Is Can One an investment opportunity?

Value Investing Case Study 62-1: A fundamental analysis of Can One to see whether it is a value trap or an investment opportunity.

While the packaging sector is mature, it is not a sunset one either. With the growth of online marketing, there are even growth prospects for certain sectors.

Can-One Berhad (Can One or the Group) is one of the larger packaging companies in ASEAN with operations in several countries.

The market price of Can One is today (9 Jul 2024) about 2/3 of its 2021 peak price of RM 5.00 per share. Furthermore, the market price has risen by about 25% since the start of 2024. I wanted to find out whether the rising market price indicates an investment opportunity.

Join me as I carry out a fundamental analysis of Can One. I found a change in the business profile in 2029 following an acquisition and divestment. Before this, the performance had been declining.

The new business direction seemed to have arrested the decline. But whether Can One can build on this to create shareholders’ value is another question. Nevertheless, I do consider Can One a cigar butt investment opportunity.

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

Investment Thesis

Background

Operating performance

Financial position

Valuation

Conclusion

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Investment Thesis

There was a change in the business profile of Can One in 2019. As such, it is more appropriate to consider its performance post-2019. On such a basis, the average returns over the past few years were lower than the respective cost of funds, implying that there was no shareholders’ value creation.

While the Group is financially sound, there are no signs of improving operating performance. Nevertheless, the market price as of 9 Jul 2024 is about 1/3 of its NTA. There is also a margin of safety from its Earnings Value. From a brick-and-mortar company perspective, I would consider Can One a cigar butt investment opportunity.

Background

Can One was incorporated in 2004 as an investment holding company to facilitate its IPO under the acquisition of Aik Joo Can Factory Ltd, a lithographed tin can manufacturer?

Since then, the Group has grown such that in 2023, it reported its performance under 4 business segments:

General Packaging division. This segment has 4 sub-segments:

Tin cans. This sub-segment is principally involved in the manufacture of metal and lithographed tin cans and components in Malaysia and Vietnam.

Aluminium cans. This sub-segment is involved in the manufacture of aluminium cans in Malaysia and Myanmar. A new aluminium can plant in the USA commenced its operations in December 2023.

The cartons sub-segment manufactures corrugated cartons in Malaysia, Vietnam, and Myanmar.

Jerry cans and Rigid packaging. This sub-segment is involved in the manufacture of plastic jerry cans and plastic rigid bottles in Malaysia and Indonesia.

Contract Manufacturing division. This segment is principally involved in contract manufacturing, packaging, and distribution of carbonated and non-carbonated beverages.

Trading division. This segment undertakes sales and marketing activities for the Group. It also acts as the international procurement centre for key direct materials of the Group.

Property Development and Investment Holding division. This includes all the activities not covered under the above 3 divisions.

The General Packaging division is the biggest revenue contributor. In 2023, it accounted for 90 % of the Group’s revenue. Refer to the left part of Chart 1.

As shown in the right part of Chart 1, the majority of the Group’s revenue came from its Malaysian operations. In 2023, Malaysia accounted for 66% of the Group’s revenue.

Chart 1: Revenue by Segment and Geographic Locations

Notes to Segment revenue: Before 2019, the Group had a different segment reporting format.

There was no General Packaging segment. Instead, there was the Can segment. I have assumed that the Can segment performance was equal to the General Packaging segment for this Chart.

There was no Contract Manufacturing segment. Rather there was a Food segment which I assumed came under the current Contract Manufacturing segment.

You will notice that there was a jump in revenue in 2019. This was mainly due to the acquisition of Kian Joo Can Factory Berhad (Kian Joo Can) which led to it being an indirect subsidiary of Can One. Before this, Kian Joo Can was an associate. The 2020 performance was also impacted by the full-year accounting of this acquisition.

In 2019, the Group also divested its interest in its wholly-owned subsidiary, F & B Nutrition Sdn. Bhd. (F & B Nutrition) The entire financial position of this subsidiary was classified as assets and liabilities held for sales whilst the 2019 financial results as well as comparative figures were re-classified as Discontinued Operation.

Operating performance

Over the past 12 years, revenue grew at 13.1% CAGR while PAT declined.

I have already mentioned that revenue spiked in 2019/20 due to the Kian Joo acquisition. Thereafter in 2021 and 2022 revenue grew due mainly to an increase in selling prices.

“The increase in revenue was attributed mainly by higher selling prices because of raw material costs increases.” 2021 Annual Report

“Revenue of General Packaging…increased…mainly due to increase in sales volume, sales mix as well as revision of selling price…” 2022 Annual Report.

You can see from the left part of Chart 1 that there were 2 PAT anomalies – a PAT spike in 2019 and a loss in 2021.

The profit spike in 2019 was due to the increase in revenue following the acquisition of Kian Joo Can as well as one off gain of about RM 1 billion due to acquisition and disposal of subsidiaries.

The Group incurred a loss in 2021 attributed to:

“…the impairment losses on property, plant and equipment, rights-of-use assets, investment properties and financial instruments of RM 239.4 million that arose from impairment indicators in several lossmaking entities in the Group.”

Chart 2: Performance Index and Returns

The declining profit trend was attributed to a declining gross profit margin and higher SGA margin.

Gross profit margin declined from 2012 to 2018. This was also reflected in the declining gross profitability over this period.

Gross profit margin improved post the Kian Joo Can acquisition as reflected in the improving gross profitability from 2019 to 2023. But even then, the gross profit margin and even the gross profitability did not hit the 2012 high.

SGA margin deteriorated from an average of 4% in 2012/13 to an average of 7% in 2022/23.

The declining profits led to declining ROIC and ROE as can be seen in the right part of Chart 2. However, CFROIC improved over the past 2 years such that the 2023 CFROIC of 14% was higher than the 2012 CFROIC of 10 %.

Given the poor returns, you should not be surprised to see mixed signs when it comes to productivity or efficiency. Negative signs included:

Capital efficiency as measured by gross profitability declined by 3.4 % compounded annually over the past 12 years. Refer to the left part of Chart 2.

Asset turnover declined over the past 12 years. Refer to the right part of Chart 3.

Positive signs included:

Improvement in leverage. Refer to the right part of Chart 3.

The contribution margin over the past few years was higher than that in 2015. Refer to the left part of Chart 3.

Chart 3: 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

2019

Looking at Charts 1 to 3, you can see that 2019 was an extraordinary year. I have already mentioned the acquisition of Kian Joo Can and the disposal of F & B Nutrition in that year. There was also a profit spike.

But the acquisition and disposal hid a declining picture. If you excluded the one-off gains from the acquisition and disposal, I estimated that there would be an operating loss of RM 39 million in 2019. Furthermore, instead of a spike in PAT in 2019, there would be a loss after tax of about RM 135 million.

The conclusion is that the business faced declining profits from 2012 to 2019 and the 2019 acquisition and disposal changed the trend.

However, the 2021 loss can also be attributable to one-off results. If I ignore these one-off charges, there would be a PAT of about RM 97 million.

Thus, in projecting the future performance of the Group it would be more appropriate to look at the 2022 to 2023 performance. I would ignore the 2020 results due to COVID-19.

In this context, from the past 3 years' operating perspective, this is not a Group to shout about:

There was no growth in gross profitability.

SGA margin deteriorated.

There was no improvement in contribution margin.

Asset turnover was relatively unchanged from 2021 to 2023.

Peer performance

I compared Can One performance with those of several Bursa companies in the carton and plastic container sectors. These were:

HPP Holdings

Jishan

Ornapaper

Public Packages

Versatile creative

Table 1 summarizes the comparative size in terms of revenue. You can see that Can One is much bigger than its peers in terms of the 2023 revenue.

Table 1: Peer revenue

Note: I compared the revenue growth from 2020 as not all the peers had data going back to 2012.

Over the past 12 years, Can One performance was below average relative to its peers based on 2 metrics – return on capital and EBIT margin. Refer to Chart 4. Can One may be bigger, but bigger does not mean better return or margin.

Chart 4: Peer return of capital and EBIT margin

Market demand

There are several types of packaging based on factors such as the nature of the product, shelf-life requirements, transportation needs, and environmental considerations. The common types include:

Paper and paperboard packaging such as carton boxes.

Plastic packaging such as plastic bottles and plastic bags.

Glass packaging such as glass bottles.

Metal packaging such as cans and metal foils.

Wood packaging such as crates and pallets.

Foam packaging such as foam inserts sheets and rolls for wrapping

The packaging sector is a mature one as exemplified by the following:

The Malaysia packaging market size was valued at 19.4 billion units in 2022. The market is anticipated to register a CAGR of more than 3% during 2022-2027.” Global Data

“Malaysia paper packaging market…at a CAGR of 5.3 % during the forecast period 2024 – 2032” Astute Analytica

While it is a mature sector, the packaging sector is not considered a sunset one due to several key factors:

E-commerce growth.

Sustainability trends.

Consumer preferences. Consumers are increasingly demanding convenient, attractive, and functional packaging. This trend is leading to advancements in packaging design and material.

Technological advancements such as smart packaging, which can provide information about the product, enhance shelf life, and improve supply chain efficiency, are contributing to the sector's growth.

Financial position

I would consider Can One as financially sound.

As of the end of March 2024,

It had RM 325 million in cash and short-term investments. This is about 7 % of the total assets.

It had a debt-capital ratio of 46 %. This had reduced from its 51 % high in 2012.

Over the past 12 years, it had positive cash flow from operations every year. During this period, it generated RM 1.8 billion cash flow from operations compared to the RM 1.6 billion PAT. This is a reasonable cash conversion ratio.

It has a good capital allocation plan as shown in Table 2. You can see that the cash flow from operations was enough to fund its CAPEX and acquisitions.

Table 2: Sources and Uses of Funds 2013 to 2024

The main negative point was the high Reinvestment rate that averaged 69 % over the past 12 years.

Reinvestment rate = Reinvestment / NOPAT.

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

However, the high Reinvestment rate was due to the acquisition of Kian Joo Can. Excluding acquisitions and divestments, the average Reinvestment rate was negative. The negative arose because the Depreciation & amortization more than offset the CAPEX.

As such I would not worry too much about the high Reinvestment rate.

Valuation

The NTA of Can One was RM 9.62 per share (as of Dec 2023) compared to its market price of RM 3.10 per share (as of 9 Jul 2024).

As for its Earnings Value, I considered 2 Scenarios:

Scenario 1. I looked at the Earnings Power Value based on the past 12 years' historical performance. This worked out to be RM 7.83 per share.

Scenario 2. I used the past 2 years' performance to represent the future. I valued Can One based on a 4% perpetual growth rate and obtained RM 7.58 per shar

You can see from Chart 5 that there is more than a 30% margin of safety under all the NTA and Earnings Values.

Chart 5: Valuation

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 was based on Damodaran’s build-up approach.

Case Notes

According to Damodaran, growth needs to be funded and one way to look at this is via the Reinvestment rate.

“...The reinvestment rate is often measured using the most recent financial statements for the firm. Although this is a good place to start, it is not necessarily the best…A firm’s reinvestment rate can ebb and flow…looking at an average reinvestment rate over time may be a better measure of the future…as firms grow and mature, their reinvestment… tends to decrease... industry averages for reinvestment rates may provide a better indication of the future than using numbers from the past.”

I think that the Reinvestment rates for Can One illustrate the problem well.

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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 of the firm = 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 3.

g = growth rate assumed at 4% perpetual.

The reinvestment rate was based on the past 2 years' average rate without acquisition.

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

Table 3: Valuation under 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 two Scenarios, I am more inclined to follow Scenario 2.

I did not consider Scenario 1 based on the past 12 years' data because of the change in the business profile in 2019.

The challenge with Scenario 2 is that the value is sensitive to the Reinvestment rate. I have assumed the rate to be the average past 2 years rate. Reinvestments tend to be lumpy and using 2 years of data is probably not sufficient to take care of the lumpiness.

I normally use the fundamental growth equation to determine the Reinvestment rate.

Growth = Return X Reinvestment.

I did not do this for Scenario 2 because of the computed low Return of 3 %. Refer to item “j” in Table 3. Based on the growth formula, the Reinvestment rate would exceed 100% which would result in a negative intrinsic value.

When I looked at the Reinvestment rates of the international packaging companies as per Table 4, you can see that my assumption of 7% for Can One does not seem unreasonable.

Table 4: Reinvestment rate for International Peers

Conclusion

Given the change in the business profile in 2019, it is more meaningful to look at Can One performance post-2019. Because of COVID-19, I would focus on the 2021 to 2023 results.

Even on such a basis, this is a Group with low returns.

The average ROIC from 2021 to 2023 was 4% compared to its current 7% WACC.

Its 2021 to 2023 average ROE was about zero due to the 2021 losses. I have mentioned that this loss was due to one-off impairments. Even if I wrote back the impairments for 2021, the average 2021 to 2023 ROE would only be 4% compared to the current cost of equity of 16%.

With returns lower than the respective cost of funds, Can One did not create shareholders’ value over the past few years. From the past 3 years operating perspective, this is not a Group to shout about:

There was no growth in gross profitability.

SGA margin deteriorated.

There was no improvement in contribution margin.

Asset turnover was relatively unchanged from 2021 to 2023.

The only positive thing about the Group is that it is financially sound.

From a valuation perspective, this is a Group with more than a 30% margin of safety from an NTA basis. For a brick-and-mortar Group, the Asset Value can provide a sound margin of safety. This is especially true if the Group continues to be profitable.

I am confident that the Group will continue to be profitable. The question is whether it can improve its performance and generate returns greater than the cost of funds. Only then will the margin of safety under the Earnings Value be meaningful.

So while the is a margin of safety under the Earnings Value – Scenario 2, I would consider Can One a cigar-butt investment opportunity.

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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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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