Northgate reported its FY 2013 results todays The company incurred a £54 million charge
in order to reduce its interest expense from 7.1% to 2.8% . The lower interest
charge translates into $20 million in additional annual after-tax cash flows to
equity.
“A large part of
our sustaining capex is the replacement of machines at the end of their useful
life. We can therefore naturally contract certain asset classes within our
fleet where we see lower demand for them over the medium term and use the cash
to retire debt. I refer to this as “right sizing” the balance sheet to the
earnings of the business through the cycle.”
Epicentre
Holdings is a Singapore-listed “Apple Premium Reseller”: it retails Apple
products and third party accessories (iPad covers, speakers, etc) in Singapore
and Malaysia.
The business model is simple enough: pull people into one’s
stores by offering Apple products at a slim margin and make one’s money on the
accessories, the after-sales service, and so forth. Not complicated and there
are probably only three ways to muck it up: (1) People no longer like Apple
products; (2) Apple decides to sever its relationship with Epicentre; (3) the
Singapore Dollar takes a nosedive.
The last of these is, for our purposes, the item of interest.
The USD has appreciated against the Singapore dollar. Since Epicentre buys its
Apple-branded inventory in USD, its
gross margins on Apple products have nosedived, turned negative, and made their
effects felt all the way down the income statement. Plunging earnings, plunging
share price.
Epicentre has now negotiated an arrangement with Apple whereby
its Singapore operations (80+% of revenue) may now buy Apple-branded inventory
in Singapore dollars. Its Malaysian operations (<20% of revenue) will
continue to buy in USD.
The upshot is that gross margin should improve by a minimum
of ~3.6% and that the earnings margin should therefore improve to a minimum
~4.0% . A 4% net income margin on SGP $180
million translates into an earnings yield of ~41%. And, since Epicenter pays
out 85%+ of its earnings, it seems reasonable to expect a forward dividend
yield of 35%.
There are some other factors that justify more upside to the
valuation – the announced exit from the loss-making presence in PRC, immature new
stores in Malaysia, investments in “customer-centricity” that have
been expensed – but these are immaterial to the investment case at the current share
price.
The shares are illiquid and any buyers will be competing
with the company itself.
Disclosure: I am long Epicentre and intend on buying more
shares.
The dirty shop window: It’s hard to see what’s on offer
unless one actually reads CSF’s quarterly and annual reports. The financials,
as reported, look like this (give or take some minor rounding errors):
The notes to the financials and management’s discussion
and analysis add the following information:
First, CSF had tried to make a go of adding snack noodles to
its repertoire. But the demand for snack noodles just wasn’t there. The gross margins
were thin or negative, the opportunity cost of using the production lines for
snack noodles rather than for instant noodles were therefore high, and CSF stopped
making them.
Second, CSF invested in, and opened, a factory and warehouse
complex 30km from Jakarta in order to serve western Java. Soon after, however, that
complex was subject to a major fire, causing Rp. 27 billion in damage to
property and inventory and slowing production to 30% of what had been its capacity.
In addition, an additional Rp. 11.6 billion in G&A expenditure was tied to
that plant and that spending was therefore mostly unproductive in 2012. The factory
should be up and running at full tilt in the second half of 2013.
Third, CSF’s marketing and distribution costs rose by 84% in
2012 partly for the purpose of establishing a distribution system to service
Western Java and partly to promote the full launch, in 2013, of its line of
beverages. Capital spending also rose. These increased expenses and capital investments
had little or no corresponding revenues in 2012, and margins and asset turns
were therefore crushed:
So, as I say, that’s part of it. No-one likes to see such a
steep collapse in margins and turns and, if one hasn’t read the filings and if
one is also of the view that big is beautiful everywhere and every time (that,
for example, Coke will see off Irn-Bru) then one will read in these numbers cause
for alarm: this is just the start and it’s going to get worse; “reversion
to the mean” and all the rest of it.
What else?
The custom in the Singapore exchange is for listed companies
to pay dividends. It is so much the custom that it is quite normal for companies
go public and pay out dividends in their first quarter of being listed. Following this norm, the declared dividend
policy in CSF’s IPO prospectus was 20% of earnings. CSF paid out dividends in 2010 and 2011. But
in 2012 it amended its dividend policy: henceforth it would pay dividends in
the absence of capex claims on cash. In
2012 it didn’t pay out a dividend.
And these two overall factors – dirty windows, dividend policy
– are the long and short of it. I don’t think that they add up to an enterprise
yield of 30% but the market apparently does.
There’s a lot more to say – about the cup noodles and
beverages, about CSF’s prospects in the Jakarta market, etc – but I’ll leave it
at that. If you’re reading this and are interested in researching it further,
you should know that the market for the stock is not as illiquid as it may appear:
there are days when no shares trade and there are days when 600,000 shares
change hands; it wouldn’t take a month to buy $100,000 worth.
Consciencefood
Holding (CSF)
is a Singapore-listed Indonesian company that makes and sells just under a billion packs of instant noodles annually in Aceh, North Sumatra, Riau, Jambi, West Sumatra and South Sumatra.
Its sales in Aceh and North
Sumatra account for half of its revenues and its market share in these two
northernmost provinces of Sumatra exceeds 50%. In Sumatra overall, its
market share is 30%. (At 50 million, Sumatra is as populous as England and more
populous than California).
Which is nice because instant noodles are an
Indonesian staple: its population consumes more of it per person than any people
but the Koreans. (As a point of comparison, Americans eat 46 slices of
pizza per person per year).
Indonesian consumers often buy instant noodles by the carton, each carton containing 40 packs.
Whereas CSF's position in Sumatra (and Northern Sumatra, especially) is
strong, it is nevertheless a midget in the overall Indonesian instant noodle
marketplace: it operates in the shadow of the two giants of the instant
noodle business in the country – Indofood CBP Sukses Makmur and Wingsfood –
whose market shares in Indonesia overall are ~75% and 15% respectively
Indofood
CPB’s “Indomie” brand, in particular, is so popular that “Indomie” is
synonymous with "instant noodles" in much of the country. In the
diagram below, pulled from an analyst report on Indofood CBP, “Alhami”, CSF’s
principal brand and accounting for half its sales, doesn’t even merit a
mention. (CSF’s national market share is, in fact, 4.5%).
Instant noodle brand share in Indonesia. At first glance, this
situation looks ominous: what chance does CSF have in defending its market
share against a goliath like Indofood CBP and at what cost?
And yet, the history of the instant noodle market in Indonesia points to an altogether more
optimistic outlook for CSF.
Indofood’s market share in 1999 was actually 20%
higher than it is today. You need wheat flour to make instant noodles, and
Indofood had a lock on wheat flour imports and wheat flour milling; no wheat
flour for anyone else, no competition. Deregulation in the aftermath of the
“Asian crisis” of that period, however, meant the end for Indofood’s control of
wheat flour and this, in turn, allowed other firms to contest the instant
noodle market.
No wheat flour, no noodles.
Now, it seems to me that there are two very different ways
to enter the market. The first way, available to deep-pocketed entrants, is to
launch in Java and wage a very expensive price war with Indofood, imposing
serious losses on Indofood and oneself, taking market share, and then calling a
truce. This is the approach that Wings Group took and the four year (2004-2008)
price war between Indofood’s “Indomie” and Wings Group’s “Mie Sedaap”
– a
Javanese cockfight, if you like – is a celebrated episode in recent
Indonesian business history. The unofficial terms of the truce? Indofoods
sets the prices and Wings Food matches it. It's been that way since late 2008.
The other way, of course,
is to focus on a niche: pick your geography and demographic; develop, test,
market, and launch products for that demographic; build a dense distribution
system (Makro, Carrefour and Hypermart; mini-marts, wet markets, and
neighborhood grocery stores); and let local economies of scale and brand habit
do the rest
An analyst checking out the Carrefour in Median: the shelf space occupied by Alhami was 60 to 70 meters across.
CSF’s instant noodle offerings are positioned as
healthy and certified halal (hence “Consciencefood”), and are flavored to
correspond to the range of popular north Sumatran dishes. In addition, all of
its fixed costs – the production lines, the warehouses, the trucks, the
TV/radio/promotional spending – are all concentrated on sales within a 300 km
radius of Medan.
This latter approach, therefore, takes market
share without imposing losses on oneself since one’s average unit cost is lower
than Indofood’s. In fact, one can price the noodles at 10% below
Indofoodsand make a fatter profit.
To see why, one can run the numbers in full or
one can take a shortcut. Consider the box of 40 packs of noodles pictured
above. That box of instant noodles retails for about ~US$5.50 in local
currency. How many boxes fit in a truck that can navigate Indonesian roads? How
much would it cost for a truck to transport those boxes from Java to Medan and
back? Multiply that problem by a 25 million boxes a year and one can appreciate
the scale of the problem.
Local scale is important enough that the retail price of
imported (Japanese, Korean, etc) brands of instant noodles is 10x to 30x that
of Alhami, CSF’s premium product.
Between 1999 and 2010, then, CSF had taken more than half
the north Sumatran market away from Indofood, was growing at 18.6% a year, had
maxed out its production capacity and, in order to extend its reach into Java,
had hired a third party manufacturer to make its noodles in Jakarta.
At the same time, it had big plans for the future: it wanted
to take control of manufacturing in Java; and it wanted to leverage its
brand by entering the markets for cup noodles and health drinks. Cup noodles
and soft drinks sell for 5x and 3x the price of a pack of instant noodles so
the margin prospects are that much more attractive.
So CSF went public in 2010,
with the owner-operator Djoesianto Law selling ~45% of his stake.
Let’s pause here for a moment and consider the value of
CSF’s instant noodle business.
Note: The marketing,
distribution and G&A expenses are unallocated. Total corporate marketing
expense in 2012 was 32.6 billion Rupiah, an 83% increase over 2011: this increase in very large part represents groundwork for the launch of CSF’s line
of cup noodles and soft drinks in 2013.
Instant noodles are a cheap, fast, convenient alternative to rice. Consider Indonesia's long term per capita GDP growth rate (6%), its rate of urbanization (44%, growing at 1.7% per year), and the participation of women in its labor force (51%). Next, consider Medan's relative proximity to Kuala Lumpur and the cultural affinities between Indonesian Malays and Malaysians. Now, what's the correct multiple for this business? I'd feel lucky to buy the whole business at 8x earnings. Now consider how the market is pricing it:
A
P/E of less than 1.5x for a growing, branded consumer staple with some
moat-like properties? What’s going on? I’ll turn to that in my next post.
