Can These Consumer Ds Turn Into As?

Foreword from ShareInvestor

This article “Can These Consumer Ds Turn Into As?” by Cai HaoXiang was first published in The Business Times on 29 Jan 2018 and is reproduced in this blog in its entirety.

Indonesian chocolate, for now, is tastier than Philippine pineapples

Turnaround plays are tough to figure out. Many frogs have been kissed but still remain frogs. Strong companies tend to stay strong. Weak ones tend to stay in the dumps.

This general statement might also apply to the consumer staples space. We all want to own, for cheap, a Nestle or Unilever-like franchise throwing off tonnes of free cash flow every year. Tough luck.

The search for value-for-money consumer brands will instead take us to the realm of less diversified companies with specific risks. One example is canned products maker and pineapple plantation owner, Del Monte Pacific, listed on the Singapore Exchange (SGX) as well as the Philippine Stock Exchange (PSE).

The Del Monte brand goes back a long way. Financial history buffs might be intrigued to learn that the business was part of RJR Nabisco, the US tobacco and food giant, which leveraged buyout firm KKR eventually bought in an infamous 1988 mega-deal. The rise and fall of RJR Nabisco has been chronicled magnificently in the book Barbarians at the Gate.

We see Del Monte ketchup and canned fruit everywhere, including in Singapore. But don’t get too excited. The Del Monte empire is enormously fragmented. The same brand name is used by non-affiliated companies operating in separate regions.

The SGX and PSE-listed company, Del Monte Pacific, only has the rights to sell Del Monte products in the US, South America, the Philippines, the Indian subcontinent and Myanmar.

The Del Monte products we see in Singapore and much of Asia are actually marketed by Del Monte Asia, owned by Japanese soya sauce maker Kikkoman, which is listed in Tokyo.

Del Monte in Europe, the Middle East, Africa and the former Soviet Union is marketed by another company, Fresh Del Monte Produce, listed in New York. Del Monte Canada, meanwhile, only does Canada.

The “other Del Monte companies” page on Del Monte Pacific’s website has the gory details.

Back to Del Monte Pacific, the ghost of leveraged-buyouts past continues to haunt the firm. It embarked on a debt-laden acquisition of the US entity in 2014, Del Monte Foods Inc, sold to it by KKR, no less.

As a result, net debt soared to as high as nine times equity. That ratio has mercifully come down to around three times today. Yet, it is still significantly higher than what many investors, including myself, would be comfortable with.

Assuming US$200 million of Ebitda (a measure of cashflows) a year, and with net debt at US$1.86 billion, it might take five years or more before Del Monte Pacific’s debt load looks reasonable. One shudders to think what might happen should there be a shock to the business.

High debt would be fine if the core business was growing. But it is not. So did the company overpay for a stagnant US business? How often do you buy canned fruit or vegetables, instead of fresh ones, anyway?

Some consolation comes from the firm’s Philippines business, which is growing sales at a respectable single-digit percentage point pace, driven by canned pineapples.

As an aside, the firm has a high market share on tomato sauce in the Philippines, but the true best-sellers are banana-based ketchup brands. These belong, not so coincidentally, to Del Monte Pacific controlling shareholder NutriAsia.

Overall, the Asia-Pacific region is a bright spot for the firm. Profit before tax has been growing at the strong double-digits in recent years.

Yet because of its debt load and a stagnating US business, the risks for minority shareholders might be higher than the rewards, even while the company is trading somewhat below book value.

Indonesian Chocolate

Right next to Del Monte Pacific on the SGX roster is a slightly less complicated company, Indonesian chocolate maker, Delfi.

It is also known by its former name, Petra Foods. The name change came after the company sold its cocoa ingredients manufacturing business to Swiss chocolate supplier Barry Callebaut in 2013.

Founded by Singapore businessman John Chuang in 1984, Delfi has grown through various acquisitions. It is now one of the dominant chocolate players in Indonesia, with its “SilverQueen” brand often seen at corner shops. Other core brands include Selamat, Cha Cha and Ceres. Delfi’s market share is reportedly 50 per cent, partly due to its distribution network in suburban and rural areas.

I say Indonesia, you say emerging chocolate-loving middle class. Unfortunately, consumer spending in Indonesia has been weak.

This might be due to a mixture of low incomes and higher prices of necessities such as rice, electricity and gas. Competition from other chocolate brands has also intensified.

Sales slumped in 2015 along with Delfi’s share price.

Meanwhile, selling and distribution expenses also increased through the years from a low-teens proportion of revenue before 2015 to about 20 per cent today.

This might be a mix of lower sales growth, and how “modern trade” distributors are gaining more bargaining power. Modern trade refers to supermarkets as well as convenience stores like Alfamart and Indomaret – Indonesian versions of 7-Eleven – which are popping up everywhere. Delfi is still adjusting to the new reality of organised retail, and is investing more to build its brands.

The company began restructuring from around 2016, removing non-performing products and focusing on higher-margin ones.

As Mr Chuang said in the 2016 annual report: “We have many magnificent brands but if they are not strategically placed where our consumers want them, when they want them, then our growth objectives will suffer.”

Compared to Del Monte Pacific, Delfi’s risks might be lower compared to the potential rewards. The compan is net cash and generates operating cash flows in excess of capital expenditure needs.

Valuations have come down from well over 30 times earnings to around 20-plus times.

With elections coming in Indonesia in April 2019, the government might try to hand out some goodies in an attempt to stimulate consumption. Delfi’s product restructuring is also coming to an end.

I nibbled at the stock in late-November, speculating on a recovery, while getting prepared to average down if needed. In December, DBS upgraded the stock to “buy” from “hold”, arguing that its fourth-quarter results “should show a bottoming-out trend at worst”. We’ll see.

Either way, the two declining consumer Ds, side by side on SGX, are rather interesting. They have potentially strong brands.

In higher-risk Del Monte Pacific and lower-risk Delfi, investors have two different ways to bet on a revival in fortunes. Kiss on.