QAF

QAF may be unfamiliar to many but its brands, Gardenia and Cowhead certainly aren’t. Gardenia is the leading brand in the pre-packed bread market in Singapore, Malaysia and Philippines. Bakery business is the cash cow for QAF as it is 50.5% of total revenue and 80% of operating profit in 2015. Though QAF’s overall operating margin is mid-single digit, its bakery business is consistently between 10-15% over the past 6 years. This exhibits the profitability and importance of QAF’s bakery business.

QAF’s next biggest revenue generator is its Australia primary production (36%) under Rivalea which produces pork for the domestic market and exports to Singapore, Japan, New Zealand and other Asian countries. Rivalea also own its stockfeed mills thus able to reduce the costs of feeds for its livestock. Revenue from this segment tends to be more volatile due to the volatile exchange rate in recent years of a strengthening Singapore dollar against the Australia dollar.

The last segment of QAF’s business is the trading and logistics business. Ben Foods is the company that owns the proprietary brands Cowhead (milk, dairy products and confectionery) and Farmland (meat, potato snacks, cooking oil). Ben Foods also distribute Emmi yogurts and Campbell’s Food Service such as frozen and canned soup in Asia. This revenue segment has consistently increased over the past 6 years from $84 million in 2010 to $104 million in 2016.

The number one strength of QAF is its positive free cash flow for the past 8 years after accounting for dividends being paid out. Strong free cash flow is the number one metric to look for in businesses and companies. I foresee that this positive free cash flow will be maintained due to QAF’s economic moat in its bakery business, from the Gardenia brand.

QAF’s investment track record is also impressive. Its ROIC is consistently above 10% since 2009 and ROE is approximately 10% since 2009 except for 2013 at 7.6%. It has also a low debt to equity ratio and has a healthy cash balance at $100 million, ready to acquire businesses or for expansion into other markets. One area to keep a look out for is Gardenia’s expansion into China. Valuation wise is also healthy, trading at 11.5x P/E and P/B at 1.41x. Enterprise value over operating income is also at 6x which is a decent multiple. Dividend yield is at 4.5% based on the current share price (13/07/2016) of $1.12.

QAF is financially strong as a group as compared to its competitors like Auric Pacific which produces Sunshine bread. On the contrary, Auric Pacific’s manufacturing business of Sunshine bread is much stronger than QAF’s Gardenia as the former’s operating margin almost doubled at 20.7% as compared to QAF’s at 11.65%. One reason is that QAF’s bakery business is more diversified in terms of geographic (Singapore, Malaysia, Australia, Philippines and China vs Sunshine manufactured only in Singapore and distributed locally and to Malaysia) and variety (Bakers’ Maison in Australia which serves French style bread). QAF also suffers foreign exchange losses when profit is repatriated back to SGD especially so in 2015 when RM and AUD falls against SGD. Thus, one risk of QAF is its currency exposure to Australia, Philippines and Malaysia as evidenced in the 2015 results which has foreign exchange losses of $2.8 million as compared to $1.9 million in 2014.

Another plus point for QAF’s bakery businesses is the relatively lower price of wheat which is a key raw material for bread. Wheat prices have been coming down over the past 3 years. This could be attributed to the supply side which technology assisted in improving wheat yield and the demand side which global economy is slowing down. Wheat prices like many agricultural commodities should stay in the doldrums over the next few years as I believe the commodities market will be in a down cycle. Thus low prices for its raw material will contribute positively to QAF’s bottomline.

I employed the discounted cash flow model and the assumed terminal growth rate and operating margins assumption is conservative at 2.5% and 6% respectively. The discount factor (i.e. the weighted average cost of capital) is where I account for QAF’s geographical risk at 8%. Discounting QAF’s cash flows to present value, adding back cash and investments and less out debt, the value per share comes to $1.30. QAF has strong economic moat in its bakery business and its current price of $1.12 as of 13/7/2016 is quite attractive, a potential 16% increase. However I will wait till when its price is close to $1. My target price of $1.30 is also close to OCBC Securities’.

The catalyst for QAF to reach its target price will be its growth in China and investors aiming for solid companies that gives out sustainable dividends, its dividend yield at 4.5%. In this sluggish economic growth climate where investors are hungry for yield, defensive companies with solid business model will be attractive. I am optimistic that QAF will be a solid investment.

From the time I written this article in late June 2016, QAF’s share price has been steadily climbing from lowest of $1.03 to current price of $1.12. Will this rally in the global markets continue? I will update my equity risk premium on the next post.