I don’t often write about compounders. It
takes a different set of skills to correctly identify and conceptualise all the
moving pieces that would make a company a real compounder vs simply buying
cheap stocks. Having said all of that, there is a company I’ve been following
for a while that could turn about to be an interesting situation.
Tingyi was founded in the early 1990s, listed
in HK and is a large China based food and beverage company that is going
through some changes. It is the largest producers of instant noodles in the
world (e.g. 56% market share in China in value terms as of 2014, which is the
largest market by far). It has a majority ownership in a beverage JV with its
ParentCo, Pepsi and Asahi. This JV is the largest in China and has market share
of 55% in ready to drink tea, 26% in juices and 19% in bottled water.
Tingyi owns the Master Kong brand, which is
probably the most well-known and valued instant noodle brands in the country. Its
current market share is about 56%, with plans on reaching 60% in the coming
years. In terms of size, noodle business revenues are about 3x of the next
competitor in China, which gives it financial firepower and scale. This proved
to be very important in what can be best described as the noodle wars or sausage
wars in China. Starting in 2009, one of Tingyi’s competitors, Uni-President
began promoting new noodle products by giving away free sausages and offering
price discounts. Tingyi retorted and given its scale and firepower it was
gradually able to put an end to this nonsense. While both peers suffered a decrease
in operating margins, for Uni-President these new, aggressively marketed
products represented a large % of overall revenues while for Tingyi they
were (i) much smaller – c.15% of noodle sales and (ii) it could cover
promotional costs much easier from profits from other product lines. As a
result Uni-President was bleeding more and eventually conceded. It was very
interesting to follow this live, essentially textbook
economics 101. It will be a good lesson for competitors – whom are hurting from
margin and share loss – to consider carefully any such moves again. Incidentally, a
similar battle went down in milk teas as well.
Interestingly, while the Master Kong brand
is very famous in China it doesn’t “travel" well (but who cares if you own the
largest market). Having conducted a non-representative survey in HK, customers there prefer different brands to Master Kong (due to food safety issues amongst
others) but when in China it’s the No.1 brand they seek out. There you go, fun
fact for the day.
Tingyi got into the drinks business in 1996
and slowly expanded its brand portfolio and geographical coverage. Later it
sold a stake in the beverage business to Asahi and Itochu and in a faithful
turn of events this business was merged into Pepsi’s China unit in 2012 (more
on this below). The drinks business consists of four major types of products:
tea, water, juice and CSD and Tingyi has top market share across these segments
(est. 30% in the overall non-alcoholic drinks market in China). In addition,
with the Pepsi brand portfolio Tingyi has an exposure to faster growing
products such as sports drinks, spring water etc though these are out of reach
for most consumers yet in terms of prices. In 2012 Pepsi came knocking on Tingyi’s door after
years of losses in their China beverage business. In Q1 that year the parties
announced that Pepsi will inject its bottling plants into Tingyi’s beverage
business and take a 5% stake (!) with an option to increase it to 20% by 2015. In
it’s current shape this JV is 47.5% owned by Tingyi, 30.4% Asahi, 17.1% Ting
Hsin (Tingyi’s ParentCo) and 5% Pepsi. What did Tingyi get in exchange: an
inefficient business with a drag on margins in the last few years (EBIT margins
dropped from 9% in 2010 to 3-4% in 2012/13). No seriously, the portfolio expanded as well as revenues and given hard synergies Tingyi was able
to stop the bleeding in 2013 (promotional and raw material cost reduced,
increased sharing of beverage distribution and production between the two
companies etc). Moreover, on the HR side Tingyi is restructuring the sales and
distribution units to make the Pepsi business as efficient as their
own.
Finally, as noted above Tingyi has a substantial
distribution network in China, e.g. about 37,000 wholesalers, 118,000 directly
serviced retailers and 130 production facilities. This platform serves also as
a springboard to distribute other F&B brands and to that end Tingyi started
JVs with foreign companies (such as Calbee of Japan or most recently with
Starbucks). In addition, mgmt. is considering domestic M&A such as in
instant foods (ex noodles) to grow this segment.
Source: Tingyi. Distribution and production facilities across China
After reading about this fabulous company
you’ll probably think that the share price hasn’t seen a down day since the listing.
Well, not quite. The share price has gone exactly…nowhere for the better part
of the last six years. In fact, it’s at the same price it was in late 2009. While
sales have increased from $5bn to the current $10bn, operating and net margins
have declined from around 12% and 8% to 7% and 4%, respectively. Essentially,
revenues doubled but profitability stagnated partly due to integrating the
beverage business, noodle wars etc that took a toll on margins. However, forward
multiples remained relatively flat over the last five years: EV/EBITDA 13x,
EV/EBIT 18x and P/E 29x (rarely below 25x) on average, which is quite
generous considering all of the above. It is worth noting that Tingyi trades at a
premium to its China peers due to large market share, strong scale advantage
and expected growth trajectory.
In terms of revenues, noodles represent 40%,
beverage just shy of 60% and instant food, others etc the rest. In terms of
EBIT noodles make up over 60% (essentially the cash cow of the group). In 2014 Tingyi generated revenues of
$10.2bn and EBIT of $685m. Overall, net income and EBITDA reached $400m and
$1.1bn during the year. Results are moderately down from 2013 given a decline in
noodles sales due some food safety issues and scandals. Food safety, as I’m sure you
aware if you travel there, is a huge issue in China. Over the last year or so
Tingyi’s ecosystem was hit with a number of scandals for products
being found in food that were not exactly meant for human consumption. While
not all of them impacted Tingyi’s products specifically, some implicated
companies owned by its ParentCo. Either way it’s not a pleasant issue to deal
with and certainly affects sentiment.
Looking at valuation and earning power. These last few years have been challenging for Tingyi given all the operational issues, however the future is looking brighter. What could this business generate over the next couple of years? Assuming 7.5% p.a. revenue growth between 2014-17 (below historical rates),
element of margin recovery (though below peaks) for both EBIT and net income to
around 8.5% and 5.5% respectively (also below guidance) and historical average trading multiples, I get to a share price of around HK$26 (vs HK$16.6 currently) for 18%
CAGR. My numbers are below guidance and probably on the conservative end of things. While
I acknowledge Tingyi’s scale and capabilities many things will have to go right
in the process (Pepsi integration to mention one). But that is OK; this is an
idea with a long runway ahead of itself and not a quick turnaround. Tingyi
maintains a 50% dividend payout with a current yield of 1.7%. It’s worth noting that
there is debt on the balance sheet ($1.5bn net, mostly to pay for new HQs and
other facilities) but Tingyi generates strong free cash flow and capex will be declining in the next couple of years (mgmt. guides $600-800m
p.a.).
Tingyi reminds me of situations I’ve seen before
in many emerging market branded businesses. Large, well-capitalised, foreign company
ABC decides to enter XYZ emerging market (naturally after sitting through hours
worth of eloquent consultant presentations) only to have their head handed to
them by an incumbent local producer, either with a brand so ingrained in the
culture that no amount of advertising could change or such scale that
replicating it would take a lifetime. For instance Ulker, a Turkish biscuit
company comes to mind.
Governance wise Tingyi, like many in Asia,
is a controlled company. The founding family (originally from Taiwan) owns 1/3
of the company via Ting Hsin, Sanyo Foods another 1/3 (Japanese food co, stake
acquired in 1999) with the rest in free float in HK. There is a very good
profile on the founding family from a 2011 Forbes article if you care to read further.
Risks worth keeping in mind: (i) competitive
landscape – while competitors are probably licking their wounds, another round
of noodle wars could hurt profitability, though Tingyi would probably come out
victorious, (ii) food safety issues – it can kill a brand and Tingyi had it’s
fair share of bad news recently (while not all related to it), (iii) increase
in commodity / input prices – it’s a food business after all and (iv) delay in
integrating the Pepsi business, M&A execution etc.
