Tuesday, June 25, 2013

Northgate's 2013 Results

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.

Here’s its free cash flow history:

Here’s what its valuation looks like:

Corrected:  July 9th

This is how I arrive at 700p:

Disclosure: I am long Northgate

Thursday, June 20, 2013

More on Emeco Holdings

Some things it is helpful to know about Emeco:

“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.”



And a long presentation by the CEO here.

Disclosure: I am long Emeco

Wednesday, June 19, 2013

Portfolio Update

I’ve bought some shares in Emeco Holdings at ~AUD 0.310 (or <2x trough FCF). 

Thursday, June 13, 2013

Epicentre Holdings

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.

Longer videos featuring the CEO are here and here

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.

Friday, June 7, 2013

ConscienceFood Holding (Continued)

So, what’s going on?

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.

Disclosure: I am long Consciencefood Holding

Thursday, June 6, 2013

ConscienceFood Holding

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 Indofoods and 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.

Amended: June 8 2013

Disclosure: I am long Consciencefood Holdings.