwill write-down which represents 59% of total deal price and 83% of goodwill booked. Moreover, we believe B&R Global saw EBITDA declines of 25%+ in 2019 vs. 2018. We have yet to truly understand why that business saw that type of EBITDA decline pre-COVID.
2.The level of related party transactions is eye popping. The words “related party/related parties” are found 60 times in their 2019 10K and 71 in their Q1 10Q. In fact, this was the key reason for the short write-up a few months ago from Hindenburg Research (“https://hindenburgresearch.com/hf-foods/"). As of March 31st, HFFG has $5.9mm of AR associated with related parties vs. $4.2mm as of December 31st. We find it amusing that within 2 months of closing their biggest deal, B&R Global, HFFG decided to spend >$100mm on acquiring warehouse assets owned by one of B&R’s owners who is now a shareholder in HFFG.
3.Valuation and leverage vs. peers make absolutely no sense. Based on PF 2019 EV/EBITDA, HFFG is trading at 16.4x with leverage of 4.4x vs. SYY/USFD EV/EBITDA of 9.5x with leverage of 3.4x. Based on annualized Q1’20 EBITDA, HFFG is trading at 32.2x with leverage of 8.7x vs. SYY/USFD/PFGC EV/EBITDA of 14.2x with leverage of 5.6x.
4.While some could argue that HFFG’s multiple premium could be supported by better overall growth as they have just become the dominant Chinese restaurant distributor, this is vastly different than what has been exhibited in underlying trends. Using calendar Q1 as a proxy, HFFG exhibited EBITDA decline of 57% on sales decline of 16%. As a comparison, SYY exhibited an EBITDA decline of 30% and USFD posted EBITDA declines of 24%.
5.If valuation, poor relative trends and self-dealing was not enough, we believe HFFG may actually be the worst positioned distributor given their core focus on the Chinese restaurant industry. While we have not been able get the most accurate data, the total # of Asian restaurants in the US is ~70,000 by our approximation. However, about ~50% are tied to chains (e.g. P.F. Chang’s). That means about ~35,000 are independent, family-owned restaurants. Given HFFG’s disclosure that the PF business serves 10,000+ restaurants and their own admission that “most Chinese restaurants serviced by HF Group are operated and owned by individual families with very few workers, who are usually immigrants from China or second generation Chinese Americans,” we believe HFFG has very little exposure to chains. This is a crucial to understand because chains are the ones that are most likely to survive post Covid. A few Google searches indicates that 20-50% of all independent Chinese restaurants may seize to exist in 6-12 months (see below). Moreover, HFFG currently has 25% of its sales tied to buffet style restaurants.These businesses are unable to pivot to food delivery in the same manner as others and may not survive without a vaccine discovery.
6.Larger players such as SYY are viewed favorably due to new market opportunities and the ability to take share from challenged distributors during more difficult times.Given HFFG has higher leverage than its peers and operates in a niche market tied to single location family restaurants, it is likely that HFFG loses share over time.There are also some very profitable emerging chains coming out of China (Din Tai Fung and HaiDiLao for example) that are expanding rapidly, displacing smaller shops.As noted above, HFFG is not tied to these winners.Additionally, the lack of scale as compared to the larger players limit the company from moving into new markets for additional business.
So in summary, we believe HFFG will never come close to earning what they achieved in 2019 given the majority of their customers are significantly strained and a third of their customers will not survive. Based on current peer multiples, HFFG shares are worth $1.47-$3.20, or 58% to 81% downside. However, if we assume their EBITDA could be impaired given a large % of their customers are going to go out of business, the shares could be worth <$0.50.
PT based on 2019 EV/EBITDA
PT based on Q1'20 Annualized EV/EBITDA
PT based on Adjusted 2019 EBITDA
Price target @ Multiple:
Note: While some may argue that we should give them value for the land/warehouses they bought in early 2020 (the related party transaction), we are excluding that from our valuation because we are also not giving credit to SYY, USFD for the warehouses, distribution centers and the land they own
Disclosure: At the time of publication, the author of this article holds a position in HFFG. This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.
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