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In the Peter Lynch book that got the hook in my mouth about investing one day in Tokyo 20 years ago, he wrote about buying boring businesses, with boring, even silly names.  His exhibit A was Crown Cork & Seal, now Crown Corp.  Crown refers to bottle caps, but they are of course one of the big three in cans, another not terribly exciting industry.

 Ten years ago I ran a fund that owned basically the entire can industry.  I posted Ball Corp. on VIC back in 2003, the last chance one got to buy it cheap.  That was your classic boring business with a boring name. 

 The point of this is that this is an industry I know well.  Here is an even more boring name, the Kian Joo Can Factory.  I am now investing in emerging markets and don’t much like to fly around the world so much prefer to be in industries I know well from the U.S. side.

 What makes the can business, especially beverage cans, attractive is the following.

• Globally it is a stable oligopoly of three players, Ball, Crown and Rexam. 
• It is not a business that changes very much, except in individual emerging markets where cans are actually a secular growth business. 
• It really doesn’t matter what China does because you can’t transport cans very far – a pallet of empty cans is mostly air, worth about $600 but the size of an SUV.  There are not many industrial businesses where you can be confident that you are totally immune from Chinese overcapacity – quick, can you think of another?
• End demand is stable – beer, Coke, food.
• Metals cost is a pass-through.
• There are clearly barriers to entry, as most evidenced by the fact that nobody has entered the business in a long long time.  Regional economies of scale is the clearest barrier to entry which keeps the big players from threatening each other, but there is also some real know-how involved here, a learning curve on cost.  If you’ve ever seen a can plant you know that you don’t just decide you’re going to build a can plant and make money.  Margins are not large even for the best operators.  Next time you are drinking a Coke or a beer take a good long look at the can, study it, and think about how you would make 10 billion of those for 6 cents a piece to Coke’s specifications.  6 cents.  Including printing the graphics on the can, which is just an amazing operation to witness.  Including the aluminum (aluminum costs are a pass-through).  I can think of easier ways to make a buck than that, especially since I would have to compete with players who have been doing this for many decades and are really good at it.

 I was looking at a screen of Malaysian stocks a few months ago and found one that looked understandable and cheap called Kian Joo Can Factory.  It made me think of that Peter Lynch book.

 Ball, Rexam and Crown are all actively growing in the emerging markets, and it is an exciting place to be as beverage cans go.  We in the U.S. don’t think of cans as a luxury good, and they are not, but they are a quintessential beneficiary of the key theme in emerging markets – the growth of an emerging middle class.  Early stage emerging markets usually don’t even have beverage cans – returnable glass bottles and big multi-serving PET bottles are where the game generally starts, so there very often is no legacy incumbent can producer to acquire in the first place.  Around the time a country gets to $5,000 per capita GDP things start to change.  Modern retailers develop, households generally get refrigerators and can begin to afford packaged food and beverage.  Packaging companies are reliable beneficiaries of what becomes a long steady growth curve.

 Malaysiaat $10,000 per capital GDP is well along the path.  There are two major players in the beverage can market, each about the same size, Crown and Kian Joo.  Let me emphasize again, it is rare to have a big indigenous beverage can player in these markets.  This one looks like a sitting duck to be acquired, a point I will go into in more depth at the end of this document.

 Emerging markets now are scary and I would love to be recommending a bombed out stock in Brazil or Turkey.  Maybe next time.  Kian Joo is not the cheapest thing I’ve ever seen, and Malyasia is not a cheap market or one of the ones that has gotten bombed out in the last month.  But as emerging markets stocks go, this is one of my favorites, because it looks pretty safe and has several catalysts.

 Kian Joo is a roughly $400 MM USD market cap (3.20 MYR to the dollar). 

 Disclosure is not very good.  I could piece together enough, but I would love to know more here.

 Kian Joo is one of the top two in Malaysia in beverage cans, the leader in general cans (food, paint, etc.) and a major player in cardboard food packaging.  Beverage cans and general  cans each make up about 40% of profit and realize mid-teens operating margins.  The other 20% of the business is cartons (not corrugated boxes - think milk cartons and packages food comes in).  Cartons is not as good a business as the two can segments for them but it involves the same customer relationships.

 The beverage can market in Malaysia is split roughly evenly between Crown and Kian Joo, with the other two global players notably absent.

 It trades at about 10 times earnings, and a small premium to a clean book value.  Dividend yield is 4.5% through regular and special dividends.  Dividends are likely to go up with free cash flow as they have finished a major investment plan.

 Free cash flow has been good, not great.  The culprit has been capital expenditures in excess of depreciation in 2012 and well in excess of depreciation in 2011.  2011-12 capital expenditure levels are not at all representative.  The company built a new beverage can plant as well as a new packaging plant in that period and both came on line early this year.  Those assets were on the balance sheet and the cash had been spent in the trailing earnings numbers, but nothing had come out of those plants yet. 

 That is changing as we speak.  The investment period is over and the harvest begins.  It is hard to quantify it by quarter or anything, but the investment has been made to get ahead of years of demand growth (a can line is about 600 million cans and you either add one or you don’t, so this is not an industry where you can add capacity linearly.)

 The balance sheet is quite interesting, especially in light of the above point that they are just finishing an aggressive spending period.  Net debt is very small, less than half a turn of EBITDA.  These assets could support much more debt.

 What I really like about Kian Joo is how unique an asset it is in a consolidating industry.  The three leaders, Ball, Crown and Rexam followed a strategy of consolidating the beverage can market for the last 20 years.  They roughly evenly split the globe with strength in particular regions or countries.  (There is no global market for cans as it makes no sense to transport them.  Regional is everything in this business.)

 There is almost nothing left to consolidate.  There is one player in Europe, Canpack, which may be in play soon.  There is nothing in the U.S.  You would think there would be many in the emerging markets, but there are not.  If you do a screen of public companies in the industry you will find the big three, a handful of basket case Japanese companies, a handful in the new basket case market China (where everybody has overinvested in new capacity surprise surprise) - and not much else.  Very prominent among the “not much else” part is this cheap little overcapitalized company in Malaysia with the silly name.

 Of the big three, Crown probably can’t acquire KJ because they are already #1 and 2 in Malaysia.  Crown has been the most active of the three in Southeast Asia.

 Ball is 28% of the Chinese market and continues to add there but has no presence inMalaysia.

 Rexam is the most interesting.  If you read their latest annual, they focus page after page on emerging markets expansion, and even tell you that the highest growth is inSoutheast Asiathough they have no presence there.  They have a JV inKorea, recently gave up onChina, and have what could be a monster opportunity inIndia.  But nothing in between.  It seems clear from their own words that they covet a presence there.

 There is another possible acquirer, a domestic player in other areas of Malaysian rigid packaging that bought 30% of KJ two years ago.  Can-One is smaller than KJ, but is not afraid of debt.  There have been rumors that they want to take over the whole thing.

 So from an acquisition analysis the “butts to seats” ratio looks very favorable.  At least three butts and only one seat.

 Global comps trade at 14-15 times earnings.  Given cost of capital today this would be an accretive purchase at almost any price, but just taking that 14x number would deliver a RM3.84/sh, or a nearly 40% premium to the current price.  Earnings are very likely to increase in the next two years as they fill their newly built capacity.         

The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.

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