Cafe de Coral's Latest Financial Report: Hardly A Feast For Investors

The popular Hong Kong fast food chain's revenue, profit and gross margin all fell in its latest fiscal year, as it suffers from fundamental shifts in its home market

Key Takeaways:

• Café de Coral's revenue sagged 1.4% in its latest fiscal year, while its profit plunged nearly 30%
• The popular Hong Kong fast food chain's gross margin also fell to 10.4% for the year, amid rapid changes on the city's dining scene

Café de Coral Holdings Ltd. (0341.HK) has been Hong Kong's dominant food chain for half a century, but its age is showing lately, as it fights to retain local diners in the face of a sluggish economy and changing dining trends.

The company's gloomy picture was on display for all to see earlier this month in its latest financial report that was hardly a feast for investor eyes. Its revenue declined 1.4% to HK$8.57 billion ($1.09 billion) in its latest fiscal year through March, while its profit sank 29.6% to HK$233 million. Even excluding fair-value losses related to property assets, the company's profit was still down 25.2% to HK$330 million. Café de Coral's gross profit margin also fell 1 percentage point to 10.4% during the year.

The company blamed the misery on an economic slowdown, as well as "weak consumer appetite, outbound travel and consumption of Hong Kong residents." It also pointed the finger at "intensifying price competition in the Mainland," a reference to Mainland China, where many of the company's customers are now flocking for weekend daytrips and getaways, drawing away one of its most important sources of business.

Investors could shrug off the weak year as just a blip on the radar, especially as Hong Kong's economy continues to suffer from a post-pandemic hangover. But what could be more worrisome is the possibility that the former Hong Kong king of casual dining, and its home restaurant market, are descending into a structural crisis.

Cross-border migration

Among the challenges facing Hong Kong, front and center is a growing trend to cross the Mainland border to Shenzhen for better and cheaper dining choices. Hundreds of thousands of Hong Kongers now make such trips on weekends and holidays, leaving less traffic for restaurants in Hong Kong. Instead of seeing a gradual return of diners as interest in such Mainland daytrips wanes, the situation has only gotten worse. Now, many residents are flocking even further into the Mainland, traveling not just to Shenzhen, but also other nearby cities like Zhuhai and Zhongshan.

Among other things, Mainland restaurants are generally more affordable to budget-conscious Hong Kong consumers. The Mainland's much larger land area also provides more diversified shopping opportunities and room for larger and more restaurants with lower rents. That contrasts sharply with Hong Kong restaurants, which are known for their limited space, prohibitive rents and higher prices.

Given such trends, an obvious solution for Café de Coral might be to follow the flow and set up more shops across the border to capture demand from wandering Hong Kong diners. But the fact is that such a move is easier said than done. While the Mainland market is huge and holds big potential for successful players, finding such success has been no easy matter for Hong Kong restaurants, including Café de Coral.

Earlier effort

In fact, Café de Coral is no stranger to the Mainland. It first set its sight on the market as early as 30 years ago but finally gave up after years of going nowhere. First it failed in Northern China, where tastes are quite different from those in its historic base in China's South. Later it also shuttered all its stores in Eastern China in 2017, leaving Hong Kong-adjacent Guangdong province as the only Mainland area where it maintained a presence.

Its downfall owed at least partly to its failure to cater to the palates of Mainland diners. While Hong Kong cuisine is known for being mostly light and mild, many Mainlanders enjoy variety in their diets and often prefer stronger and spicier flavors. The higher prices typically charged by foreign chains like Café de Coral also put off Mainland diners, who often tried out the chain and then never went back.

In an earlier era, Hong Kong chains could also take advantage of a slightly exotic aura among Mainland Chinese for anything associated with the former British colony. But those days are now long gone. As China's economy takes off and local consumers look farther afield for new and exotic flavors, their admiration for Hong Kong cuisine has rapidly faded, bringing another major barrier for Cafe de Coral in the Mainland market.

What's more, the conservative company, always protective of its profit margins, is hardly cut out to engage in the type of race-to-the-bottom cutthroat competition that repeatedly plays out on the Mainland. Many Mainland restaurant brands use a franchise model to give them thousands of shops across China. But most Cafe de Coral restaurants are self-operated, which naturally constrains its ability to expand and gain scale.

Rise of "two-dish meal boxes"

Its failure to crack the Mainland market aside, Café de Coral and its peers are also having to deal with structural shifts on Hong Kong's own dining scene. While fast food diners and traditional Hong Kong-style cafes were historically a go-to place for low-income residents, the rise of "two-dish meal boxes" is hitting both types of restaurants hard. Such boxes are mostly delivered on a takeout basis, making them cheaper by eliminating the need for physical dining spaces. The average two-dish meal box costs just over HK$40, or far less than traditional combo meals at low-end restaurants typically costing HK$60 to HK$70.

Local Hong Kong eateries have also had to contend with an influx of Mainland restaurant chains, including names like Tai Er Sauerkraut Fish, Baheli Beef Hot Pot, Muwu BBQ and Xiao Noodles. Those Chinese cousins are far more experienced at luring diners with low prices, sometimes selling below costs to outmaneuver their rivals. Such cutthroat new entrants could significantly erode Cafe de Coral's market share, adding to its investors' concerns.

In an earlier era when Hong Kong's economy boomed on its status as a window to China, well-managed local companies could always make it through the temporary downturn to prosper in the next boom cycle. But those days increasingly look like a thing of the past that's unlikely to return. With such major structural changes taking place all around it, Cafe de Coral's best days could well be behind it already.