Description

Note: This company is based in Thailand and trades on the Bangkok Stock Exchange.
Foreign investors are allowed to invest in the restricted shares TWFP-R and the foreign shares TWFP/F

Figures above in THB, not US$

IDEA

TWFP is the largest vermicelli manufacturer in Thailand with a 44% market share. The Company has a 60 year history and well established brands. The Company’s stable market share, high operating margins (avg 21% last 5Y) and high ROE (avg 21% last 5Y) are strong indications of a moat.

Recently, the share price declined from Thb 38 to Thb23 after the Company issued a profit warning. We believe the causes to be temporary and find the valuation at 7.6X Normalized Earnings compelling for a quality business with a strong market position in a market that is expected to grow at 3-5% p.a., a net cash balance sheet and managed by a good owner-operator.

ACTIVITY

For the purpose of this write-up we will focus on the Thai vermicelli business as this business represents 97% of sales. TWFP also has a 33% and 30% stake in 2 tapioca starch producers that contributed Thb 42mio to last year’s profit of Thb 290mio.
TWFP is the largest vermicelli manufacturer in Thailand with a total production capacity of 22,000 tons per year and has a market share of approx. 44%. Local consumption is estimated to be 37,000 tons per year or Thb 3bio in value.

Key raw materials for vermicelli (also known as glass noodles) are bean starch and potato starch as opposed to wheat or rice based noodles. The Company directly imports or buys bean starch and potato starch through distributors in the EU or China.
Although vermicelli is not the major staple food for Thai people, it’s widely popular as the product can be cooked in various dishes. TWFP believes sales are correlated with an increase in purchasing power and therefore the economy as vermicelli is considered a healthy and premium product.
Since vermicelli is not complicated to produce, several producers compete with the same product in the market. Most competitors are price-based and focus on distribution and product quality with several quality ranges aimed at different groups of customers in different locations. Consumers are largely loyal to a brand.
TWFP’s main brands are Double Dragon, Phoenix and Double Kilin. The Company makes 80% of sales through wholesalers.
The competitive landscape has not changed much over the last 10 years with 4 major and 10-15 medium to small manufacturers.

Since 2006 the Thai vermicelli market grew from 30,000 tons to 37,000 tons and in sales value from Thb 2bio to Thb 3bio. Both volume and prices increased by 3% p.a.
Over that period TWFP’s market share grew from 36% to 44% as sales increased with 7% p.a. The Company increased its production capacity from 10,000 tons to 21,000 tons in 2007 with a focus on fresh vermicelli.

GROWTH

TWFP expects the vermicelli market to grow with 3-5% p.a. as consumers pay more attention to a healthy diet and standards of living improve with a growing economy. Fresh vermicelli grows faster than dried vermicelli and is now >50% of TWFPs product mix, up from 33% in 2005. Reasons for its success are convenience and lower price relative to dried vermicelli.

Although the Company does not provide figures on capacity utilization we suspect that the Company has excess production capacity and the ability to grow sales and earnings without the need for major growth capex. Our view is based on an increase in production capacity of 120% since 2007 versus an increase in sales of only 66% over the same period. The impact of changes in the product mix is likely small. The lower priced fresh vermicelli (double kilin brand) has grown from 36% to 50% of sales mainly at the expense of dried vermicelli (double dragon brand). A 14% shift in product mix at prices that are 8% lower should still leave substantial excess capacity. As mentioned above, for the vermicelli market as a whole prices increased at 3% p.a.. 

In 2011, TWFP expanded its business into the rice noodle business with the launch of a high quality and safe product at a reasonable price. The Thai rice noodle market is estimated to be Thb 17bio, more than 5X larger than the vermicelli market (Thb 3bio).

TWFP noodle sales are small (approx 1% of total sales) but growing at >100% p.a.. The Company decided to expand its rice noodle production line in 2013 to accommodate its increasing market share in the domestic market.

VALUATION 

TWFP trades at 7,6x Normalized Earnings and 6,1x Net of Excess Cash. This assumes 5 year average Ebit margin and other income and share in profit from associates (ttm).

P/FCF 2014 Normalized: 10 (Net Excess Cash 8). Normalized capex is estimated at the avg capex/sales for the last 9Y. This is likely too conservative because with excess capacity we anticipate that capex for the next few years will remain below historical average.

Thai President Foods is an interesting peer with a 40 year history, a strong brand (mama) and a 54% market share in the noodle market. The Company is much larger than TWFP with a market capitalization of $900m at 17X trailing earnings adjusted for excess cash. Over the last 5 years Thai President Food achieved an average operating margin of 16%, ROE of 16% and EPS growth of 6% p.a.. This compares to a market capitalization of $65m at 6X trailing earnings adjusted for excess cash, average operating margin and ROE of 21% and EPS growth of 8% p.a. for TWFP.

MANAGEMENT

Mr. Ho KwonPing has been Chairman and CEO of TWFP for many years. Ho joined his father’s business, the Wah Chang Group, when his father suffered a stroke in 1981. The family still owns a 24% stake today. The CEO’s direct stake increased to 6,9% in 2013 from 3,5% in 2012. HO is also CEO of Banyan Tree, another family business.

Ho’s focus has been on organic growth and long-term value creation with a conservative balance sheet. He emphasizes brand building to create, maintain and increase a competitive advantage. Gradual and continuous improvements are made to improve operating margins.
Over the last 8 years sales have grown at 7% p.a., operating margins improved from 15% to 23% and EPS increased with 19% p.a..
TWFP’s dividend policy consists of a fixed component of 1/3 of Net Income and a variable component depending on capex requirements and debt repayment. 

WHY CHEAP

TWFP issued a profit warning for 2014Q3 and the stock price fell from 38,5 to 23,2.

Profit fell 36% versus 2013Q3. Sales were 8% lower because of poor consumer spending (confirmed by similar development for Thai President Foods) and a difference in timing of sales promotion.
Gross margin declined due to higher cost of raw materials and selling expenses increased with 10%.
Share of profit from associates was lower as a result of lower sales and higher competition.

The Company’s explanation for the developments in Q3 is in line with developments at its peers.  We see no company specific problems and the causes of the recent decline seem cyclical and temporary in nature. 

CONCLUSION

We believe a temporary interuption of sales and earnings growth has created the opportunity to purchase a quality business with a net-cash balance sheet, good management and decent growth potential for 6x trailing earnings (net of excess cash).

Catalyst

Normalization of sales and profits.