Description

IDEA

TWPC was formed in 2015 by the amalgamation of formerly separately listed Thai Wah Starch PCL and Thai Wah Food Products PCL, combining 2 strong players with niches in vermicelli (glass noodles) and tapioca starch. The new CEO, Mr Ren Hua Ho, grandson of the founder, Wharton educated and former Bain consultant believes the separate companies have historically traded too cheap as a result of low liquidity and the absence of investor relations. As recent investments mature, EPS and ROE should increase and the new company will demonstrate consistent growth. In combination with improved liquidity, better capital allocation and much improved transparency towards shareholders which could bring the valuation more in line with its peers.

Over the last 2 years the company has made investments to increase its production capacity and sales are expected to increase from 2016 onwards. At 10.5X TTM and 7.7X Normalized After Tax Operating Earnings we have good downside protection and we feel we are not paying for the likely earnings growth and other initiatives mentioned that can boost the share price.

THE BUSINESS

Thai Wah Food Products (TWFP) was the largest vermicelli manufacturer in Thailand with a 44% market share. The Company has a 60-year history and owns well established brands. The Company’s stable market share, high operating margins (avg. 20% last 5Y) and high pre-tax ROCE (avg. 41% last 5Y) are strong indications of a moat. The market for vermicelli in Thailand is expected to grow at 3-5% going forward. We refer to our earlier write-up (12/2014) for more details on this business.

The company is expanding its production capacity for vermicelli from 22,000 ton per year to 23,100 ton by 2016 and for rice noodles from 1,100 to 4,050 ton. The rice noodle market in Thailand and the vermicelli market in Vietnam are still fragmented and the new amalgamated TWPCC set a goal to be a market leader within 2 to 3 years.

Although some rice noodle producers have a strong market position in certain regions, none have a large national market share in Thailand. TWPCC has been testing the market since 2011and has now increased its production capacity aggressively. The production lines of vermicelli and rice noodles are separate but there are synergies available through the distribution channels of vermicelli.

Management targets operating margins similar to the Thai vermicelli business when scale is achieved.

Thai Wah Starch (TWS) was one of 4 large tapioca starch producers in Thailand. Tapioca is a starch extracted from cassava root and is used as a thickening agent in various foods. The climate in Thailand is perfectly suited to grow the cassava plant and the country accounts for 60% of worldwide exports. TWS’s starch business is a branded premium B2B business with 15-20% gross margins. The company does not sell through brokers but has its own salesforce.

TWS is increasing its production capacity in 2016 from 363,000 ton to 480,000 ton per year in response to a shortage of supply caused by growing demand from China. Growth of consumer food demand in China is still expected to exceed economic growth, even whilst the broader Chinese economy is showing signs of slower growth.

The starch business has operating margins of 8% and a pre-tax return on capital of 27% (5Y avg.). This compares with operating margins of 20% and a ROCE of 41% for the vermicelli business. ROE should benefit from recent initiatives to optimize the balance sheet such as the sale of non-core assets. The new CEO has instructed a RE broker for the sale of the land portfolio, in our view a positive sign from the new generation monetizing legacy holdings.

VALUATION

Net of cash and non-operating assets, TWPCC is currently valued at 10.5X TTM and 7.7X Normalized After Tax Operating Profit.

Net cash and non-operating assets represent THB 1.9b on a market-cap of THB 5.3b. Cash equals THB 1b and corporate bonds THB 400m. For historical reasons the company owns land in Thailand that Knight Frank valued at THB 400m. We understand that the new CEO has instructed a broker to sell the land as part of his strategy to improve the return on capital. Minority participations in 2 starch producers are valued at THB 300m or 11X TTM After Tax Earnings.

We described above the investments made to increase production capacity in 2016. Management expects sales to increase from THB 5.5b (ttm) to THB 6.5b in 2017.

65% of the sales increase should come from starch, a market with a shortage of supply for several years. A lot of the growth is coming from China where consumer food demand is expected to grow at a higher rate than GDP. Even with a slowing economy demand for starch is projected to increase. To achieve this, TWPC has expanded its salesforce in China. With a growing demand and a shortage in supply , TWPC can reasonably expect to increase sales of starch.

35% of the increase in sales is expected to come from rice noodles in Thailand and vermicelli in Vietnam. TWPC has been testing this market for years and believes with the increase in production capacity, investments in sales and distribution and synergies with the existing business, it can become a market leader for rice noodles in Thailand and vermicelli in Vietnam within 2 years. Whilst we would welcome this increase, we are less certain of its outcome.

TTM operating margin of the newly combined company is 8,05%, substantially lower than the 5-year average of 10.7%.  The lower margin is the result of accounting and 1-off expenses related to the amalgamation and higher sales expenses in anticipation of the production increase.

The current operating margin is 2.65% lower than the historical average because of the following 3 reasons, all of which we believe are not permanent:

1) 1-off expenses related to the amalgamation of 0.6%

2) 0.8% related to the increase in depreciation of re-valued PP&E and amortization of intangibles such as trademarks and customer relationships created as a result of the amalgamation.   

3) the balance (1.2%) can be explained by below average operating margins for TWS and TWF.  SG&A has been high with the recent investments in sales and distribution in anticipation of the higher production capacity. When sales increase the margin should normalize.

MANAGEMENT

The Ho family is the largest shareholder with a stake in excess of 25%. Mr. Ren Hua Ho is CEO and son of the current Chairman.

Ren Hua graduated from Wharton and worked for Bain as a consultant before taking up directorships in several family businesses. He spent the last 5 years in China for their luxury resorts business, Banyan Tree Holdings Ltd, before becoming CEO of TWPC.

Transparency has improved greatly with a CEO who’s fluent in English and is available to investors. Investor Relations was not a priority before but we have already noticed a great improvement.

He told us the company’s focus has been the same for 20 years with a focus on sales growth, premium brands and margins. As the investments made in 2014 and 2015 mature he expects the ROE to increase to 15% from historical levels of 10-11% which he sees as too low. TWPC has instructed a broker to sell some legacy assets, land in Thailand, another sign of a new approach.

When we asked him why the company needed to hold a large cash balance he replied the focus is on growth and TWPC wants to maintain a conservative balance sheet and pay a stable and increasing dividend.  We explained that we believe it makes sense to buy-back shares at the current share price but we received no indication yet if that would be considered.

CONCLUSION

TWPC is a regional market leader in branded food and branded B2B trading at 10.5X After Tax Earnings with a high probability of improving operating margins and sales growth. If we ignore 1-off and non-cash expenses and assume normalization of selling expenses the P/E drops to 7.7X.

This multiple is very attractive for this business, especially with the capex already spent to allow sales to grow substantially over the next few years.

The new CEO is aligned with shareholders and is focused on growing sales, margins and ROE.  

Ren Hua has improved transparency and shares have become more liquid after the amalgamation of 2 smaller businesses.

Catalyst

• Sales growth

• Improvement of operating margins

• Improved capital allocation with sale of legacy assets

• Improved transparency to shareholders

• Improved liquidity as free float has increased after amalgamation