Unsettled by a potential global trade war sparked off by Trump slapping tariffs worth a whopping US$50 billion on Chinese goods, and China retaliating by planning to tax a matching US$50 billion of American products, Dow Jones Industrial Average (DJIA) plunged 724 points on 22 March 2018 breaching its 100-day moving average last seen in November 2016. This is the fourth time that we are seeing DJIA plummeting more than 600 points within a single day in just the first quarter of this year alone. Likewise, the local benchmark Straits Times Index had also pulled back 4.9 percent from its high of 3,609.24 in January this year to 3,430.76 as at 2 April 2018.
When there are fears in the street, bargain hunters will be all excited as they get into treasure hunting for opportunities. Just as we are looking for the babies that are thrown out with the bathwater, QAF is a company that has caught our eyes.
QAF’s main operation is in the running of its two core business segments – bakery and primary production. Its flagship brand “Gardenia” bread, being ranked as the “Number one selling bread brand” according to global marketing research firm Nielsen Corporation, has extensive presence in key markets including Singapore, Malaysia and Philippines. Meanwhile, QAF’s wholly-owned subsidiary Rivalea Group (Rivalea), is also a leading integrated pork production operator in Australia with an approximately 17 percent market share. QAF’s bakery and primary production divisions each contributed 40.1 percent and 46.4 percent to the group’s FY17 revenue respectively.
QAF’s trading and logistics segment, which accounted for 12.9 percent of the group’s FY17 revenue, distributed a wide range of premium third-party and in-house brands food and beverage products to the foodservice industry. Some of the well-known brands consisted of Cowhead dairy products as well as Farmland processed food. Apart from that, other functions which QAF engaged in such as leasing investment activities and licensing fee income were classified under the group’s investment segment, which accounted for the remaining 0.6 percent of its FY17 revenue.
Sailing Against Headwinds
Apart from the negative market sentiment, things have not been turning out well for QAF in the last year. The group sold off 20 percent of its interest in Gardenia Bakeries KL (GBKL) to its long-time partner Padiberas Nasional because of regulatory reasons. Owing to the deconsolidation of GBKL’s financial results, QAF’s revenue from its bakery division has been adversely affected. In the meantime, QAF has also ceased operations of Gardenia Fujian and recorded $2.6 million of provisional costs for its loss-making operations in China.
Meanwhile, Rivalea continued to be badly hit by lower selling price and margins attributable to the cyclical oversupply situation in the pork industry, although this was partly mitigated by higher sales volume achieved. Further disappointment came after announcements that the proposed listing of Rivalea’s primary production segment will be put on hold, even after $4.1 million of legal and professional fees in relation to the listing had already been incurred.
Bad news came one after another with an occurrence of ammonia leakage in the group’s warehouse at Fishery Port Road in January 2018, leading to the issuance of a stop-work order by the Ministry of Manpower until certain measures have been taken. The group expects to incur repair and maintenance cost of approximately $2 million in its trading and logistics segment due to the incident in FY18.
As a result of QAF’s plans to establish new bakery plants in Philippines and Malaysia so as to increase its production capacity and tap on its economies of scale, the group has incurred an expansion capital expenditure (CAPEX) of $67 million in 2017 and the figure is expected to jump to $116 million this year. How the escalating CAPEX is going to impact the company’s cash flow is going to be a major concern in investors’ minds.
Apparently the confidence of investors in QAF has been badly shaken from the spate of misfortunes last year, which manifested in the company’s share price shedding more than 35.2 percent from its high of $1.575 in February 2017.
QAF’s FY17 net profit sank 73.6 percent to $31.8 million on the back of a 4.6 percent decline in revenue to $848.6 million, largely due to the deconsolidation of financial results of GBKL. Excluding the one-off non-cash exceptional gain from disposal of GBKL in FY16, net profit would have fallen 48 percent instead.
Over a five-year period, net profit grew at a compounded annual growth rate of 1.3 percent despite its top-line shrinking at a CAGR of negative 4.6 percent, underpinned by an improving profit margin. We see resilience in QAF, evident from its financial results, as that the group still managed to remain profitable and maintain positive cash flow from operations every year.
With cash equivalents of $136.5 million and $113.1 million of borrowings, QAF sits comfortably on a net cash position of $23.3 million as at 31 December 2017. Moreover, the group’s balance sheet remains strong with total liabilities of $290.9 million standing at roughly half of its equity of $530.6 million. This also translates to a current ratio of 1.9 times, another indicator of the group’s sound financial health.
After falling by around 30 percent in the first half of 2017, pork prices have since stabilised or slightly improved. Coupled with the group’s meaningful expansion plans for its bakery segment, there are reasons to believe that QAF’s performances may look better as it rides out the challenging conditions.
Pulling The Trigger
Coming down to $1.02 a share as at 2 April 2018, QAF is trading near its 52-week low and well supported by the critical $1 psychological support level that is tested twice in September 2015 and February 2016. The current price translates to a price-to-earnings ratio of 17.9 times and a price-to-book ratio of 1.1 times, which we reckon as not too expensive.
In addition, should QAF continue to maintain a dividend payout of $0.05 – which it has been consistently doing so since FY12 – investors can well expect a yield of 4.9 percent based on current market price. As such, we believe that now could be a good time to accumulate QAF – a company with strong brands and significant market leadership. This is especially so for investors who are looking to build up a position in the defensive consumer staple sector.