Value Investing Case Study 60-1: Apollo Food Holdings: A cash cow or a premium gamble? Decoding its future after the takeover.
There was a change in the controlling shareholders of Apollo Food Holdings Bhd (Apollo or the Group) in Dec 2023.
The key people (Dato' SY Cheah and Datin GL Soon) behind the new controlling party are the indirect major shareholders of Golden Scoop. This is the master franchisee of Baskin-Robbins in Malaysia and Singapore since 1988 and 2011 respectively.
Following this change in the controlling shareholder, there was an unconditional mandatory takeover offer. This was for all the shares not owned by the new controlling shareholders at RM 5.80 per share.
I want to highlight 3 key points in the Offer Document for the takeover:
Apollo would continue to be listed. If the mandatory takeover offer resulted in less than 25% of the shares being held by the public, the Offeror would rectify this.
The Offeror intends to continue with the existing businesses of the Group.
The Offeror may consider expanding the product ranges of Apollo either organically or via acquisitions.
Following the completion of the takeover offer, the Offeror had 78.4 % of Apollo as of 29 Jan 2024. Given the plan to maintain the listing status of Apollo, I am sure that the new controlling party would find ways to comply with the required public shareholding spread of at least 25%.
I was more interested to see whether there was an investment opportunity at the current market price of RM 6.80 per share (24 Jun 2024). This was RM 1.00 per share more than the takeover price. I wanted to see whether the market price reflected just the existing business or if it had imputed some new ventures or acquisitions.
My fundamental analysis based on its existing business showed that there is no margin of safety at the current market price. The market is pricing Apollo based on additional new ventures or acquisitions.
Should you speculate and buy assuming that the Baskin-Robbins business is going to be injected into Apollo? Well, read my Disclaimer.
Contents
Investment Thesis
Background
Operating performance
Financial position
Valuation
Conclusion
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Investment Thesis
The past 12 years' performance of Apollo is nothing to shout about. Revenue only grew at 1.2 % CAGR while PAT grew at 4.8 % CAGR. The bulk of the growth came from the past 2 years reversing the 2013 to 2022 trends. But the Group is financially sound and I would consider it a cash cow.
Apollo has a new controlling shareholder. Given this, I would expect a new business trajectory. Unfortunately, there is not much information on this yet. Based on the past 12 years' performance, I estimated that there is no margin of safety from an Earnings Power Value perspective.
Case Notes
An investment thesis is a vital tool for any investor because it provides clarity, focus, and direction in decision-making. Learning how to draft an investment thesis is crucial for investors, especially those who want to make well-informed, rational, and successful investment decisions.
It defines your reasoning.
A clear thesis encourages disciplined decision-making.
It helps assess risks.
It provides a benchmark to evaluate whether the investment is performing as expected.
An investment thesis is not set in stone - it is a living document. If the facts change, you can update your thesis or adjust your investment accordingly. This approach keeps you grounded and aligned with your investment principles.
Background
The Group is one of the leading manufacturers of chocolate confectionery products and layer cakes in Malaysia. According to its 2023 Annual Report, Apollo has 2 fully owned operating subsidiaries:
Apollo Food Industries (M) Sdn Bhd is principally engaged in manufacturing and trading in compound chocolates, chocolate confectionery products, and layer cakes in the overseas market.
Hap Huat Food Industries Sdn Bhd is principally engaged in distributing and marketing of compound chocolates, chocolate confectionery products, and layer cakes in the local market.
In 2023, Malaysia accounted for about 68 % of its revenue. Sales to ASEAN countries (excluding Malaysia) accounted for another 29% with the balance from other countries.
I reckoned that the new controlling shareholders took over the operations in Jan 2024. I based this on the Bursa announcement on the changes to the Board. There has not been much information on the changes at the operating level.
I would attribute most of the FYE 2024 performance and those before this to the old Board and management team. My analysis covered the 2013 to 2024 performance which I have classified as the existing business.
Operating performance
Over the past 12 years, revenue grew at 1.2 % CAGR while PAT grew at 4.8 % CAGR. This is not a high-growth Group. However as shown in the left part of Chart 1, revenue and PAT declined from 2013 to 2022. The turnaround started in 2023. We see a similar pattern for gross profitability.
Is the improvement over the past 2 years was due to some management turnaround effort or some externally driven one-off events?
Chart 1: Performance Index and Returns
The Group did not provide many details on its operations in its Annual Report. There was not much Management and Discussion in its Annual Reports.
As such I could not find any explanation for the downtrends from 2013 to 2022. We know that the 2021 and 2022 results were impacted by COVID-19. Apollo stated the following to explain the revenue increase in 2023:
“The reopening of Malaysia’s borders has increased the demand for the Group’s products which resulted in higher sales. A large proportion of revenue was contributed by local market…”
I could not find any explanation for why the 2023 revenue reversed the past 10 years' trend. Looking at it negatively, the Group was responding to some pent-up demand due to COVID-19. Thereafter the demand levelled off.
Again, management did not explain why the PAT turned around in 2023. However, I think there are several reasons for this:
Gross profit margin averaged 27 % for 2023/24 compared to the 2013/14 average of 29%. So, the growth in PAT in 2023/24 was more attributable to revenue growth than gross profit margin improvements.
There were lower effective tax rates of 21 % and 18 % respectively for 2023 and 2024 compared to 25% for 2021 and 2022.
Note that the profit in 2024 was boosted by RM 18.7 million one-off gain from the sale of an investment property
I would also conclude that the improvement in the gross profitability in 2023 and 2024 was due more to lower growth in the total assets relative to gross profits.
Given the PAT pattern, you should not be surprised to see similar patterns for the returns. As can be seen from the right part of Chart 1, returns were generally on downtrends since 2013/14. The turnaround came in 2023/24.
To get a better understanding of the profit picture,
I broke down the operating profit into its fixed and variable components as shown in the left part of Chart 2.
I also carried out a DuPont Analysis of the ROIC as shown in the right part of Chart 2.
I could not see any discernible trend in the contribution margin. While the contribution margin in 2023 and 2024 was higher than that in 2022, I am not sure whether there will be a repeat of the 2017 to 2020 pattern. Besides the better contribution margin in 2023/24 followed the better revenue. As such the improvements could be due to economies of scale.
Chart 2: Returns and DuPont Analysis
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 DuPont Analysis showed that the better ROIC in 2023 and 2024 compared to 2022 was due to better operating margin, asset turnover, and leverage.
The better gross profit margin in 2023 and 2024 compared to that in 2022 can explain some of the better operating margins.
The better asset turnover is because of better revenue growth compared to the increase in the total assets.
The better leverage was the result of reducing capital employed. This was because capital employed was derived by deducting cash from total equity. The increasing cash led to the reduced capital employed.
As I will show later, this is a Group with negligible Reinvestments. Revenue could grow without a corresponding growth in total assets. This business characteristic could explain the better leverage even when revenue declined.
Growth prospects
The Malaysian confectionery market is not a high-growth one as exemplified by the following:
“The Malaysia confectionery market was valued at MYR1.38 billion… in 2021 and is expected to grow at a CAGR of more than 3% during the forecast period (2021 to 2026)”. Global Data
The key point was that based on the above market research quote and the growth rate shown in Chart 3, Apollo appeared to have lost market share.
Chart 3: Sales value for Malaysia
Reinvestment rates
Growth needs to be funded and one metric to assess this is the Reinvestment rate defined as Reinvestment / NOPAT.
Reinvestment = CAPEX & Acquisition – Depreciation & Amortization + Increase in Net Working Capital.
From 2013 to 2024, Apollo had an average negative Reinvestment rate due to the total negative Reinvestment. This in turn was because, in many years, the amount spent on CAPEX was less than the Depreciation & Amortization. Furthermore, in certain years, there was a decrease in the Net Working Capital.
This negative Reinvestment rate meant that the Group did not have to allocate much of its cash flow from operations to fund its growth. The low growth rate almost meant that the Group did not require much growth funding.
Financial position
I would rate Apollo as financially sound based on the following criteria.
As of the end of April 2024 (its financial year end),
It had RM 119 million in cash and short-term investments. This is about 49 % of the total assets.
It had zero debt over the past 12 years.
Over the past 12 years, the Group generated positive cash flow from operations every year. During this period, it generated RM 375 million cash flow from operations compared to the RM 294 million PAT. This is a good cash conversion ratio.
I have already mentioned that it had a negative Reinvestment rate.
It has a good capital allocation plan as shown in Table 1. Given its low CAPEX, it had lots of excess funds, the bulk of which was returned to shareholders.
I would consider Apollo a cash cow and as shown earlier, this cash generation characteristic enabled it to have an increasing leverage. This in turn boosted its returns.
Table 1: Sources and Uses of Funds 2013 to 2024
Valuation
The NTA of Apollo was RM 2.80 per share (as of April 2024) compared to its market price of RM 6.80 per share (as of 24 Jun 2024).
Given its low earnings growth track record, I think it is more appropriate to value Apollo based on its Earnings Power Value (EPV). I considered 2 Scenarios.
Scenario 1 – based on the past 12 years time-weighted average values.
Scenario 2 – based on the 2023 and 2024 average values.
On such a basis, I found that it had an EPV of RM 5.11 per share under Scenario 1 and RM 6.78 per share under Scenario 2.
The new controlling shareholders acquired the controlling stake for RM 5.80 per share. Compared to my EPV under Scenario 2, I would deduce that they do not think that the past 2 years' performance is sustainable.
They probably looked at the past 12 years' performance and included some premium for control. I suspect that the previous controlling shareholders would not have sold off their stake without some premium.
The market price of RM 6.80 almost matches the value under Scenario 2. The market is anticipating that the new controlling party would be able to improve the business performance so that it can be sustained at the past 2 years' average performance.
Chart 4: Valuation
Why is the current market price higher than the take-over price? I suspect that the market is anticipating improving returns. These could be due to:
Improvements in the existing business. The new management could improve both the top line and bottom line. Apollo's revenue trend pre-COVID-19 was opposite to that of the confectionery market. So, there are possible revenue growth prospects. Profits could also be boosted by improving operating efficiencies.
I suspect that some in the market may think that the Baskin-Robbins business could be injected into Apollo. The challenge here is that it is hard to estimate the improved performance for this. This would depend not only on Baskin-Robbin's performance but also on the price that Apollo would pay for the acquisition. There is not enough information at this stage to estimate the impact. Buying at a higher price is a speculative play at this juncture.
Valuation model – Scenario 1
The EPV 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 and WACC of 6.7 % was based on Damodaran’s build-up approach. Note that the WACC is the same as the cost of equity as there was no debt.
Valuation model – Scenario 2
The valuation model under Scenario 2 is shown in Table 2. 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 left part of Chart 2.
g = growth assumed at 0 % for the EPV.
The other assumptions are explained under the Notes in the table.
Table 2: Valuation – Scenario 2
Risk and limitations
The value of a company will depend on the assumptions used in the valuation. Although I have estimated the intrinsic values based on 2 Scenarios, I am more inclined to follow Scenario 1.
I did not consider Scenario 2 based on the past 2 years' data because its trend seemed at odds with the 2013 to 2022 trend. I have postulated that the 2023/24 trend could be due to pent-up demand following the opening of the economy post-COVID-19. But there is another possibility.
If the discussions for the sale have been going one for some time, there may be some incentive to boost the performance. Of course, this is pure speculation on my part as I was not privy to the sale discussions. That is why I used the past 12 years' data rather than just the past 2 years.
Secondly, you have to assume that the owners of Baskin-Robbins would also be seeking to make money from any sale of Baskin-Robbins.
In other words, the benefit to the new controlling shareholder for any injection of Baskin-Robbins would probably come from both Apollo and Baskin-Robbins. For the other shareholders of Apollo, the benefit comes from only the Apollo side. Given this, it is better to wait for the terms of the injection (if any) to be known before speculating on the price of Apollo.
Having said the above, the RM 6.80 per share represents a 33 % increase from my conservatively estimated EPV under Scenario 1. As such it is not a far-fetched number as it is matched by my EPV under Scenario 2.
But I am a conservative value investor and as such would not consider an investment in Apollo at RM 6.80 per share. But a person with a different risk-tolerant profile may think otherwise.
Case Notes
Synergy refers to the concept that the combined value and performance of two companies will be greater than the sum of the separate individual parts. This is often expressed with the equation:
1+1 = 3
Synergy is a driving force behind many mergers and acquisitions, as it represents the additional value that can be created through the combination of companies.
According to Damodaran, one can systematically evaluate whether the anticipated synergies in a merger or acquisition justify the transaction and the premium paid. He suggested the following steps to assess the value of synergy
Estimate the independent cash flows of the firms involved.
Estimate the combined firm's cash flows.
Identify and quantify the synergies.
Calculate the incremental cash flows from synergies.
Discount the synergy cash flows to present value.
Assess the overall value of the synergies
Given this, you can understand why I did not try to estimate the value of Apollo assuming the acquisition of the Baskin-Robbins business. There is not enough information to do so.
Valuation is more than just number-crunching. You have to ensure that the numbers are derived from realistic assumptions. As a sanity check, I often look at what others have done.
As you can see, fundamental analysis requires expertise and time. Visualizing a company’s business performance and investment risk (by comparing market price with intrinsic value) is one way to shortcut the process. The Fundamental Mapper help investors make informed decisions as it provides such insights in an easy-to-see format.
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Conclusion
The historical
performance of Apollo is not something to be excited about. Its revenue,
profits, and returns were trending down from 2013 to 2022. But there were extraordinary
growths over the past 2 years.
Management had
not provided a good reason for the past 2 years' growth apart from stating that
it was due to the opening of the economy post-COVID-19.
My analysis
showed that the PAT growth was due to higher revenue and lower tax rates. But
the revenue in 2024 seemed to have levelled off and I do not think the lower
tax rates are sustainable. As such I would expect that 2024 would be the peak
PAT.
You can see why
I consider Scenario 1 as more likely. But I have a caveat.
All the above conclusions
did not account for the change in management. There is always the possibility
of improved performance or the injection of Baskin-Robbins into Apollo.
There is not
enough information at this stage to see the changes to be made. I would expect
changes as the new shareholders have paid a slight premium based on my estimate
of the EPV under Scenario 1.
Is Apollo an
investment opportunity? I would say that it is based on the take-over price of
RM 5.80 per share. But at the current market price of RM 6.80 per share, there
is not enough information to draw a meaningful conclusion. As such I would not
consider it an investment opportunity at the current market price.
However, this
is a stock to keep a close eye on as I do not expect the new controlling
shareholders to allow business to continue as it is. I would carry out another
analysis and valuation if there is news of any change in the business
direction.
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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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