Is Ajinomoto an investment opportunity?

Value Investing Case Study 59-1: A fundamental analysis of Ajinomoto Malaysia to see whether it is an investment opportunity.

Ajinomoto Malaysia Bhd (Ajinomoto or the Group) has been on my radar for many years. I have not invested because I could not find a good margin of safety.

But 2 things happened over the past few years. First, there was COVID-19 that caused its share price to drop by about 40%. Next was the relocation of its manufacturing facility to a new plant in 2022. I suspect that it faced initial teething problems that impacted its operating results.

The food sector is mature, and bottom-line growth will have to come from revenue growth and improving operating and capital efficiencies. I wanted to see whether Ajinomoto would have a different profit path with the new plant.

Join me as I look at Ajinomoto's performance over the past 12 years and use it as a basis to see whether the future would be better.

I found that over the past 12 years, there were gains from 2 land transactions that boosted Ajinomoto's performance. The average PBT contribution from these land sales was about equal to the contribution from the operations. Nevertheless, given the new plant, my analysis showed that Ajinomoto is an investment opportunity.

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

Investment Thesis

Business background

Operating performance

Financial position

Valuation

Conclusion

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Investment Thesis

Ajinomoto bottom line over the past 12 years was boosted by 2 land gains that resulted in about the same contribution to the past 12 years' earnings as the operating profits. The land gains are one-off items and moving forward we have to rely just on the operations.

Ajinomoto is a mature company with revenue growing at 6.1 % CAGR over the past 12 years. But this is a company that relocated to a new plant in 2022 and I believe that its operating results since then provide a good picture of its future. It is also financially sound. On such a basis I found that there is more than a 30% margin of safety making it an investment opportunity.

Business background

Ajinomoto started in 1961 as a monosodium glutamate (MSG) producer under the AJI-NO-MOTO brand. It was one of the very first Japanese companies to be set up in Malaysia.

In 1965, the Company was recognized and approved as a Halal Food Manufacturer by the Department of Islamic Development Malaysia (JAKIM) and has since maintained this certification.

The Group has since grown into a dynamic food and seasoning manufacturer serving the Asian market. The Group today has 2 business segments:

Consumer business. This segment manufactures and distributes a wide range of seasoning and food products for the consumer market. Its products include chicken stock, all-in-one seasoning, menu seasoning, pepper, sweetener, and jelly drink with amino acids. In 2024, this segment accounted for 77 % of the Group’s revenue but only 21% of the Group’s operating profit.

Industrial business. This serves the food manufacturing and food industries. The products are marketed under the TENCHO and ACTIVA® brands. These products are widely used in various processed foods such as instant noodles, snacks, sauces, dairy products, and seafood.

While the Industrial segment only accounted for 23% of the 2023 revenue, it contributed 79 % of the 2023 operating profit.

Ajinomoto serves mainly the Asian and Middle Eastern markets. In 2024, Malaysia accounted for 57 % of its revenue. The balance came from:

The Middle East which accounted for 21% of the 2024 revenue.

The rest of Asia (excluding Malaysia) with account for 20 % of the 2024 revenue.

Others with 2% of the 2024 revenue.

In 2022, the Group relocated to its new plant in Bandar Enstek. This enabled Ajinomoto to sell off the site of its old plant with a substantial one-off gain of RM 391 million in 2024. At the same time, as will be shown later, this land sale and relocation affected the returns of the business.

Operating performance

Over the past 12 years, revenue grew at 6.1 % CAGR. It is not a high-growth Group.

However, excluding 2023, we do not see the same growth trend for PAT. Refer to the left part of Chart 1. You can see 2 PAT peaks – 2017 and 2024.

The 2017 PAT was boosted by the RM 121 million gain from the compulsory acquisition of its land by the government.

The PAT was boosted in 2024 by the RM 356 million gain (after real property gains tax) from the sale of the land where its former manufacturing plant was located.

Chart 1: Performance Index and NOPAT

Note: Ajinomoto did not classify its operating costs into the cost of sales and other selling and administration expenses. As such the gross profit was estimated. In my analysis, I used the cost of sales data from TIKR.com for this.

Given the land gain, a more realistic picture would be to look at the operating profits ie before interests, and one-off gain. On such a basis the operating profit grew from RM 26.7 million in 2013 to RM 60.3 million in 2024 at 7.7 % CAGR. Refer to the left part of Chart 1.

You can see that NOPAT declined in 2021 due to COVID-19. Note that Ajinomoto has March as its financial year-end. The 2021 results covered most of the 2020 calendar year which was impacted by the measures taken to control COVID-19.

According to Ajinomoto, the profit decline in 2022 was due to :

“…to the hike in raw material prices and fuel costs, higher freight and transportation costs, increase in staff costs, depreciation, computer hardware and software maintenance and other operating expenses…”

But NOPAT in 2024 seemed to show a recovery to pre-COVID-19 levels.

To get a better picture of the operating profit, I broke it down into its respective components as shown in the right part of Chart 2. The gap between revenue and total cost (fixed + variable) represented the operating profit.

Ajinomoto generated operating profit every year over the past 12 years.

But the contribution margin over the past few years was lower than that in 2013. The manufacturing facility relocated to its new plant in 2022. I suspect that this could explain the declining contribution margins in 2022 onwards. The good sign is that there seemed to be improvement in 2024.

Ajinomoto has a high operating leverage. Its average fixed cost was about 40% of the total cost over the past 12 years. This meant that a small change in revenue would have a big impact on its profits. I would think that Ajinomoto would benefit from the improving revenue trend.

Chart 2: Returns and Operating Profit

Note to Op Profit Profile. I broke down the operating profits into fixed costs and variable costs.

Fixed cost = SGA, Depreciation & Amortization and Others.
Variable cost = Cost of Sales – Depreciation & Amortization.
Contribution = Revenue – Variable Cost.
Contribution margin = Contribution/Revenue.

The left part of Chart 2 tracks the trends of 3 return metrics – ROIC (NOPAT/Invested capital), ROE, and CFROIC (Cash flow from operations/Invested capital). I defined Invested capital = Total equity + total Debt – Cash and cash equivalents.

The returns over the past few years were nothing to shout about.

You can see the ROIC and CFROIC up-trending to peak in 2019 but declined since then. The 2024 ROIC and CFROIC were lower than their respective 2013 values.

I have mentioned that the 2024 PAT was boosted by the gain from the land sale. If I excluded this gain, the 2024 ROE would be lower than that for 2013.

However, from an overall past 12 years perspective, Ajinomoto delivered an average ROIC of 20% and an average ROE of 15%. (Note that the ROE included the land sales).

These were higher than the current WACC and cost of equity of about 7% each. In other words, shareholders’ value was created. If you are a shareholder, this is one set of metrics that you would look at even though part of the ROE was contributed by a one-off land sale.

To further see why the ROIC had the “peak and decline” pattern, I carried out a DuPont and margin analysis of the ROIC. Refer to Chart 3. You can see that the Operating margin and Leverage had a big impact on the ROIC. This was confirmed by the following correlations:

81% between ROIC and Operating margin.

96 % between ROIC and Leverage.

Chart 3: DuPont Analysis and Margins

Note to Margin Chart: Net margin = GP margin – SGA margin.

When I looked at the margin trends as shown in the right part of Chart 3, you can see that the drop in gross profit margins post-2021 is reflected in the declining ROIC post-2021.

However, there was no significant increase in gross profit margins between 2015 and 2019. This meant that Leverage had more impact on the ROIC during this period.

Leverage increased in 2017 due to the increase in total assets in 2017 because of the compulsory land acquisition. Ajinomoto received RM 145 million for the land which it then invested in short-term investments. This boosted the total assets relative to the equity. Considering that its total assets in 2016 were RM 367 million, the monies from the land acquisition had a big impact.

Leverage declined in 2020 because Ajinomoto took on an RM 101 million loan to fund the construction of the new factory. This debt increased the capital employed leading to reduced Leverage. This debt remained at about the same level till 2024.

The lower Leverage and gross profit margins post-2021 led to the declining ROIC.

Based on the findings I would state that the “humped” pattern for the ROIC and CFROIC is not an “operating” issue. Rather it was due to the sale of the land (for the 2016 uptrend) and the new factory construction (for the 2021 decline).

Moving forward, they would no longer be issues and I would expect more “stable” returns. In this context, I would see the 2014 ROIC and CFROIC as a good base to improve from.

Growth prospects

Ajinomoto is in the food seasoning industry. Over the past 12 years, its revenue has grown at 6.1% CAGR mainly through organic growth. I would consider this a reasonable performance as the seasoning market is not a high-growth one.

“The Asia-Pacific Seasoning and Spices Market size is estimated at USD 5.28 billion in 2024…growing at a CAGR of 5.63% during the forecast period (2024-2029)”. Mordor Intelligence

“The Asia Pacific Seasoning & Spices Market would witness market growth of 5.8% CAGR during the forecast period (2022-2028).” KBV Research

“The Middle East and Africa Spices and Seasoning Market size is expected…to grow at 5.6 % to reach USD 687 billion by 2029” Market Data Forecast

I would like to point out that from 2019 to 2024, the revenue growth was

5.6% CAGR for Malaysia.

17.1 % CAGR for the Middle East.

4.2 % CAGR for the rest of Asia (excluding Malaysia).

The higher growth rates in the Middle East and the Halal certification give me confidence that there is still a revenue growth path for the Group.

Peer comparison

On a global scale, Ajinomoto is a small player in the seasoning industry where it had lower growth rates than some of its larger peers. Refer to Table 1.

Table 1: Peer Revenue

Compared to its peers, Ajinomoto's performance would probably be at best average. I based it on 2 metrics – ROE and EBITDA margin. Refer to Chart 4.

Chart 4: Peer comparison

Note that the peers were publicly listed companies selected from the list shown in Chart 5.

Ajinomoto Chart 5: Asia-Pacific Seasoning and Spiced Players

Chart 5: Asia-Pacific Seasoning and Spiced Players. Source: Market Wide Research

Financial position

I would rate Ajinomoto as financially sound based on the following criteria.

As of the end of Mar 2024,

It had RM 453 million in cash and short-term investments. This is about 41 % of the total assets.

It had a Debt Equity ratio of 7 %. This had come down from its 2022 high of 20 %.

The Group generated positive cash flow from operations for 11 out of the past 12 financial years.

Excluding the land gain and the new factory constructions, I estimated that its average Reinvestment rate (Reinvestment/NOPAT) from 2013 to 2019 was 3%.

Reinvestment = CAPEX – Depreciation & Amortization + Increase in Net Working Capital.

The low Reinvestment rate was because the Depreciation & Amortization offset a lot of the other 2 expenditures.

It has a good capital allocation plan as shown in Table 1. Its cash flow from operations was sufficient to cover its CAPEX. Note that the CAPEX was high because of the new factory construction. Historically without the factor construction, the average annual CAPEX was about RM 11 million.

Table 2: Sources and Uses of Funds 2013 to 2024

My main concern is with its cash flow conversion ratio. During the past 12 financial years, it generated a total of RM 551 million from the cash flow from operations compared to a total PAT of RM 576 million (excluding the 2024 land gain). While acceptable, most of the companies I covered had conversion ratios greater than 1.

Valuation

The NTA of Ajinomoto is RM 14.96 per share (as of Dec 2023) compared to its market price of RM 15.70 per share (as of 14 Jun 2024).

The market focuses on earnings and as such it is more meaningful to look at the Earnings Value. I looked at 2 Scenarios here:

Scenario 1 – based on the past 12 years’ time-weighted average performance.

Scenario 2. There is now a new manufacturing plant. As such I took the 2024 revenue as the base revenue. For the contribution margin and capital turnover ratio, I took the 2022 to 2024 average performance to represent the future performance. I assumed its Reinvestment rate to be 3%.

I estimate is Earnings Value to be RM 17.97 per share under Scenario 1. The Earnings Value under Scenario 2 was RM 25.51 per share. Note that under both Scenarios, the valuation included RM 7.44 per share of cash and cash equivalents.

You can see that there is more than a 30% margin of safety under Scenario 2. Refer to Chart 6.

Chart 6: Valuation

Valuation model – Scenario 1

The Earnings Value under Scenario 1 was determined based on the average of 2 valuation approaches:

Free Cash Flow to the Firm model as per Damodaran.

Residual Income model as per Penman.

I used the past 12 years’ time-weighted values to determine the relevant inputs. The cost of equity of 7.1 % and WACC of 6.8 % was based on Damodaran’s build-up approach.

Valuation model – Scenario 2

The valuation model under Scenario 2 is shown in Table 3. It was based on the single-stage Free Cash Flow to the Firm model (FCFF) where:

Value = FCFF X (1 + g) / (WACC – g).

FCFF = EBIT(1 – t) X (1 – Reinvestment rate).

The EBIT was based on the operating profit model as illustrated in the right part of Chart 2.

Reinvestment rate = 3% as per the historical rate without the new factory and land gain.

g = growth assumed at 3% perpetual growth rate.

The other assumptions are explained under the Notes in the table.

Table 3: Valuation model – Scenario 2

Case Notes

Damodaran argues that every valuation starts with a narrative. The story provides the qualitative context, which is then translated into numbers. This process ensures that the financial projections and assumptions used in valuation are realistic and plausible stories about the company's future.

Damodaran’s view is that a compelling narrative is not just a marketing tool but an essential component of valuation. By grounding financial projections in a coherent and plausible story, investors and analysts can achieve a more nuanced and realistic assessment of a company's value.

It is obvious that if you have a very positive picture of a company, you will end up with a high valuation and vice versa. The valuation of Ajinomoto under the 2 Scenarios illustrates this point.

I have always used historical performance as the base. The best situation is to get a good margin of safety on this basis and be confident that the future will be better than the past.

The more challenging case is to have a margin of safety based on some projected performance as per Scenario 2 in the Ajinomoto case.

What would you do as a newbie? It all boils down to the narrative. As a sanity check, I look at other analyses to see whether I have missed anything. One good source of this is sites like 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

Over the past 12 years, Ajinomoto's average PBT can be categorized into 3 – from operations, from the land gain, and other non-operating assets (main cash and cash equivalents).

You can see from Table 4 that the land gain was significant.

Table 4: Component ROA

Notes

a) Assets derived based on the difference between total and non-op assets. Profit is based on average operating profit.

b) Non-operating assets = cash, short-term investments, and securities. Profit-based difference between total and operating profit.

c) 2017 and 2024 gain average over 12 years.

d) Assets based on 2024 total assets before the RM 2.12 per share dividend payments. Profits based on PBT.

Ajinomoto had announced that it would distribute a special dividend of RM 2.12 per share in 2024. Even with this, there would be about RM 300 odd million cash and cash equivalent with the company. The historical return from cash and cash equivalents was low. Table 4 illustrates what I meant.

The best would be for the company to return most of the cash to shareholders as the business does not require a lot of Reinvestments. You can imagine the impact on the share price if this happens. But I doubt this will happen.

As such I viewed Ajinomoto based on the current policy. In this context,

Ajinomoto is in a mature sector with low single-digit growth. However, it is a profitable business capable of generating about RM 60 million operating income annually. This is about RM 0.70 per share and with a low Reinvestment rate, most of it can be returned to shareholders.

The company is financially sound and there is more than a 30% margin of safety under Scenario 2. Its performance is acceptable comparable to its global peers.

What are the potential catalysts?

There is excess cash and I hope that more will be returned to shareholders.

There is a good revenue growth track record. Continued revenue growth given its high operating leverage will boost its profits.

The Group has overcome its teething problems at the new plant and we should see an improvement in the contribution margin.

I hope you can see why I consider Ajinomoto an investment opportunity at the current market price.

END

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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.

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