SGX:UD2 - JAPFA LTD

[WeiChiLoh]

http://chemiccapital.blogspot.sg/2014/09/japfa-ltd-stock-pitch.html

 

Hi guys, would anyone be so kind to read my thesis? I realized that it is a little sloppy but I really do need some advice so as to move up the learning curve. (Yes, this is also a plug to my blog)

Couple of stuff I learn from this short project:

 

1) DCF is highly imprecise in itself. Changes in the terminal growth rate or discount rate can radically change valuation. Given this, using EBITDA multiples as a proxy seems like a better and easier way to the valuation process.

2) I would like to thank ScottHall in my previous thread for giving me advice on the fact that I have way too many tabs! Much work, little reward. Low return on brain damage. Maybe EBITDA multiple would be sufficient.

3) It doesnt make sense for CAPEX to substantially exceed D&A in the long term.

 

Please fill free to blast my work. Constructive criticism would be awesome!

Any advice would be great! I am still in high school, so....there are many things to learn!

[Fat Pitch]

3) It doesnt make sense for CAPEX to substantially exceed D&A in the long term.

 

This does often occur in many businesses. It is usually the result of inflation since replacing equipment becomes more expensive in the future and the need to fend off competition with increased investments just to maintain current volumes.

 

I have a question about the business you outlined. Is the economic useful life of the company’s PP&E really 12.2 years? If that’s the case then the FCF the business generates for 2014 is ~109mm when you adjust for working capital adjustments minus 55 mm for depreciation of current equipment nets you 54 mm. With working capital of 645mm + 653mm for PPE that gives us a ROIC of ~4.2%. This business won't make the owners very rich.

[yadayada]

I don't like ebitda multiples. Usually jsut try to figure out what earnings will be. What FCF will be. The higher return on capital is, the higher FCF will be similar to earnings most years.

 

And capital allocation skills deserve a premium on upside. If they buy back at the right times then that can really give a steroid injection to upside %.

[WeiChiLoh]

3) It doesnt make sense for CAPEX to substantially exceed D&A in the long term.

 

This does often occur in many businesses. It is usually the result of inflation since replacing equipment becomes more expensive in the future and the need to fend off competition with increased investments just to maintain current volumes.

 

I have a question about the business you outlined. Is the economic useful life of the company’s PP&E really 12.2 years? If that’s the case then the FCF the business generates for 2014 is ~109mm when you adjust for working capital adjustments minus 55 mm for depreciation of current equipment nets you 54 mm. With working capital of 645mm + 653mm for PPE that gives us a ROIC of ~4.2%. This business won't make the owners very rich.

 

Hi! Thanks for reading! Interesting, i did not think about the fact that the cost of fending off competitors would increase maintenance CAPEX. I will keep that in mind from now on.

And yes I agree that this business wont make the owner very rich. The business is capital intensive and the industry is expanding at rapid pace, which means capital requirement is very high in order to maintain CAPEX. However, there is a portion of the business which I did not really elaborate and that is the Greenfields brand that JAPFA owns. It is high margin and I believe has economic goodwill. If the company focuses its capital on expanding its Greenfields brand, I believe JAPFA would be able to generate very high ROIC. 

[WeiChiLoh]

I don't like ebitda multiples. Usually jsut try to figure out what earnings will be. What FCF will be. The higher return on capital is, the higher FCF will be similar to earnings most years.

 

And capital allocation skills deserve a premium on upside. If they buy back at the right times then that can really give a steroid injection to upside %.

 

The reason why I think EV/EBITDA multiple should be used is because of the effects of minority interest. I am not sure if I am logical on this point, but companies with significant minority interest such as JAPFA would report very low earnings after taxes. However, that does not mean that the company is not valuable. Therefore an EV/EBITDA multiple would be the most appropriate as EV and EBITDA is pre-minority interest.

[cameronfen]

I didn't verify this myself, but according to Anonomous Analytics and their write up on Tianhe Chemicals, Frost and Sullivan does a lot of work in investor relations and research meant to put a company in a favorable light rather than unbaised research, so I would be wary of any Frost and Sullivan research that the company provides you.  I think they do other types of market research so if you found it from a different source than from JAPFA you may be okay. 

 

I'm also confused are you advocating going long the company?  How come the DCF projects a Stock price of like .57c. 

[WeiChiLoh]

I didn't verify this myself, but according to Anonomous Analytics and their write up on Tianhe Chemicals, Frost and Sullivan does a lot of work in investor relations and research meant to put a company in a favorable light rather than unbaised research, so I would be wary of any Frost and Sullivan research that the company provides you.  I think they do other types of market research so if you found it from a different source than from JAPFA you may be okay. 

 

I'm also confused are you advocating going long the company?  How come the DCF projects a Stock price of like .57c.

 

Yes I am advocating a long, however, I believe something must have gone wrong somewhere and I will be reworking it next week. For example, after doing some sanity check, I find that I am not putting a lot of weight on JAPFA's Greenfields brand, which should generate significant FCF. Rather the bulk of value seems to be come from their somewhat low margin, capital intensive DOCs and Animal Feed business.