Xiao Noodles Tempts Hong Kong Investors With 'Cheap Eats' Story

China's fourth-largest noodle chain has filed for an IPO, reporting its revenue grew 34% in the first half of this year as consumers gravitated to its affordable food

Key Takeaways:

• Xiao Noodles' Hong Kong IPO application could attract strong investor interest due to its focus on the lower end of China's restaurant market
• The noodle chain's revenue rose 34% in the first half of the year, far faster than its rate of new store openings, as its profit nearly doubled

The rapid rise of "poor man's meals" is providing a feeding frenzy for restaurants at the bottom of China's food chain, as increasingly frugal consumers who still want to dine out search for the cheapest meal options. That trend is providing a boom for noodle chains that typically occupy one of the bottom rungs of the restaurant food ladder due to the low costs of their fare.

One such chain, Guangzhou Xiao Noodles Catering Management Co. Ltd., is hoping to sell investors on its strong positioning in the "cheap eats" dining segment, filing this week for a new listing into one of Hong Kong's hottest IPO markets in years. The company is relatively small, with just 451 restaurants to its name at the end of June.

But many of its metrics look relatively healthy compared with some of its peers that are suffering from falling sales and tumbling profits. Xiao Noodles isn't completely immune from those trends, reporting recent declines in same-store sales, table turnover and average spending per customer.

But the company is defying the market in reporting strong revenue growth in the first half of this year that far outpaced its new store openings, showing more people are buying its food despite spending less per person. And the company's profits are also performing quite well, nearly doubling in the first half of the year.

Here, however, we should point out that one factor that appears to be driving the company's recent strong performance is ongoing subsidy wars by China's takeout dining delivery companies, which is encouraging value-conscious customers to eat more restaurant food at home. Other food chains have commented on this trend as well, and analysts are pointing out that everyone is likely to take a hit when the three major takeout delivery giants, Meituan, Ele.me and JD.com, start to cut back on their subsidy wars.

But for now, at least, Xiao Noodles appears to be offering a tasty alternative for restaurant-minded investors with its low-cost noodles. Such noodles are a Chinese fast-food favorite, accounting for nearly a third of the country's quick service restaurant (QSR) market, according to third-party research in Xiao Noodles' listing document. China's overall noodle restaurant market is expected to grow 10.9% annually over the next five years to reach a savory 510 billion yuan ($72 billion) in 2029, according to the listing document.

One of the biggest pieces of that noodle market is spicy fare from Chongqing and Sichuan province, which is Xiao Noodles' specialty. Sales from that segment are expected to outpace the broader noodle market with 13.2% annual growth to reach 135.7 billion yuan in 2029. Xiao Noodles was China's fourth largest noodle chain last year, based on gross merchandise value (GMV). But reflecting the segment's highly fragmented nature, which includes thousands of mom-and-pop noodle shops, Xiao Noodles obtained that status with just 0.5% share of China's massive noodle market.

Cheap eats

Xiao Noodles' fare is quite cheap, with an average order size of just 31.8 yuan at the company's self-operated stores in the first half of this year, or less than $5. That was even lower than the 38 yuan average ticket for leading fast food giant KFC in China during the second quarter, and less than half the 76 yuan for Pizza Hut in the second quarter and 73 yuan average spend per customer at the popular Tai Er sauerkraut fish chain in the first half of this year.

Like many of its peers, Xiao Noodles has been steadily lowering its prices to cater to China's increasingly thrifty consumers. It said such price lowering was the main factor behind a steady drop in its average spending per order, which has fallen 12% from 36.2 yuan in 2022 to the latest 31.8 yuan in the first half of this year. At the same time, the company's seat turnover rate has dropped from 3.9 in 2023 to 3.4 in the first half of this year.

The company has made up for the lower spending and seat turnover rates partly with an increase in takeout orders during the takeout delivery subsidy wars. It has also engaged in a relatively aggressive campaign of new store openings, which saw its restaurant count more than triple from 133 at the start of 2022 to 451 at the end of June this year, with another 101 restaurants in pre-opening preparation.

All these various trends translated to 34% revenue growth for the company in the first half of the year, as the figure rose to 703 million yuan from 526 million yuan in the year-ago period. Such growth was well ahead of its 8% rise in store count over the same period, and also came even as same-store sales for the company's self-operated restaurants fell 3.1% during the first half of the year.

The company doesn't really explain how it was able to post such strong revenue growth in the first half of the year despite the same-store sales decline and the relatively small growth in its store count. The big increase in takeout orders could help to explain it, if such orders aren't attributed to individual stores. And the company also notes that it's expanding aggressively in Hong Kong recently, where prices are generally higher than on the Chinese Mainland.

Xiao Noodles also looks quite good at running an efficient operation, reporting the operating margin for its self-operated restaurants has risen steadily in the last three years to reach 15.1% in the first half of this year. It notes that part of that greater efficiency is coming from opening more stores in areas outside of city centers with cheaper rents, and also from cheaper rents in general as China's property market remains sluggish.

The combination of strong revenue growth and improving margins has turbocharged Xiao Noodles' bottom line, with its net profit nearly doubling to 41.8 million yuan from 21.4 million yuan a year earlier. Its adjusted profit, which typically excludes stock-based employee compensation, more than doubled to 52.2 million yuan from 22.5 million yuan over that time.

At the end of the day, Xiao Noodles looks like a relatively strong proposition thanks to its focus on the lower end of the dining out market that's likely to thrive in the current climate of consumer caution. Its growth could slow somewhat when the takeout dining subsidy wars ease, which could already be happening. But any growth at all in the current market looks relatively impressive, and Xiao Noodles is posting some of the stronger growth we've seen.

Benzinga Disclaimer: This article is from an unpaid external contributor. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.