Description

Delfi is a Southeast Asia-, particularly Indonesia-, focused chocolate brand family, manufacturer, and distributor. Although it is listed in Singapore, it is highly focused on the middle-income emerging markets in its region – Indonesia, Philippines, and Malaysia. For understanding the business, I highly recommend prior VIC posts by Chalkbaggery and zeke375. I will cover the business here, but the core has not changed in the past couple years, and those write ups provide a valuable foundation.

Two major factors worth our inspection have changed since those earlier posts (mid 2020, and early 2021):

1. Delfi’s share price has risen approx 50%

2. Delfi has continued to execute solidly on its strategy, with improving fundamentals in inflection, and now benefitting from the disappearance of Covid headwinds

I don’t believe it’s relevant, since Delfi was a great investment at the time of earlier posts, but for emphasis, I think <1> is a larger factor than <2>, so that Delfi is a better investment now that at any point since the onset of Covid

I’ll start with a brief overview of the investment

1. Value

   1. Delfi is cheap. It’s trading roughly 11x P/E from an H2 2022 run-rate

   2. Delfi is in a net cash position, with essentially no gross debt

   3. Delfi is growing. H2 revenues were up over 20% in USD terms (over 30% in local), with incrementally expanding margins, leading to 75% increase in net profits (in USD terms; higher local). Some of this is passing residual Covid comps, but we project at least 15% earnings growth each of the next 2 years

2. Strategic position

   1. Delfi benefits from a promising demographic backdrop. It is the market share leader for chocolate in Indonesia, meaning powerful brand affinity. Indonesia is a consensus growing EM, with an expanding middle class, with rising affordable luxury consumption

   2. Furthermore, Delfi benefits from a powerful strategic position: they have success both in the ‘general trade’ (imagine a bodega) and ‘modern trade’ (think supermarket, or 7-11). This success, and the durability of the distribution networks and relationships, acts as a moat against MNCs, and helps explain their difficulty in making headway in Indonesia (and other regional markets like Malaysia and Phils)

3. A variety of outs

   1. Delfi has a GAARP story: absent M&A, it should compound fundamentals for the next decade

   2. Delfi has takeout potential. As cheap as it screens to a value investor, it should screen even more cheaply to Nestle, for whom Delfi would provide inroads to important distribution partners and networks, benefitting not only from Delfi brands’ dominance, but improving the economics for Nestle (or another MNC’s) products generally targeted at higher price points for the higher income segments. And in the process helping establish taste and brand loyalties that would set up Nestle (or another MNC) for decades to come

      1. The question here is whether the family would sell. The founder is 75, but his sons are involved in the business

   3. Delfi offers the opportunity for a transition from “orphaned stock” to “hot, EM growth, consumer class” story

      1. Orphan: It’s Singapore-listed. It’s small-cap. It’s illiquid. It has a history of having been in the worse, higher-capital intensity contract manufacturing business. Moreover, that transition into the focused, branded consumer space, “broke” the stock, likely scaring off some potential investors. This translates to less competition to own the shares, and helps explain the price

      2. Renewal: as an illustration, look at larger-cap, more liquid, Indonesia-listed Mayora, which trades at a much higher multiple (30 P/E, revenues growing LSD), and no evidence of a comparably good business

   4. Another spin on it: Delfi is the quintessential value-momentum stock: still very cheap, and having finally broken out of a depressed valuation

      1. As speculated in earlier posts, we share the belief that the combination of illiquidity and exits from a couple larger instos (we speculate in large part due to size, as opposed to a view on fundamentals) unduly impacted the stock and helped present the attractive entry point

      2. The above might have some merit as a purely quantitative, empirical phenomenon

      3. More mechanically, I foresee structural momentum: with improving fundamentals, driving up the share price, Delfi will screen for more investors, including becoming in-scope for passive flows

4. Margin of safety

   1. AI is not likely to alter the adoption curve for chocolate in Southeast Asia, nor is it likely to propel new winners

   2. Governance. I won’t pretend these are the sharpest, most-aggressive capital allocators. But they’re aligned, and have a high reputation. I’d call them middle-of-the-road here: you’re avoiding the true disasters of family-controlled Asia emerging, but don’t expect aggressive buybacks. Fortunately, you don’t need it to do well here

Delfi's trading at a favorable valuation, with a price-to-earnings (P/E) ratio of approximately 11x based on H2 2022 run-rate. This valuation is lower than its peers in the consumer goods sector, making it an attractive investment for value-oriented investors. Delfi's low valuation relative to its growth potential could be attributed to its illiquidity and limited investor awareness, which have created an opportunity for investors to capitalize on the stock's potential upside.

Delfi's balance sheet is characterized by its virtually debt-free status, providing the company with financial flexibility and reducing the risk associated with highly leveraged companies. Chalkbaggery highlights that Delfi's strong financial position has allowed the company to invest in its growth initiatives, such as expanding its distribution network and launching new products, without incurring significant debt.

Delfi has exhibited impressive revenue growth, with H2 revenues increasing by over 20% in USD terms (over 30% in local currency), driven by strong demand for its products in its core markets. This growth can be partially attributed to the easing of Covid-related headwinds, but also reflects the company's ongoing efforts to innovate and expand its product offerings to cater to the evolving tastes of its target consumers.

The company's incrementally expanding margins have translated to a 75% increase in net profits (in USD terms; higher local) during H2. Delfi's efforts to streamline its operations, optimize its product portfolio, and focus on higher-margin products have contributed to its improved profitability. These efforts have not only enhanced the company's financial performance but also strengthened its competitive position in the market.

We expect Delfi's earnings to grow by at least 15% annually over the next two years, driven by its ongoing growth initiatives, strong market position, and favorable demographic trends in its core markets. As zeke375 previously highlighted, Delfi's ability to maintain consumer interest through continuous product innovation and targeted marketing campaigns should enable the company to capture a larger share of the growing middle-class consumer segment in Southeast Asia.

Some comps:

To step back and focus on Delfi’s strategic and market position: Delfi operates in a region with promising demographic tailwinds. As the market share leader for chocolate in Indonesia, the company benefits from strong brand affinity among its target consumers. Indonesia is widely recognized as a growing emerging market, characterized by an expanding middle class and rising disposable incomes. This demographic backdrop has fueled a growing demand for affordable luxury products, such as premium chocolate offerings, creating an attractive growth opportunity for Delfi.

Delfi's position as the market share leader in Indonesia's chocolate industry is a testament to the strength of its brand portfolio and its ability to cater to the evolving preferences of the country's growing middle class. Delfi's success in maintaining its market leadership reflects its grasp of the local consumer tastes and its continuous efforts to innovate and expand its product offerings.

Delfi has established a solid presence in both the general trade (e.g., bodegas) and modern trade (e.g., supermarkets, convenience stores) channels. This dual-channel strategy has allowed the company to reach a wide range of consumers and build long-lasting relationships with its distribution partners. Delfi's extensive distribution network, which spans both trade channels, serves as a genuine barrier to entry for multinational competitors looking to grow in the Indonesian market.

Delfi's strong market position and distribution network act as a competitive moat against MNCs attempting to gain a foothold in Indonesia and other regional markets like Malaysia and the Philippines. As Chalkbaggery explained in their post, Delfi's entrenched position in both general and modern trade channels has made it difficult for global competitors to displace the company's leading market share. Moreover, Delfi's deep understanding of local consumer preferences and its ability to tailor its product offerings accordingly provide an additional layer of competitive advantage that MNCs struggle to replicate.

I often like to frame an investment from the perspectives of the different ‘outs’ or ways to win it offers:

Absent any significant mergers or acquisitions, Delfi has the potential to deliver growth at a reasonable price (GAARP) by compounding its fundamentals over the next decade. The company's strong market position, favorable demographics, and growing demand for its products provide a solid foundation for consistent, long-term growth.

More attention-grabbingly, Delfi's attractive valuation should also appeal to multinational corporations (MNCs) like Nestlé, which could benefit from acquiring the company as a means of gaining access to its extensive distribution networks and established brand presence. Such a transaction would not only enhance the acquirer's product portfolio but would also improve the economics for MNC products targeted at higher-income segments, helping to foster brand loyalty and taste preferences for decades to come. The key question, however, is whether the founding family would be willing to sell, given that the founder's sons are actively involved in the business.

More gradually, Delfi has the potential to transition from an "orphaned stock" to a "hot, emerging market (EM) growth, consumer class" story. As an orphaned stock, Delfi is Singapore-listed, small-cap, illiquid, and has a history in the less desirable, capital-intensive contract manufacturing business. The company's transition to a more focused, branded consumer space led to a temporary "broken" stock that may have deterred some potential investors. This situation has resulted in less competition for shares, contributing to the stock's attractive valuation.

To illustrate what renewal could look like, compare Delfi to Indonesia-listed Mayora, a larger-cap, more liquid company trading at a much higher multiple (30x P/E) with lower single-digit revenue growth and no evidence of a comparably strong business. As Delfi's fundamentals continue to improve, it is poised to gain recognition as a value-momentum stock, making it an increasingly attractive investment opportunity.

Moreover, the combination of illiquidity and exits from larger institutional investors has likely contributed to Delfi's depressed valuation, providing an enticing entry point for new investors. As the company's fundamentals improve and its share price rises, Delfi will likely become more visible to a broader range of investors, including passive investment vehicles.

To expand briefly on the exits: by our estimates, 2 large institutions reduced their stakes by 120m shares (roughly 40% of the float) – one from 70m to approx 0; another from 70m to approx 20m – the last 30m of which was sold in Q4 2021. So it would be unfair to say that this sell pressure has only just lifted, but it helps characterize the listlessness for most of the past 4 years.

I’m a bit more muted in my expectations from management: Delfi won’t be the most aggressive capital allocator. That said, they have demonstrated a balanced and aligned approach to running the business. As a family-controlled enterprise in the emerging Asian market, Delfi has successfully steered clear of the governance pitfalls often associated with such companies. And I agree with the earlier posts, noting management's track record and reputation are commendable, providing investors with a sense of confidence in their stewardship.

The founders and their family maintain a significant ownership stake in the company, ensuring that their interests are closely aligned with those of minority shareholders. While investors shouldn't expect aggressive stock buybacks or other financial engineering tactics, the management has consistently pursued a strategy that focuses on organic growth, product innovation, and expansion into new markets.

I also take some comfort in the company’s reputation in the Singapore business community, as well as the hurdles that the Singapore listing imposed, conferring some higher standard of transparency and accountability than many of its regional peers.

Moreover, Delfi's management has demonstrated an ability to adapt to changing market conditions and seize opportunities to strengthen the company's competitive position. For instance, the transition from contract manufacturing to a branded consumer goods business has enabled Delfi to enhance its margins and establish a more robust, sustainable growth trajectory.

Risks:

– The stock is pretty illiquid. Given its small-cap status and listing on the Singapore exchange, trading volumes tend to be low, which could make it challenging to establish a meaningful position at an attractive price. Moreover, in the event of a need to exit the investment, the illiquid nature of the stock could lead to significant price impact and higher transaction costs. Despite this risk, a long-term investment horizon of 5+ years based on Delfi's GAARP (Growth at a Reasonable Price) story should help mitigate the impact of illiquidity. Additionally, the possibility of a takeout by a larger industry player could provide an opportunity for an attractive exit, albeit uncertain in its timing.

– Strategic missteps: seems like a stretch given Delfi's history and the management's track record, it’s conceivable they could do something disastrous, like aggressively pursue growth in China. Such an investment in a new, competitive market would divert resources away from the core business and disrupt the company's growth trajectory.

However, considering the significant ownership stake held by the founding family, it is reasonable to assume that management would be cautious in their approach to expansion, as any missteps could substantially affect their wealth. As such, the likelihood of Delfi pursuing overly aggressive or misguided strategies is relatively low, with too-conservative decisions being the likelier mistake

Catalyst

Potential catalysts:

– Structural momentum. As the fundamentals improve and multiple expands, it’ll screen for more investors, most notably passive

– Aforementioned potential takeout