Consumer: Fraser & Neave Holdings Bhd

2 Permai, Tanjung Bungah, Penang by BSG Property

Introduction

F&N is mainly involved in the manufacturing of soft drinks (carbonated), dairy products and glass bottles and containers. It is the second largest F&B (food and beverage) company in Malaysia losing no.1 spot to Nestle Malaysia Bhd. The group has decided to exit from the glass business to unlock the value of its investment in Malaya Glass Products and fully focus on being a regional F&B enterprise. F&N completed the sale of MGP in July'2010 for RM710 million cash.

The group has also just sealed an agreement for the sales and distribution of Red Bull energy drink (all 3 Red Bull products) in Malaysia in April'2010. Red Bull has a very good presence within Malaysia as it is the leading energy drink with a 40% market share. With that, revenue loss from MGP disposal ~8% is being offset by the gains from Red Bull ~10% of revenue to F&N.

Not known to many, F&N also has a property division which has its focus on the development of Fraser Business Park with a gross development value (GDV) of RM350 million. Phase one has 80 shop/office units all sold out. Phase two is an ICT hub with HELP university college with hostel complex, services apartments, e-Hotel, retail entertainment space, hypermarket, food court and outlets with 1,800 parking lots. F&N has a signed lease agreement with HELP for a 15-year period.

Still ~98% of F&N's revenue comes from its core F&B line. With about RM1 billion in cash, F&N purchased a 23.08% stake in Cocoaland Holdings Bhd for only RM54.6 million in Aug'2010. With that F&N has just entered the snack food market in Malaysia. Cocoaland is the sole manufacturer of coco pie in Malaysia and a leading manufacturer for gummies in ASEAN region & also exports. This is in line with F&N's strategy and the synergistic deal is a win-win for both parties.

Fundamental

1. Does the company have an identifiable durable competitive advantage?

Being Malaysia's largest soft drink company it has a very established portfolio. 100PLUS, F&N Fun Flavours (like Sarsi & Orange that we always see at Chinese weddings), SEASONS and Fruit Tree & Coca-Cola products (to end in Sept'2011). Though not dominant, its dairy products hold a big punch with F&N Sweetened Condensed Milk, Teapot & Carnation (mamak stall favourite), Farmhouse and Magnolia brands. See below for portfolio pictures:

Soft drinks: http://www.fn.com.my/food.aspx

Dairies: http://www.fn.com.my/Dairies.aspx

2. Do you understand how the product/service works?

It's a consumer product no need for further explanation.

3. What is the chance that it will become obsolete (KO) in the next twenty years?

With brands that will continue to provide stellar performance for the company, answer is NO.

4. Does the company allocate capital exclusively in the realm of its expertise?

Yes & No. It previously has the glass division and now still with a property division. Though F&N is good at unlocking the values for both, in the end they realised it is best to focus on what they do best which is F&B and recent activities shows they are doing it.

5. What is the company's financial history and status?

Financial Chart 1 (updated)

Net profit margin after taxation and return of equity trends well except after 2007 to present due to increasing retained earnings after obtaining Nestle's liquid milk business. The 5-year average for the company vs industry vs sector is as below. Sector is more broadly categorised like Consumer while industry is much more specific; for F&N is it Prepared Foods.

• Net Profit Margin: 6.22% vs 5.80% (Industry), 6.07% (Sector)
• Gross Profit Margin: 27.50% vs 48.92% (Industry), 36.76% (Sector)
• ROE: 14.34% vs 12.27% (Industry), 14.33% (Sector)
• Revenue Growth Rate: 16.68% vs 6.32%, 9.99% (compounded annual growth rate)

[Updated] ROCE is the true return to shareholder equity without accounting debt being used as leverage. Because F&N used debts to finance their expansion on two new plants there is some gap to be filled between its ROE and ROCE since 2007. At the meantime it is fine as the ROCE is hovering at near industry levels meaning F&N is taking just a nice level of debt to create value for shareholders.

Gross margin is far from average. Cost of goods sold is high. Revenue GR of 16.68% is due to the 200% revenue increase of the group's liquid milk business it acquired from Nestle. I computed that the annualised average over 10 years is 7% which is more appropriate. Also this % is in line with the revenue growth rate of the industry and sector.

Financial Chart 2

Very nice chart showing consistent growth on both EPS and DPS. F&N has maintained a good ~70% dividend payout ratio to its earnings per share since 2005 and ~50% for the years before it.

 

6. Is the company conservatively financed?

With RM1 billion cash in hand, liquidity is not an issue but F&N has debts of about RM563 million which amounts to a DE ratio of 0.4 as of financial year 2009. Well it still below my threshold limit of 0.5. The bulk of the borrowings came during 2007 of RM330 million and subsequently another RM90 mil in 2008 and RM200 mil in 2009. All of these were needed for the liquid milk business it obtained from Nestle in the year 2007 & also for the two new plants in Pulau Indah, Malaysia and Rojana, Thailand.

Inventory turnover at 2.5 months is at a healthy level over the last 5 years, this simply implies that F&N is able to sell its good every 2.5 months and replace inventory with new goods. Receivable turnover is at 3.5 months on average of the last 5 years. This figure is okay too.  

7. Is the company actively buying back its shares?

Over 2008 and 2009 there were five buybacks of 12,500 shares which is not a lot. But F&N has treasury shares of 237,100 for use but not likely to be utilised given their abundant cash.

8. Is the company free to raise prices with inflation?

Yes and the group always has a habit of openly announcing price hike before it takes effect. Sugar is an important element for the manufacturing of dairies and soft drinks for F&N.

9. Are large capital expenditures required to update plant and equipment?

Oh yes. Started in Oct'2009 the RM350 million canned milk plant in Pulau Indah will be the largest in Southeast Asia when it is completed in early 2012. F&N also opened its dairy plant at Rojana, Thailand in Sept'2009 tagged at RM250 million price tag.

Discounted Cash Flow Analysis

Instead of using the 16.88% revenue growth rate, I will use my own computed annualised rate of 7%. To be really save I can also opt for 5% which was the rate before F&N acquired the liquid milk business from Nestle in 2007.

Operating Costs: 91% of revenue (distribution & marketing expense ~17%)

Corporate Tax: 25%

Capital Expenditures: RM150 million +7.5% each year (not factoring cost of new plants as 1 time only)

Depreciation: RM120 million +7.5% each year

Working Capital Cost: +5% each year in line with revenue growth rate

Discounted Rate: 10%

Fraser & Neave Holdings Bhd is fairly valued at RM11.18. The current trading price of RM14.28 is expensive and at a premium for purchase. The P/E ratio of F&N is at 22.78 with Industry at 26.95 while sector at 15.24. In my opinion overvalued at time of writing. 

If I were to put 7% revenue rate and working capital growth it is only fairly valued at RM11.93. To be frank the figures I put in my valuations for DCF are very conservatives so put some flexibility in there and I will still not overpay >RM12.50 for F&N.

Looking at the chart below, I am able to see a sharp spike followed by minor correction very recently. If I apply VSA (volume spread analysis) it is smart money toying with greedy investors as a higher high price together with lower low volume shows absence of momentum and pressure to sell which resulted in minor correction. Best not to jump into F&N now.

The very resilient share performance of F&N over the last 10 years

 

Conclusion

Let's start with competitors. In the soft drinks segment, F&N has to battle with: 

1. The Coca-Cola Company (TCCC) which is setting up a bottling plant in Negeri Sembilan to be ready by end of 2011 when F&N loses its right to sell Coca Cola products in Sept'2011. TCCC has no track record in Malaysia so it remains to be seen how well they can perform.
2. CI Holdings which has exclusive rights to bottle and distribute Pepsi and 7UP in Malaysia. CI launched Tropicana Twister an orange juice product which proved to be very successful. CI Holdings' financial record hasn't be nice either until Tropicana product made the figures better since 2008.
3. Yeo Hiap Seng with Brands like Yeo & Justea and is market leader in soya bean and tea (herbal and chrysanthemum) drinks. YHS is in the blues with continuous falling share price after losing rights to sell Red Bull to F&N and lower sales in Indon due to cancellation of 15/31 of Yeo's product pending new registration.

To counter the loss of Coca Cola, F&N has earmarked up to 50 drink variations to be launched in 2010-2011. F&N also has plans to expand market reach of its drinks as exports particularly Indonesia which is evident on its new plant in Pulau Indah to support that. F&N lost Coca Cola rights because they were unhappy that F&N did not improve the sales as much as it did on other line of products. According to CEO Ng Jui Sia, Asians have preference of fruits juices over carbonated soft drinks. TCCC was established because it thinks it can do better than F&N.

Now we take a look at dairy segment which contributes more revenue than soft drinks to F&N.

1. Dutch Lady Milk a solid company which I wrote before. F&N Carnation has the largest market share 60% in condensed milk but the liquid milk business belongs to DLady. Financial record is good for DLady so F&N will need to maintain its lead on condensed milk.
2. Malaysia Milk Sdn Bhd but is not listed. Sellers of Vitagen, Marigold products including the Peel Fresh line, mlik, yogurts, jelly and condensed milk. Vitagen is quite untouchable and Peel Fresh providing a lot of rivalry to F&N's juice products.
3. Nestle Malaysia the biggest F&B player by market capitalisation. It is generally dominant in powdered milk products and fortified drinks such as Milo, Nestum etc. Nestle does many things with a portfolio of over 300 products under several brand names. Though size matters it does not rule the liquid milk business nor fruit juices nor soft drinks.

Overall F&N has many work to do here and is keen to expand through exports and the new dairy plant in Pulau Indah slated to be ready in early 2012 is going to be a regional hub for F&N's export activities to Indonesia and to serve the local market. Whereas the new plant in Rojana, Thailand will be used as a staging point for the group's eventual entry into the Indochina region that has about a population of 220 million people (Cambodia, Laos, Myanmar and Vietnam).

F&N the Lion King?

With still a lot of cash in hand, F&N is still looking for more M&A (merger & acquisitions) opportunities. Cocoaland is just the beginning and it was a good deal buying at a discount and a win-win for both parties. Market is tough and intense as seen in the net profit margins of less than <10% across most F&B companies. With focus fully shifted on soft drinks and dairy products, F&N is on the right track at least.

I am not so worried about the debts being used as leverage because it is needed and has the financial power to pay it off in less than 3 years. F&N has been managed very well for many years and is expected to continue to do so. With good ROE figures, consistent capital appreciation & decent dividend payouts, F&N is a buy for me on this good blue chip stock. F&N do exports to more than 20 countries and that fits my criteria.

Buying into F&N at the right time might be difficult as the major shareholders consist of parent company Fraser and Neave Ltd at 57.33% and Permodalan Nasional Bhd at 24.24% thus leaving little room for free float. Swapping DLady for F&N is a viable choice as DLady does not export. Will wait and see if any news could rock the share price down a little or at least put it at a fairly valued price. Btw this is my Raya goodie though one day late haha. Happy Aidilfitri to all my readers :)

Tech Talk Bursa Malaysia WW36

Looking back at the previous week's tech talk.

1. RSI has high area of overbought signal which is greater than previous week WW34. Strong bullish activities. No swing test and no divergence signal. 40-50 support line still unbroken.
2. MACD also shows signal level of overbought which is higher than in mid March and mid April in which both resulted in some minor correction. KLCI not performing anywhere near centerline & no crossover expected.
3. Resistance set at 1430-1450 points while support level is at 1390-1370 points.

The KLCI broke the lower resistance barrier that I have set and settled down at 1435 aided by encouraging macroeconomic data from China and latest US data showing the world’s largest economy appearing not in great risk of falling back into recession.

Relative Strength Indicator (RSI)

Chart Setting: SMA 1, RSI (14, 20), Mar'10 to Sep'10

Still trending at overbought signal area but we see some profit taking activities towards the end of the week. No swing test and no divergence signal expected in coming week but do note that sellers dominated the trading floor on the last day.

Moving Average Convergence Divergence (MACD)

Chart Setting: EMA 12, EMA 26, MACD (26, 12, 9), Mar'10 to Sep'10

Now we start to see some signal of correction just like it did on mid March and mid April. KLCI not performing anywhere near centerline and thus crossover again is not expected for the coming week.

Resistance and Support Level

Chart Setting: Mar'10 to Sep'10 (6 months)

New resistance now set at 1450-1470 points while support level is now at 1410-1400 points (the KLCI psychological barrier).

In a Nutshell

Interestingly the market has been up for three consecutive weeks despite suggestions & my pessimistic views that valuation are expensive. I think many people see no reason to go against the tide apparently and this is common in the world where greed takes over logically thinking when times are good.

Once again I will say that it is about time the market consolidates and correct itself. Perhaps professional money will react in the coming week and short for profit taking to the expense of amateur greedy investors.

Trading/Services: Parkson Holdings Bhd

Introduction

Formerly known as Amalgamated Containers (ACB) but exited from the dry cargo container manufacturing in 2002 after 12 years of trying. Following the exit, it ventured into three core activities which are motorcycle/automotive, steel services and international trading businesses. Again except for East Crest International Limited, whose principal activity is investment holding, the activities of all other subsidiaries and its associate were discontinued upon the completion of the disposals of the subsidiaries and associate on September 19, 2007.

Eventually the company changed its name into Parkson after acquiring the brand from Lion Diversified its retail assets. The Company acquired new subsidiaries whose principal activities are in the operations of department stores. On June 11, 2008, the Company acquired Prime Yield Holdings Limited. On June 11, 2008, the Company’s subsidiary, Parkson Corporation Sdn Bhd, also acquired Kiara Innovasi Sdn Bhd. In October 2008, the Company acquired a 30% interest in Nanning Brilliant Parkson Commercial Co., Ltd and the list goes on.

Lion Group boss Tan Sri Wiiliam Cheng holds a 21.9% direct equity stake and 32.5% indirect stake in Parkson Holdings Bhd. Amstell Mills Sdn Bhd also a Lion Group's steel product unit holds a 14.88% direct stake. Meanwhile Parkson Holdings owns a 51.5% stake of Parkson Retail Group which is listed in Hong Kong Stock Exchange and provides exposure to China market.

Now Parkson is a pure regional retail player and operates as you know the "Parkson" brand in China, Malaysia and Vietnam. It has 35 stores in Malaysia. In China, it is the largest department store chain with 43 stores across 26 major cities. The China retail operations are listed on the Hong Kong Stock Exchange via Parkson Retail Group in which its investment arm, East Crest International holds a 55% equity interest. In Vietnam it has 6 Parkson department stores (Ho Chi Minh City, Hai Phong and Hanoi). 

Fundamental

1. Does the company have an identifiable durable competitive advantage?

Being no.1 in China, Malaysia and Vietnam as the largest department store chain is something to boast about. Competition in China is nevertheless heating up with foreign retail players like Wal-Mart Stores Inc and Carrefour SA but they are less than half Parkson's size and operate in quite a different market segment. China also has many many small retail players. In Vietnam, Parkson is dominant while in Malaysia it faces off Isetan, Metrojaya and Tangs in which both are not as big as Parkson either.

2. Do you understand how the product/service works?

Parkson's business model is one that not many people are familiar with. Its focus is on asset-light strategy where it does not own many properties but letting out space to branded names with long term leases and gets commission from sales (called concessionaires). Parkson does not tie up its cash with unsold inventories therefore not an operating expense to worry. The inventory is handled by the manufacturers of the brands instead. 

3. What is the chance that it will become obsolete (KO) in the next twenty years?

Not through my eagle eyes haha. Retailing has been an ever increasing business line since the days shopping malls started. As long as you have a growing population or a big base of population with improving income levels, retailing will always survive as people need somewhere to dispose their hard earned cash.

4. Does the company allocate capital exclusively in the realm of its expertise?

Yes. Ever since it has gone into pure retail in late 2007, it only has plans to expand in its expertise which is retailing. Long gone are the days it tried to venture into different fields. Their said natural expansion will be into the Indochina retail market namely Cambodia (Phnom Penh) in 2012 and also to strengthen their grip in China, Malaysia and Vietnam with 12 additional stores by end of 2010 spending around RM250 million in the process.

5. What is the company's financial history and status?

Financial Chart 1 [Updated]

Net profit margin after taxation and return of equity trends well. I took off the 2007 growth rate as it was 400% after divesting old businesses and go into pure retail.  Also I had to use the 3-year average for the company vs 5-year average of the industry (I have no idea how to get the 3-year average of the industry) is as:

• Net Profit Margin: 23.40% vs 1.29% (Industry), 12.04% (S&P 500)
• Gross Profit Margin: 62.59% vs 22.72% (Industry), 28.88% (S&P 500)
• ROE: 25.76% vs 6.65% (Industry), 10.16% (S&P 500)
• Revenue Growth Rate: 10.34% vs 8.31%, 9.93% (compounded annual growth rate or CAGR)

[Updated] ROCE the true returns to shareholder equity is half of the ROE. If you read on later you will know that Parkson has debts and a lots of them. This big gap between ROE and ROCE simply means Parkson has been able to create so much value to shareholders because it is leveraging a lot from debts. Nevertheless, they have been paying it off as scheduled and you can see that a convergence could very well happen in 2010 or 2011 assuming they continue to par down the debts. With so much cash in hand, they could also close the gap in just one year.

Ignore the pre-retail years (<2007). Earnings Per Share has been on the rise in post-retail years (>2007) with a growth rate of 10.69% thanks to strong retailing income and the divestment of non-profitable business lines. 

Parkson does not have a dividend policy yet but it has been paying out almost half their earnings as dividends to shareholders. Thus there is no clear financial number to show how strong their dividend payout is. A 50% payout ratio is probably a good estimate.

6. Is the company conservatively financed?

Parkson does have a lot of cash in hand with RM2 billion as of 2009. BUT they do leverage on debt as well also around RM2 billion. DE ratio has been at 1.67 (2007), 1.53 (2008) and 1.16 (2009), it is on the downtrend. A ratio greater than 1 indicates that a company has more debt than assets but don't forget Parkson runs on asset light strategy. They managed to par down the ratio by acquiring new assets (new department stores) & improve shareholder equity. If they really do want to pay off they can just do it with that big pile of cash in hand.

7. Is the company actively buying back its shares?

There were many buybacks since 2008 until now. Buybacks turn shares into treasury so in 2009 there was a 1:100 treasury share distribution to each investor.

8. Is the company free to raise prices with inflation?

Parkson does long term leases and profit sharing with their brand partners. As far as Parkson is concerned, it can only raise the price of leasing and have no control on product selling price.

9. Are large capital expenditures required to update plant and equipment?

Reasonable large as Parkson is targeting a 15%-20% retail space growth annually or 9-12 new stores, China (5-6), Malaysia (2-3) and Vietnam (2-3). Parkson also needs cash for potential merger and acquisition opportunities and retail property acquisition. This is why they do not want to simply use they big horde of RM2 billion cash in hand to pay of debts unless absolutely necessary. 

Discounted Cash Flow Analysis

I only have 3 years worth of historical results of Parkson to try and project the revenue for Parkson in the next 5 years. Instead of using 10% revenue growth rate, I will use 7% to be slightly conservative.

Operating Costs: 70% of revenue

Corporate Tax: 25%

Capital Expenditures: RM300 million growing 10% each year

Depreciation: RM125 million growing 10% also each year

Working Capital Cost: 5% each year as asset light model does not require a lot

Discounted Rate: 10%

Parkson Holdings Bhd is fairly valued at RM6.60. Yes you heard me :) The current trading price of RM5.48 puts it at a big discount. The P/E ratio of Parkson is at 21.07 with S&P 500 at 16.10. It shows you high multiple which an investor is willing to pay RM21 for RM1 of current earnings for the stock. The China retail industry PE is 20.9. A high P/E ratio could also indicate that the market has high hopes for this stock's future and bid up the price. It could also mean it is an overpriced stock. With DCF saying otherwise and other retailers in China with the same PE valuation, Parkson's PE is normal in such industry in my humble opinion as investors remain upbeat with high expectations in this sector.

The stock came crashing down hard before the 2009 meltdown after restructuring of ACB selling off its steel service and electronics business. During the meltdown instead of going down it gradually increase to date. 

One reason why Parkson has not been trading at its fair value is because there is lingering concern of the state of other companies under the stable of the Lion Group. Lion Crop, Lion Diversified, Lion Industries are all in net debt positions. Amsteel Corp Bhd and Silverstone Corp Bhd were also removed from Bursa Malaysia before due to debt problems. The Parkson stock does not command the premium it should because investors are concerned with the health of the other companies though not related directly except for having the same major shareholder, Tan Sri William Cheng.

Conclusion

Parkson is the single one company in Malaysia with tremendously large exposure to China consumer market. China having recently just taken over Japan as the world's second largest economy will see China consumer spending taking off as the government is switching growth from expansionism to sustainable growth via domestic spending. Similar to the model in the United States which resulted in the world's biggest consumer market to date. Although it is already the largest department store chain in China the scope for expansion is still tremendous.

I like Parkson so does Tan Teng Boo, fund manger of iCap because it provides a cheaper alternative to the robust China retail consumer industry at undemanding valuations. RM5.50 vs Parkson Retail Group of ~RM6.80. With operations in Malaysia providing consistent profitability & the already profitable but small Vietnam operations, prospects for Parkson looks good. Vietnam with a population of 80 million people is in a current economic state which is quite similar to China 20 years ago which will undoubtedly grow as a powerhouse in the Indochina region. Vietnam will one day surpass the earnings of Parkson Malaysia.

If you are one that has tried to invest in China equities via funds I am quite sure to say that they are not performing well as you expected right haha. This is mainly due to China stock market that is speculative in nature and the performance of its index does not correlate very well with the economic growth. Why not go with Parkson Holdings? I also foresee that Parkson Holdings will have a dividend policy in order to maintain its status as a cash-generating jewel or cash cow. Almost all companies that generate a lot of income sooner or later will begin rewarding shareholders via good dividend payouts (Panamy, DutchLady, GenM to some extend and etc).

If you are like me holding some shares in ICAP, then you already have exposure to Parkson Holdings. At RM5.50 I would still choose to go into Parkson Holdings directly and hold it long-term 5, 10 or maybe 15 years until you see China overtakes US as the world's largest economy estimated to be in the year 2030-2035. I need to say this: Buying into Parkson is an aggressive investment perhaps one of my most because:

• The Lion Group does not have a good track record but Parkson is totally a different entity just the same boss.
• Parkson has debts and the ratio is more than 1. I would normally not invest in companies with more than ratio 1 but I have said before there are exceptions, very few.
• Little data only 3 years since it went into pure retail although Parkson brand started in 1985 but there was no accounting records I could find.
• China arena is nevertheless competitive. The country is simply too big for just one player to dominate unlike Malaysia.

If you have the appetite to eat such calculated risks & be as optimistic as me then you are OK la if not I would recommend ICAP instead of Parkson directly. I still can find something cheap at such bullish times. This is my Merdeka present for all my readers :) Happy 53 years old Malaysia!