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.
