KFima – my investment plan

Value Investing Case Study 14-3: I last covered KFima in the middle of 2021. In addition to an update, I share in this post what I plan to do with my investment in this company.

 

I bought Kumpulan Fima (KFima or the Group) in 2014/15 at an average price of RM 2.23 per share. At that juncture, the Group’s NTA was RM 2.29 per share. I classified KFima as a Quality Value company and considered that there was a sufficient margin of safety based on the RM 3.19 per share EPV.

During the past 8 years, the Group experienced 2 extraordinary events:

• A land title dispute for its Indonesian plantation. There was a marked reduction in profit in 2017 due to the impairment of RM 29 million to cater for this.

• The 2018 results were affected by the loss of a major supply contract by the Manufacturing division. 

Has the Group overcome these so that there is now a brighter future? The share price had declined from the time I bought it to reach a bottom in Mac 2020. However, it has now risen to RM 2.42 per share as of 27 May 2022. 

Chart 1: KFima Market Price          Source: TIKR.com

Join me as I review the prospects of KFima and decide what to do with my investments.

Should you go and buy it? Well, read my Disclaimer.

If you are not familiar with the Group, I suggest that you read the following posts first.

• Is Kumpulan Fima a value trap (Part 1 of 2).

• Is Kumpulan Fima a value trap (Part 2 of 2).

Contents

• My investment

• Business fundamentals

• Valuation

• Conclusion 

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My investment

I bought the shares in KFima in 2014/15 at an average price of RM 2.23 per share as I found that it was a fundamentally strong Group. It had an overall Q Rating of 0.80 then. 

At that juncture, the Group’s NTA was RM 2.29 per share and it had an EPV of RM 3.19 per share. I could not see any reason why the market was underpricing the Group. As such, I had classified it as a Quality Value investment.

I had expected the market to re-rate it within a few years. Unfortunately, the price began to decline after I had bought it. It did not help that the Group encountered the land title dispute and the loss of a major supply contract.

I have not sold any of KFima shares since my purchase. Over the past 7.77 years, I had received on average about RM 0.30 of dividends per share. The result is that my total return is about 2.6 % per annum on a compounded basis. Refer to Table 1 for the computation.

This is of course based on the current market price.

Table 1: My Investment Return

Over the past 15 years, my stock portfolio on a total return basis had achieved a CAGR of 7 % compared to that of the KLCI of 5%. Assuming that I want to achieve the 7 % CAGR, this must mean that the selling price of KFIMA should be RM 3.49 per share.

This 7% CAGR was derived as [(3.49 + 0.30) / 2.23] ^ (1/7.77). Note that I have assumed the same duration and dividends.

The question then is whether the market price of KFIMA could reach this RM 3.49 per share level quickly.

Business fundamentals

For the 3rd quarter of 2022 ending 31 Dec 2021, the Group achieved a revenue of RM 480 million and a PBT of RM 120 million. This was 34 % and 86 % higher than the respective revenue and PBT for the corresponding period last year. 2 segments accounted for the bulk of the improvements. They more than offset the lower performance of the Manufacturing segment.

• The Plantation segment had 55 % higher revenue and 515 % higher PBT compared to those of last year.

• The Bulking segment had 72 % higher revenue and 40 % higher PBT compared to those of last year.

This augurs well for the prospects of the Group as in my posts last year, I had concluded the following:

• Plantation segment. There is still the potential to increase the planted areas and improve the FFB yield.  

• Bulking segment. Long-term growth would depend on capacity expansion. 

I was pleased to note the following expansion programme in its 2021 Annual Report:

• The Group in Sep 2020 acquired 3,237 hectares of oil palm plantation land in Gua Musang, Kelantan. This increased the Group’s total plantable landbank to 18,877 hectares, of which 13,891 hectares were planted as of the FYE 2021.

• In 2021 the Group commissioned seven new tanks and related infrastructure in North Port. This project marks the first step in implementing the Bulking segment expansion plans. 

Based on the Q3 2022 YTD results, I extrapolated the 2022 performance as shown in the following chart. It shows improvements in revenue, PAT, and gross profitability. 

Chart 2: Performance Index

Gross profitability is defined as gross profits/total assets. According to Professor Novy-Marx, it has the same power as the Price Book Value ratio in explaining stock returns. 

In the past, the performance of the Group was very dependent on the Manufacturing segment. The loss of a major supply contract in 2018 affected the Group’s prospects. It would appear that the other business segments have more than made up for this loss.

Financial Strength

I would also rate the Group as financially strong.

• As of the end of Dec 2021, the Group had a DE ratio of 0.13. In fact, with RM 382 million of cash and cash equivalents, the Group is in a negative net Debt position.

• Over the past 12 years, there was only one year when the Group had a negative Cash Flow from Operations. Over the past 12 years, the Group generated about RM 110 million in annual Cash Flow from Operations compared to its average annual PAT of RM 75 million.

• Based on Damodaran’s synthetic rating approach, the Group would have a triple-A rating.

Chart 3: Sources and Uses of Funds

Regional contribution

The Group operates in 3 countries:

• Indonesia for part of the Plantation segment business.

• Papua New Guinea for the majority of the Food segment business.

• Malaysia for mainly the Plantation, Bulking, and Manufacturing segments. 

You can see that the revenue from the Indonesian operations had increased in 2022. This augurs well for the Group as it demonstrated that it had been able to do well notwithstanding the land title dispute.

The Papua New Guinea operations had grown. Historically the Food segment was a low return operation so any increase in revenue would be positive for its long-term prospects.

Chart 4: Revenue by Regions

High inflation environment

With the Ukraine invasion and the global supply-chain problems, it looks as if we are entering a period of high inflation. Now whether we would enter a period of stagflation is still debatable.

The good news is that I would consider KFima as one of the companies that would do well in a high inflation environment. This is because it has a strong Balance Sheet. In a high inflation environment, interest rates would be higher. This would be detrimental for highly geared companies.

Furthermore, 3 of its business segments - Plantation, Food, and Bulking - will probably do well in such an environment. 

• The palm oil sector will hold its own given the disruption to the sunflower seed oil from Ukraine. 

• Food is considered a necessity and hence the Group would be able to pass on its costs. 

• The demand for palm oil and petrochemicals would also be positive for the Bulking segment.

The Group also has an average reinvestment rate of 29%. In a high inflation environment, it would cost more for companies with a high reinvestment rate to fund their growth. The low rates for the Group would be advantageous.

Refer to my post “Investing in a high inflation environment” for the characteristics of companies that would do well in a high inflation environment.

The only concern I have is the high level of cash of RM 136 million as of the end of Dec 2021. In a high inflation environment, the purchasing power of this would be quickly eroded. I would expect the Group to quickly redeploy this into investment in securities if there are no immediate cash requirements. 

Valuation

A valuation of KFima along the same lines as what was carried out last year showed an increase in values as compared to those last year. The EPV and Earnings value with growth (EV with growth) this round were 60 % and 69 % higher than those computed last year.

Chart 5: Valuation

Note

The valuation included the 2022 results extrapolated based on the Q3 2022 result.

Table 2: Valuation Comparison

Note

The valuation for 2022 included the 2022 results extrapolated based on the Q3 2022 result.

The major reasons for the increase in the values this round were:

• The EBIT(1-t) this round was higher at RM 79 million compared to RM 74 million last year. This was due to the improved 2022 performance.

• The WACC this time was lower at 7.9 % compared to 10.8 % for last year.

My main concern is with the WACC. The WACC for 2022 was derived based on Damodaran’s Jan 2022 datasets. I am sure it did not take into account the Ukraine invasion and the high inflation impact. These 2 factors would mean greater risk. The Jan 2022 datasets did not incorporate the higher risk.

Damodaran does not have updated datasets taking into account the latest economic scenario. One way to account for the higher risk is to use the higher discount rates of 2021.

Based on these, I would obtain an EPV of RM 3.24 per share and an EV with growth of RM 3.38 per share. They are about 19% and 24 % lower than the earlier respective values using the Jan 2022 datasets. But there would still be sufficient margins of safety at the current market price of RM 2.42 per share (as of 27 May 2022).

Sum-of-parts valuation

The above valuation was based on a consolidated basis looking at the performance over the past 12 years.

We all know that the Group comprises 4 business segments that have their respective prospects and risk profile. The Manufacturing and Plantation segments business face significant disruptions in 2017 and 2018 respectively.

Given this profile, it may be more realistic to value KFima based on a sum-of-parts basis. At the same time, we should look at the past 4 years’ performance.

Also, different countries would have different country risks and equity risk premiums. Looking at a sum-of-parts valuation makes more sense than using the consolidated basis. This is because these differences are specifically accounted for in the valuation model.

I thus modeled the Group as per the following chart. 

Chart 6: Sum-of-parts Valuation Model

The key assumptions for each of the business segments were:

Table 3: Sum-of-parts Valuation Assumptions

Notes

(a) Based on 2019 to 2022. 

(b) Unlevered cash adjusted for the respective segments.

(c) Takes into account the country in which the segment operates.

(d) All segments had the same cost of debt. 

The various segment values and the Group values were computed as follows:

Table 4: Computation of Sum-of-parts Value

You can see from Table 4 that the EPV for some of the segments were less than their respective Asset Values.

• For the Manufacturing segment, this reflected the low business prospects.

• For the Plantation segment, this was because the palm oil trees were relatively young. There are prospects to improve the yield as they mature. At the same time, there is still land available for planting.

• For the Food segment, this was because of the low returns. I estimated that the EBIT/TCE for this segment to be 8% compared to 22 % for the Bulking segment.

Note that because of the high returns, the Bulking segment EPV is much higher than its Asset Value.

The EPV for the Group was computed to be RM 3.73 per share compared to RM 4.01 per share based on a consolidated basis.

Note that the WACC for the above table was computed based on Damodaran’s Jan 2022 data sets. If I was to estimate the sum-of-parts value to account for the higher risk, I would reduce the EPV by 20% (assuming the same reduction as earlier). 

The equivalent EPV based on the sum-of-parts value would be RM 2.98 per share. There is still a 23 % margin of safety. 

Case Notes You can see from above that different assumptions and models will provide different margins of safety. Which should you use then? I vary the margin of safety depending on the nature of the investment. Compounders and Quality Value companies are those that are strong fundamentally. Any mispricing is probably due to market sentiments rather than concerns about the business prospects. As such I am prepared to accept a 15 % to 20 % margin of safety for such cases. Turnarounds are companies facing some problems that have to be addressed to return to profitability. The risks here are greater than for Compounders or Quality Value companies. As such, I look for a larger margin of safety of 30% for Turnarounds. As you can see, there is a certain amount of judgment when investing. Experience helps. If you are a newbie, one way to accelerate your learning curve is to look at what others have done. A good example is a site such as Seeking Alpha.* Click the link for some free stock valuation examples. If you subscribe to their services, you can tap into their business analysis and valuation.

Case Notes

You can see from above that different assumptions and models will provide different margins of safety. Which should you use then?

I vary the margin of safety depending on the nature of the investment.

Compounders and Quality Value companies are those that are strong fundamentally. Any mispricing is probably due to market sentiments rather than concerns about the business prospects. As such I am prepared to accept a 15 % to 20 % margin of safety for such cases.

Turnarounds are companies facing some problems that have to be addressed to return to profitability. The risks here are greater than for Compounders or Quality Value companies. As such, I look for a larger margin of safety of 30% for Turnarounds.

As you can see, there is a certain amount of judgment when investing. Experience helps.

If you are a newbie, one way to accelerate your learning curve is to look at what others have done. A good example is a site such as Seeking Alpha.* Click the link for some free stock valuation examples. If you subscribe to their services, you can tap into their business analysis and valuation.

Conclusion

The analysis showed that there is a sufficient margin of safety at the current market price. If you are a value investor, KFima would be an investment opportunity.

However, I am already an investor in KFima, and based on my risk management criteria, I should not increase my investment in KFima. 

Rather, my goal is to wait for the market to re-rate the Group so that I could exit with a decent return. As shown earlier, I am targeting an exit price of RM 3.49 per share. This is a realistic target as:

• The EPV on a consolidated basis is RM 4.01 per share. On a sum-of-parts basis, it is RM 3.73 per share. Both of these were based on Damodaran’s Jan 2022 datasets.

• The Ukraine invasion and high inflation means higher risks. Taking this into account, the EPV on a consolidated basis is RM 3.24 per share while it would be RM 2.98 per share on a sum-of-parts basis. The Earnings value with growth would be higher.

There is a run-up in prices over the past few weeks as shown in Table 1. This could be because the market is reacting to KFima’s better performance. If so, this would be a catalyst for the price to go higher.

I am hoping that this re-rating would occur before the end of the year. If I had to wait longer, I would look for a higher exit price so that I could get the equivalent CAGR given the longer holding period. 

End

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If the above article was useful, you can find more insights on how to make money in my e-book. The e-book is now available from Amazon, Kobo and Google Play.

PS: If you are in Malaysia or Singapore, the e-book can only be download from Kobo and Google Play. 

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.

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