Is New Toyo International a Value Trap? (Part 2 of 2)

Value Investing Case Study 09-2:  This post focus on whether there is a buying opportunity for New Toyo.  It considers not only valuation but also the risks. 

Is New Toyo International a value trap?


New Toyo International Holdings Ltd (New Toyo or the Group) is currently trading at SGD 0.175 (as of 29 Jan 2021) per share compared to its book value of RM 0.35 per share (as of 30 Jun 2020) ie about a 50 % discount. 

This discount can be viewed as either a value trap or a bargain. How can you tell which is the correct view?

A value trap is one where while the stock appears cheap, there is a reason for it. This could be due to an insurmountable decline in the business. Or there is a potential impairment that could wipe out a significant portion of the book value.

Is New Toyo facing such a situation?  I don’t think so. Join me in this part of the 2-parter series as I argued why New Toyo is not a value trap.

Part 1 was published on 7 Feb 2021 while Part 2 is presented here.

If New Toyo is not a value trap, it must mean that there is an investment opportunity given the mispricing. Does it mean that you should go and buy? – well read my Disclaimer. 

This blog is reader-supported. When you buy through links in the post, the blog will earn a small commission. The payment comes from the retailer and not from you. Learn more.



Contents

  • How well did Top Management Seize Opportunities?
  • Is there a great Buying Opportunity?
  • Will Shareholders’ Value continue to be created?
  • How to minimize Risk and secure your Investments
  • How to Gain from the Case Study

How well did Top Management Seize Opportunities?


Top Management

There are 7 members on the Board of Directors: 
  • The current Chairman is the founder of the Group.  He was the Executive Chairman and Managing Director of the Group for many years since the Group listing till 2011. He left the Board in 2011 and returned as Non-Executive Chairman in 2016. (Note: The position was re-designated from Non-Executive Chairman to Executive Chairman on 1 Nov 2020).
  • During the period 2012 to 2013, the Chairman's son served as Chairman of the Board.
  • The current Group CEO is one of the pioneers of the Group and was appointed to this position in 2016. She had also served as the Executive Chairman from 2014 to 2016.
  • There are 5 Non-Executive Independent Directors. 2 of them have been recently appointed while the other 3 have been Board members for 6 to 14 years.  

The Chairman and his family own about 52% of New Toyo International Holdings Ltd making this an owner-managed group. 

Apart from the Group CEO, 3 other senior managers were featured in the 2019 Annual Report. The CFO joined the Group in 2018 while the other 2 have been with the Group for more than 13 years.

How did top management perform given the long tenure and alignment of interests with shareholders?

Business operations

I compared New Toyo's top management operating performance with its peers based on 2 criteria - revenue growth and return on assets.

The analyses showed that New Toyo did not perform as well as its peers on these 2 metrics as detailed below.

As the packaging industry is a diverse one, I selected the peers from SGX and Bursa Malaysia as follows: 
  • There were 2 packaging companies on SGX with a similar scale of revenue as New Toyo.
  • There were about a dozen packaging companies listed on Bursa Malaysia. I identified 3 packaging groups with a similar scale of revenue as that for New Toyo.  For those peers with several business segments, I only look at their respective packaging segment performance.

As can be seen from the chart below, New Toyo's revenue performance did not stand out. New Toyo was completely out-performed by Tat Seng Packaging Group Ltd and Scientex Bhd packaging segment.
  • Tat Seng's revenue growth was driven by its expansion in China.
  • Scientex had exceptional growth in 2013 and 2019 following some acquisitions.
New Toyo Peer Revenue Index
Chart 1: New Toyo Peer Revenue Index

In terms of return on assets, New Toyo's performance was near the bottom of the peer group as can be seen from the table and the chart.
  • New Toyo and Southern Packaging's current returns have deteriorated compared to their respective returns in 2008.
  • Tat Seng and Thong Guan plastic segment returns have improved compared to their respective returns in 2008.
  • Sceintex packaging segment had the most consistent return on assets over the past 12 years

New Toyo Peer Average ROA
Table 1: New Toyo Peer Average ROA

While the peers’ products are not exactly the same as those of New Toyo, the Group had its share of acquisitions and expansion into China. It had divested out of the corrugated carton segment.

If you view top management's role as developing new products and markets, you would conclude that they did not outperform the peers. 

New Toyo Peer ROA
Chart 2: New Toyo Peer ROA

New projects and ventures

Over the past few years, the Group had undertaken several joint ventures and/or expansions that were discontinued a few years later. 

In 2016, the Group expanded to Dubai with a total paid-up of SGD 4.26 million to act as a springboard for Eastern Europe.  In 2019 the Group restructured the Dubai operations for a third party to manage it. There were SGD 6.2 million impairment and redundancy costs associated with this. 

In 2017, New Toyo ventured into the manufacturing of tissue paper in China reporting a positive picture of global demand.  After recording a loss of SGD 18.1 million in 2019 the Group decided to close this business. This is not the first time that the Group had divested out of the tissue paper business. In 2002, the Group had divested its tissue paper mill in Vietnam. 

However not all the ventures ended with negative results.

In 2016 the Group acquired PT Bintang Persona Jagat (BJP) in Indonesia for SGD 33.48 million making the Malaysian operations redundant. The Malaysian operation ceased with SGD 3.8 million retrenchment and PPE impairment expenses.

The BJP acquisition came with a 6 years exclusive supply agreement commencing from 1 Jan 2017 to 31 Dec 2020. The BJP contract should prove to be beneficial to the Group like the Anzpac acquisition in 2008.

Anzpac was acquired from British American Tobacco (BAT) for SGD 61.8 million.  This was together with a 7 + 3 years agreement to supply BAT with cigarette packs and cartons. 

Over the 10 years period, the Group experienced a positive net cash flow from the Anzpac acquisition (Refer to Note 1).  

At the same time, the Anzpac equipment has been relocated to the Group Vietnam operations and is still in use. 

Looking at the above projects and ventures, I would conclude that 
  • The top management has a good track record for investments within the tobacco sector and/or within the ASEAN regions.
  • There is concern about the track record outside the tobacco industry and or the ASEAN regions.

Is there a great Buying Opportunity?

I generally use two approaches in assessing the intrinsic value ie Asset-based and Earnings-based. 

My base case Earning Value for New Toyo is assuming the following:
  • The average past 12 years' performance represents the future.  I ignored the gain from the sale of properties in 2016 and 2018 in the cash flow analysis.
  • Ignore growth.
  • New Toyo business model has resulted in frequent disposal and acquisitions of new plants and businesses. As such impairment and retrenchment costs should be viewed as part of the “normal” operating expenses rather than one-off expenses. 

For companies like New Toyo undergoing a turnaround, the base case Earning Value would not be realistic. In a turnaround, you would assume that the future should be better than the historical performance. 

In Part 1, I have shown that over the past 6 years, there have been significant costs equal to SGD 6 million per year due to redundancies, impairments, and one-off business losses. 

After a turnaround, such costs should not occur again. I guesstimated that an Optimistic Earning Power Value would be based on 
  • Adding back such costs.
  • Assuming 17% tax rate for those added back items.
  • Assuming the 2018 profits to be the average of the revised profits for 2017 and 2019

New Toyo Valuation
Chart 3: New Toyo Valuation

The chart and table sum up New Toyo valuations:
  • The Earning Power Value is less than the Asset Value. This is not surprising as the Printed Carton and Label segment has not generated returns above the cost of capital.
  • Over the past 5 years, there have been periods when the market price has been greater than the Optimistic Earning Power Value.
  • The Optimistic Earning Power Value and Asset Value should provide enough margins of safety at the current market price. 

New Toyo valuation metrics
Table 2: New Toyo Valuation Metrics

It is a conservative approach as I have yet to take into account the contribution of the property development joint venture.

The above is of course a simplistic valuation analysis.  
  • If you believe that the future would be better than that projected, the EPV would be higher than the Optimistic EPV.
  • If you believe that the future would be worse than the base case, then the EPV would be lower than the base case.  

Will Shareholders’ Value continue to be created?

If you have been following my blog, you will know that a high-quality company is one that has a good chance of increasing shareholders’ value. 

With New Toyo Earning Value < Asset Value, will it be able to create shareholders’ value?

New Toyo has an overall Q rating score of 0.42 placing it in the middle of the ranking of the panel companies.

The rating reflects the strong financial position and low-risk profile. However, the rating highlights its poor growth.  This is not surprising given the poor track record of its expansion into Dubai and the Tissue paper business. 

I will interpret the rating to mean that New Toyo would be able to sustain its earnings but do not expect to see significant earnings growth.

New Toyo Q Rating
Chart 4: New Toyo Q Rating

How has New Toyo actually performed in terms of growing shareholders’ value?

From 2007 to 2019 if you assumed that no dividend was paid, shareholders’ funds have grown at a compounded annual growth rate of 5 %. This is below its cost of funds.

Is it possible for New Toyo to enhance its shareholders’ value? 

As shown in Part 1, the Printed Carton and Label business returns are below its cost of funds. Given its success in the tobacco sector, New Toyo could focus on improving the returns here. 

Furthermore. New Toyo has a good cash generation history.  Over the period from 2008 to 2019 the Group
  • Generated SGD 270 million cash from operations.
  • Spent about SGD 133 million cash in investments.
  • Paid out about SGD 90 million as dividends (about 56 % payout ratio)

Conclusion? New Toyo will be able to generate cash to fund new investments without affecting its dividend payments. 

To benefit the shareholders, it must achieve the 10% average ROE it achieved in the 2008 - 2010 period.  
  • For a start, New Toyo should improve on its assessment of new ventures.  
  • If I was management, I would look into improving the returns for the Printed Carton and Label business. 

Case Notes

A stock market is a place where people buy and sell pieces of paper representing part ownership of businesses. So, there are 2 ways to invest:
  • Buy and sell pieces of paper.
  • Buy and sell part ownership of businesses.

If you follow the former you are basically investing based on market sentiments as you don't care about the underlying business. Your success depends on how well you can read crowd behaviour. People use charts, trend lines, and technical indicators to help gauge market sentiments.

If you follow the latter, you believe that price will eventually reflect the value of the underlying business as determined by its fundamentals. If you see a situation where the price is less than the value as determined by its fundamentals you buy. Your success here depends on your understanding of businesses.

If you are not good at reading human behaviour or understanding business, then you can index.

My case studies are intended for those who follow the “buying and selling part ownership of businesses.” This requires you to understand the business and to make an informed judgment about what it is worth. 

As this case study demonstrates, this is not so clear-cut.

How you handle it comes from experience. If you are just starting out to analyze and value companies, it may be helpful to supplement it with third-party analyses.  There are several financial advisers who provide such analyses. Those who do this well include people like The Motley Fool. Click the link for some free stock advice. If you subscribe to their services, you can tap into their business analysis, valuation, and risk assessment.




How to minimize Risk and secure your Investments?

Risks

When I look at the risks in investing in New Toyo, I would see the main ones as 
  • Privatization.
  • Turnaround and New ventures.
  • Single customer

Privatization

With the Chairman and his family owning about 52 % of New Toyo International Holdings Ltd, they would need about SGD 37 million to take it private at the current market price of SGD 0.175 per share.

I do not think that this could be done with a capital reduction exercise even though the Group has SGD 42 million cash as of the end of Jun 2020. This is because the Group has financial liabilities of SGD 63 million as of the end of Jun 2020.

Would the Chairman and his family then spend SGD 37 million to take it private? 

To benefit from privatization, either
  • The shareholders could extract cash from the private company. This could involve asset sales and extracting the cash from the company without disrupting the operations.
  • The company could be relisted again after it has been turned around. The shareholder would benefit from a higher market price on re-listing.

I am not sure whether the former could be pursued as there are not many non-operating assets.

As for the latter, the numbers don’t make a compelling case for privatization. 

Firstly the privatization offer would probably have to be at a price higher than the current market price. SGX privatization rules require the offer to be made at a fair and reasonable price. I think this would make any offer price to be closer to the book value of SDG 0.35.

Secondly, if you assume that the Group can achieve a steady 10 % ROE, it would result in an EPS of SGD 0.045.  I would think that it would take about 5 years to generate the track record for relisting.  The total cost (acquisition price plus interest) by then assuming 7 % interest per annum would be about SGD 0.47 per share.  To cover this cost, the shares would have to be re-listed at least at PE 11 multiples based on an EPS of SGD 0.045. There is not much margin of safety. 

Turnaround and New venture

In a narrow sense, turnaround here is about returning the current business to profitability. This should present the lowest risk for New Toyo as the current management team has managed to achieve better performance in the past. 

At the same time, the industry is not experiencing any secular decline or digital technology threats. In a sense the 1H 2020 points to positive signs of a turnaround.

However, to generate a quantum leap in performance, New Toyo has to diversify ie venture into new business areas. But its track record has not been very encouraging given the Dubai and Tissue paper experience. Furthermore, while opportunistic, its venture into property development has yet to see any results.

I would consider this the biggest risk for New Toyo - whether it can develop the expertise to assess new ventures and to operate profitability.

The risk mitigation here is that I have not imputed any growth into New Toyo valuation.


Turnaround

Single customer

Over the past 11 years when the information was reported, a single customer contributed an average of 48% of the Group revenue. Although not specifically mentioned, I believe that this is the BAT.

A loss of this customer would impact the Group. This was the rationale for the return of the founder as Chairman in 2016 - to help renew the supply contract.

This risk remains.  The main risk mitigation is that the Group has managed to serve the customer for a very long time.  I would expect the Group to go all out (and possibly affect its margins) to keep this source of revenue. 

How to Gain from the Case Study

What is the investment thesis?

The current print packaging industry is expected to grow at about 4 % to 5 % per annum. This means that New Toyo can expect steady growth after it has turnaround the business.

The turnaround situation arose because the Group had incurred redundancy and impairment expenses for repositioning its business to a lower cost base. At the same time, it faces business loss in diversifying into the tissue paper business

The Group has ceased and restructured the loss-making operations and has seen the first signs of improvement in the 1H 2020 results. The challenge for New Toyo is venturing into new areas for any quantum leap.

However, there is ample margin of safety at the current price when compared to the Asset Value and Optimistic Earning Power Value.

The conclusion is that New Toyo is not a value trap. This is because
  • I do not expect further impairment of PPE.
  • The current businesses have the potential to deliver a steady return

However, there are some concerns so that New Toyo may be a cigar-butt type opportunity.  
  • Management performance has not the best among its peers.
  • There is a poor track record in venturing into new business areas.
  • The single customer risk remains.

There is buying opportunity at the current price.  But I would put a dollar cap on the buying price even though there is a margin of safety from the Asset Value at this price. An upside from this cap would depend on management achieving beyond a 10% ROE consistently.


End of Part 2 of 2


Coming Next on 7 Mac 2021 Wing Tai


Note 1:  Estimated cash flow for Anzpac

Item

Year

Cashflow

(SGD million)

Notes

Acquisition

2008

(61.8)

Incl goodwill

Contract profits

2009 - 2018

7.5

Refer to notes (a)

Depreciation

2009 - 2018

42.0

Refer to notes (b)

Disposal

2018

21.5

Sale of investment properties

Net cash flow

 

9.2

 


a) During the 10 years, the Printed Carton and Label segment made an average segment profit of SGD 11.3 million compared to an average segment profit of SGD 10.4 million for 2007 / 2008.  

Assuming that all the increase is due to the Anzpac-BAT contract, this is equivalent to SGD 0.9 million per year segment profit.  I assumed a 17 % tax rate to get 0.75 million annually.   

I have assumed that the relocation costs and retrenchment/impairment costs (SGD 8.5 million in 2017) have been accounted for in the segment profit.   

b) SGD 42 million was recognized as PPE following the acquisition.  Based on the 10% depreciation rate, the full amount would have been depreciated over the 10 years P&L period.  



Reading guide
If you are a first-time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation.  I suggest that you check up the Foundations series - Fundamentals 01,  Fundamentals 02, and Fundamentals 03.   I also have a Definitions page in case you are not familiar with the terms I have used. 





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Disclaimer & Disclosure
I am not an investment adviser, security analyst, or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.

This blog is reader-supported. When you buy through links in the post, the blog will earn a small commission. The payment comes from the retailer and not from you.




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