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


  1. Great find Red. Have you been to Indonesia or SG out of curiosity? I never saw these when I was in Jakarta (or in SG, where a lot of Indo snacks are imported to satisfy expats' "hunger for home"), but must be because I've never been to Sumatra. I'll look into this some more.

    Do you know anything about Djoesianto? There have been some worrying things about SG-listed Indo companies (frauds and such), and there has been no shortage of private equity interest in Indonesian consumer goods companies since 2010 which makes me scratch my chin a bit that something is awry.

    Also, have you been following SCSH? Talk about a kick-save by the non-DIP Convert holders, sheesh.

    1. I've been to Indonesia (and Sumatra, specifically) a few times for work in a previous life.

      I'm not worried about fraud in the sense of the scale of the business being a fabrication: it would take remarkable collusion by a number of sell-side analysts (who have all been on fieldtrips to CSF's HQ and plant), Carrefour, Makro etc to pull it off. The name of the operating subsidiary is Olagafood and it's most definitely a Sumatran rather than Javanese operation.

      I've read up on Djoesianto. Typical entrepreneur: tried a few things, came up with this right after deregulation, worked at it until its needs became large enough to need public investment; did well from the IPO, doesn't pay himself too much; hasn't done anything egregious in terms of related party transactions (the HQ land was his and was leased by the company at market rates before the copmpany bought it at roughly the going market rate.

      I can understand any nervousness about the change of heart wrt the dividend, especially since it goes somewhat against the grain of local practice.

      It doesn't seem to me that that Djoesianto is looking to sell any time soon. He thinks he's onto a good thing that he can pack his distrib network with more FMCGs, create a competitive distib network in the Jakarta environs and make the company much bigger than it is today. Time will tell whether he's right about that. ABC President, I know, has created a JV with another regional instant noodle company in Java but I don't think CSF has anything to gain from partnering up in this way.

      SCHS -- I've not followed the latest developments..

  2. I should add that this post has a few hundred readers from Indonesia, Singapore, & Malaysia. I'd welcome some comments if you have any additional insight to share on this scrip.

  3. Some additional info:

    Hunter Hall (an Aussie investment fund) owns 7% of the shares

  4. Hey red,

    Very interesting find.
    However, as was said before, dealing with an indonesian company, I wonder how we can know there isn't any fraud /cooking the books going on. This is my first and foremost worry when dealing with companies in third world regulation countries.

    Its just I'm familiar with too many frauds in 3rd world companies listed in western stock exchanges.
    I guess the fact that you saw CSF's noodles at the different retailer networks in Indonesias does kind of mitigate my fears, but I'm still concerned about book's values, especially the net cash position being imaginary...

    I wonder why did CSF took a very big loan in order to develop its new Jakartha operation while it has so much cash on its b/s and a very good cashflow from current operations..

    I hope it doesnt relates to the other fact of cancelling the dividend..

    I really hope its only fear talking..

    1. Hi Michael,

      It's pretty easy to spot a fraud, imo, but its very hard to disprove that a stock isn't a fraud. Try, for example, disproving that Berkshire Hathaway isn't a fraud.

      The vast majority (perhaps all) of the recent frauds on the Singapore Exchange were S-Chips -.i.e. China domiciled "businesses" promoted by individuals in Hong Kong and Malaysia.

      It seems to me that the very hardest way to perpetuate a fraud is to do it via a cash-generative fast moving consumer goods company, in an island where one has a reputation to uphold, selling stock to the wealthiest and most influential people in one's own country, relying on Ernst & Young's inability to check bank balances, while still owing 55% of the equity.

      Still, I think it important that people invest only in stocks with which they are completely comfortable and can understand why it's not for everyone.

  5. Interesting idea. Looking at the financials right now and I wonder where you get the 12.6 billion marketing expense for cup noodles from and the 11.6 billion G&A expense for the Jakarta factory. From the latest annual report:

    Marketing and distribution expenses increased by 83.9% from Rp17,721 million in FY2011 to Rp32,580 million in FY2012, due mainly to the increase in advertising and promotion expenditure incurred in the face of increased competition in FY2012 and to maintain our market.

    Administrative expenses increased by 72.5% or by Rp16,399 million from Rp22,612 million in FY2011 to Rp39,011 million in FY2012, due to the increase in employee benefit expenses and other operating expenses since we commenced the operation of Jakarta factory in April 2012, and due to the recognition of idle capacity cost incurred in production cost of Rp5,100 million since we have not fully utilized of our production capacity, mainly in the Jakarta factory and cup noodles production line.

    Seems to me that the marketing expenses are for their current products, and that approx 16 billion of administrative expenses are related to the Jakarta factory.

    1. Hi AV,

      I suspect that quite a lot of the clarity and intent of that passage (and of some others in the AR) has been lost in translation.

      Here’s a back of the envelope using the numbers from the IPO prospectus (in blue) and extrapolated therefrom (in black).

      The ARs since the IPO don’t break out the components of marketing and distribution expense but the prospectus does. You’ll notice that, in prior years, trucks and fuel are ~ ½ the marketing and distribution expense and that advertising (or “promotional expenses”) is ~1/5th of that total.

      It’s a question of judgment, of course, but I suspect CSF didn’t need more trucks to distribute the same number of packs to its traditional Sumatran distribution outlets. Ditto for commissions and salaries, and benefits.
      So, the question is whether it’s plausible that maintenance advertising spending per unit tripled in a year. That’s unlikely, in my view: (i) I’ve found no evidence that there has been any other entrant into the Sumatran market; (ii) we would have seen some gross margin pressure in the face of any such increased competition.

      Much more reasonable, in my view, would be to allocate the ~12.5 bn in increased expense to trucks in Java, to the promotional activities surrounding the experimental launch of the cup noodle line, and to the anticipated rollout of the beverage line. They’re going to be producing juices and tea at an annual rate of 112 million bottles and, if I were them, I’d be preparing the ground for that.

      Here is the phrasing at the top of page 3: “To protect our market share and further drive brand awareness, our Group substantially increased advertising spending in FY2012”.

    2. Hey red,

      Thanks for sharing your cost analysis sheet.
      Would you be able to tell me please what's the calculation behind the Cup noodle production in cell G36, and the Beverage production in cell H39?

      And maybe you can put a link for the IPO prospectus?



    3. Hi Michael,
      A copy of the IPO prospectus is here:

      G36: installed capacity of 86 million cups per year & production started in June 2012, so maximum production of cup noodles = 96/2 = 43 million cups.

      If promotional expenses average Rp 4.4 per cup in line with instant noodles, then that would account for 0.91 bn in increased marketing expense. I suspect, however, that since noodles are new and high margin, and since the number of units is so much smaller, that the per unit marketing expense for noodles is higher than that Rp 4.4/cup figure.

      H39: CSF has invested in equipment with the capacity to produce 300 bottle per minute, 20 hours a day, 312 days per year. That's installed capacity of 112 million bottles per year. I wanted to give an idea of the scale of the contribution from drinks in 2013 and to suggest that it may explain some substantial part of the increase in the marketing expenditure in 2012.

  6. Nice find. Reminds me a bit of See's Candy, doesn't have to be #1 in the country as long as you have a niche or area and a strong competitive advantage in that niche.

    Its interesting also about the fraud aspect, by coincidence I came across a Singapore listed company recently that also is very lowly valued


    1. I like & follow your blog.

      I’m familiar with Sino Grandness (and China Minzhong, too). I understand the risk side of the risk/reward case but I'm not sure I understand the reward side. From my perspective, the value is in loquats-as-a-drink not in the company; in the long run it's a commodity product with commodity returns.

      I also don't like the implications of its GS financing: it's the worst possible way to raise money. If the beverage segment (whose name I've forgotten) doesn't list in HK, where in the world are they going to get the money for to pay back the exchangeable notes? GS, it seems to me, is interesting in acquiring the company's assets and selling them on to a bigger player. I think the idea that GS had done its due diligence, and that therefore this company is what the longs hope it is, is far too optimistic.

  7. Thanks for the interesting idea. It's one of the cheapest looking stocks I have come across in several months.

    I have a question about Conscience's competitive position and margins compared to Indofood. Specifically, I don't understand why CSF should have (much) lower average unit costs than their larger competitor. The post says this is because they have a large market share in a small region. That doesn't explain the higher margin, however, because Indofood has an even higher market share in the rest of the country. If CSF's business model were really so much more efficient, Indofood could just replicate their distribution in multiple 300km regions throughout the country and have even better margins because of their higher share. Instead, their margins are much worse.

    I'd love to get a handle on what is really driving the higher margins. If they are sustainable, this would a great investment.

    1. Hi Robert,

      Certainly Indofood could replicate CSF's model in the future. While that would improve Indofood's margins, I'm not sure that it would affect CSF in any meaningfl way. What I guess I'm inferring from the record is that Indofood didn't operate in that way in the past, thereby allowing several new entrants (including CSF) to make rapid market despite the presence of a price war during much of that period. (For example, Indofood operates 16 separate factory-and-distribution centers throughout the country, or a complex for every 650 million packs of instant noodles whereas CSF's Medan complex services 1 billion packs).

      Now that those share gains have been attained, and knowing how habit-forming regular purchases of branded consumer staples can be, it seems reasonable to me that barring a serious price wr breaking out in Sumatra, CSF's earning power there can be more or less counted on.

      Indofood has found new paths of less resistance -- milk, foreign export, baked goods, etc -- along which it can grow, so I'm not sure that it is of a mind to disturb the status quo in its core business.

  8. After reading CSF 2013 Q1 report few issues come to mind:

    1. Gross profit deteriorated to 20% from 30%.
    The reason: "raw material cost, labor cost, depreciation expenses and other productions costs... also due to fire that affected our warehousing operations at our Jakarta factory."

    2. The annual interest income derived from Rp380,226m (at the end of 2012)
    with an average rate of 5.8% is 22,053. =5,513 quarterly, 33% more than the reported income in 2013 Q1. Why the discrepancy?

    3. The annual cost of Rp226,154m of debt (at the end of 2012) with an average rate of 2.7% is Rp6,106m. =Rp1,526m quarterly, less than half of the reported cost in 2013 Q1. Why the discrepancy?

    4. And in a general sense, how is it possible that the company is able to borrow money with an int.cost of only 2.5-3%, while it earns a nice 5.8% on this cash in daily bank deposits?? Maybe they should just operate as a bank...

  9. A couple more points:

    5. The much anticipated beverage line has once again been postponed to 2013 H2 (I hope for the last time).

    6. There is a huge amount of cash on the company b/s - Rp498b. Some of it, about Rp75b, derives from a decrease in the inventories and trade receivables accounts compared to the end of 2012. This is due to the fire in Jakarta, which drastically decreased its operation. Thus, the company got back to the size of these accounts as in 2011, prior to Jakarta operation.
    However, even if we deduct this Rp75b sum, the company still has a net cash position of about Rp167b.
    I wonder whether this amount is justified, though as long as the company can earn on it (5.8%) more than the cost (2.7%), I'm kind of ok with it...

  10. Re: Q2, Q3, Q4

    interest expense March 2013 = 3,596/average(226,154 & 253,009) = 1.5%;
    interest income March 2013 = 4,130/average(380,226 & 498,076) = 0.94%


    interest expense December 2012 = 7,101/average(226,154 & 2,396) = 6.21%
    interest income December 2012 = 10,798/average(380,226 & 224.287) = 3.57%

    Re: Q6
    Excess cash is justified IFF management anticipates growth capex in excess of cash flow. Does CSF need that much cash for capex? I doubt it very much.

  11. Hey red,

    Thanks for the quick response.

    I still don't see how a 1.5% cost of int.expenses in one quarter, about 6% in a full year, coincides with the reported annual cost of debt of 2.5-3%.

    What is your take on the odd situation of CSF's ability to earn more on its cash than it needs to pay on its debt?

    I hope Mr.Law will decide to restore the dividend once he has understood CSF has much more cash than it needs..

    1. Hi Michael,

      The reported cost of debt = [base rate + 2.5%], not 2.5%.

      That's what "at cost of fund + 2.5%" means. These are variable interest, short-term loans secured by working capital and fixed assets. You can see how the base rate has evolved over time here:

      So the interest rate on CSF's bank deposits have not exceeded its cost of borrowing.

    2. Hey red,

      Thank you for the clarification.

  12. Have you considered the impact of rising sea water levels or is this a short-term play?

  13. Hey red,

    Another guy questions CSF's net cash position and operation in general:

  14. How do you feel about this net net coming delisting below it's value? I am deeply saddened by the majority shareholders decision.

  15. Well, I don't think we can blame the guy: there was obviously no benefit to being listed so the rational thing would be to take it private.

    He could have taken it private at the prevailing market price of $0.145 but he did the decent thing and offered a 20% premium.

    That's the downside of owner operated businesses.


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