Is Harrisons an investment opportunity?

Value Investing Case Study 71-1: A fundamental analysis of Harrisons Holdings (Malaysia) Bhd to see whether it is a value trap or an investment opportunity.  

Is Harrisons an investment opportunity?
Since its inception in 1990, Harrisons Holdings (Malaysia) Berhad (Harrisons or the Group) has established itself as one of the largest and most reputable players in the industry. 

With a robust distribution network cultivated over 102 years, particularly in East Malaysia, Harrisons has diversified its revenue streams across consumer products, industrial chemicals, and retail ventures, including the well-loved Famous Amos Cookies.

But is Harrisons merely a legacy brand, or does it hold genuine investment potential in today's market? 


Join me as I delve into a detailed fundamental analysis covering its financial performance, operational efficiencies, and competitive positioning. From examining growth rates and profitability to evaluating its valuation metrics against peers, this article aims to uncover whether Harrisons represents an investment opportunity or remains a value trap. 

My analysis shows that there is a good margin of safety. While there are some concerns, I would rate Harrisons as fundamentally ok. 

To be transparent, this was a company that I invested in and made significant returns several years ago. I am now looking to see whether history could repeat itself. I also took the opportunity to compare my analysis with those by Stock Market GPT, a fundamental analysis AI site.

Should you buy it? Well, read my Disclaimer.

Contents

  • Company background
  • Operating performance
  • Financial position
  • Valuation
  • Conclusion
  • AI response
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Company background

Harrisons was incorporated in March 1990 as a private limited company under the name of Jantoco Trading Sdn Bhd and assumed its present name in 1991. Harrisons Holdings (Malaysia) Bhd was listed on Bursa Malaysia in October 1999.

Jantoco acquired companies within the Group in the late 1990s from Harrisons and Crosfield PLC, (H&C PLC) a public company listed on the London Stock Exchange. H&C PLC was well known for the plantations it operated previously under Harrisons Malaysia Plantations Berhad and Golden Hope Plantations Berhad. 

Harrisons is one of the oldest, largest, and most established sales, marketing, warehousing, distribution, and services organizations in Malaysia. 
  • This is particularly in East Malaysia where Harrisons has been in business for 102 years and developed a very good distribution network that ranks amongst the best in the country. 
  • Harrisons’ income is currently derived mainly from consumer, building, and engineering products, agricultural and industrial chemicals, and the operation of shipping and travel agencies. 

As can be seen from Chart 1, the bulk of its revenue and earnings came from its trading and distribution operations. Note that the retail operations started in 2018 covering the Famous Amos Cookies in Singapore and the Komonoya brand products in Malaysia.

Harrisons Chart 1: Segment Revenue and EBIT
Chart 1: Segment Revenue and EBIT

Operating performance

Revenue over the past 12 years grew at 4.7 % CAGR. Refer to the left part of Chart 2. But I would break this growth into 2 based on the start of the retail business:
  • 2012 to 2018. Revenue grew at 3.2 % CAGR.
  • 2018 to 2023. Revenue grew at 6.4 % CAGR.

PAT on the other hand had a faster growth rate of 8.4 % over the past 12 years. Note that the loss in 2014 was due to a one-off “settlement of RM 31.50 million with customs for alleged unpaid import and excise duty and sales tax amounting to RM 91.75 million.”

You can see from the right part of Chart 2 that the improving profit was because the Group has been able to improve its gross profit margin at a faster rate than the increase in Selling, General, and Administration (SGA) expenses.

The other positive sign was the improving gross profitability.

Harrisons Chart 2: Performance Index and Margins
Chart 2: Performance Index and Margins

Given the profit pattern, you should not be surprised to see similar patterns for the returns. Refer to the left part of Chart 3. Over the past 12 years:
  • ROIC averaged 10 % compared to the current WACC of 7 %.
  • ROE averaged 9 % compared to the current cost of equity of 8 %.

With returns greater than the respective cost of funds, I would conclude that Harrisons created shareholders' value.

You can see that CFROIC was quite volatile. I will discuss this a bit more when I look at its financial position.

If you look at the right part of Chart 3, you can see that the contribution margin post-2018 was significantly higher than that pre-2018. 

The other key feature of Harrisons is that its fixed cost is a very small component of the total cost. In 2023 the fixed cost only accounted for about 9 % of the total cost. This meant that as revenue increased, there would be a bigger increase in the profits.

Harrisons Chart 3: Returns and Operating Profit
Chart 3: 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.

Efficiencies

I have already mentioned about the improving gross profitability and contribution margin. These reflect improving capital efficiencies and operating efficiencies respectively.

When I looked at other capital and operating efficiencies metrics, there were mixed results. Refer to Chart 4.
  • Operating efficiencies post-2018. While operating profit margin and ROA improved, there were no obvious trends for inventory turnover and operating expense ratio.
  • Capital efficiencies post-2018. While there were improvements in the capital turnover (revenue/TCE), cash conversion cycle, and asset turnover, free cash flow turnover (FCFF/TCE) was volatile without any obvious trend.

These findings suggest that while the operating and capital efficiencies post-2018 were better than those pre-2018, I am not sure that they will continue to improve post-2023.

Harrisons Chart 4: Operating and Capital Efficiency Trends
Chart 4: Operating and Capital Efficiency Trends
TCE = Total Capital Employed  = Equity + total debt - cash.

Peer comparison

In my article on DKSH, I compared DKSH with Harrisons and 2 other trading cum distribution companies. 

For this article, I chose the peers to be DKSH and 2 logistics companies that I have covered in my blog article – CJ Century Logistics and FM Global Logistics.

As can be seen from Table 1, the distribution companies’ revenues are much larger than those of the logistics companies. However, in terms of growth rates, the logistics companies have larger growth rates.

Harrisons Table 1: Peer revenue
Table 1: Peer revenue

I looked at the trends of 4 metrics to get a sense of how well Harrisons performed compared to its peers – return on capital, EPS, EBIT margin, and Free Cash Flow margin. Refer to Charts 5 and 6. 
  • In terms of capital and operating efficiencies, Harrisons’ return on capital and EBIT margin is about average.
  • In terms of profitability management, Harrisons did better than average for the EPS and Levered Free Cash Flow margin.

I would rate Harrisons' overall performance as average. 

Harrisons Chart 5: Bursa Peer Return on Capital and EPS
Chart 5: Bursa Peer Return on Capital and EPS

Harrisons Chart 6: Bursa Peer EBIT margin and Levered Free Cash Flow margin
Chart 6: Bursa Peer EBIT margin and Levered Free Cash Flow margin

Financial position

I would rate Harrisons’ financial position as at best average.

I have already mentioned about the volatile CFROIC. This was because of the volatile nature of the cash flow from operations. Over the past 12 years, there were 4 years with negative cash flow from operations. This was despite being profitable for 11 out of the past 12 years

In total over the past 12 years, the Group generated RM 346 million cash flow from operations compared to the cumulative PAT of RM 365 million. This is at best an average cash flow conversion rate. 

Over the past 12 years, it had an average Reinvestment rate (Reinvestment/NOPAT) of 50 %. This is a high rate.  This matched the rate derived from the fundamental growth equation.

Growth = 4.7 %

Average ROIC = 9.6 %

Average Reinvestment rate = growth/ROCE = 4.7 / 9.6 = 49%

But the above negative points are matched by the following positive points:
  • As of the end of Jun 2024, it had RM 172 million cash, equal to 18 % of its total assets.
  • It had a good capital allocation track record. Refer to Table 2. You can see that its cash flow from operations was more than sufficient to fund the CAPEX and dividends.
  • Its Debt Equity ratio was 0.53 as of the end of June 2024. This had come down from its 2019 high of 0.67.

Harrisons Table 2: Sources and Uses of Funds 2012 to 2023
Table 2: Sources and Uses of Funds 2012 to 2023

Valuation

In estimating the intrinsic value of Harrisons, I adopted the following narrative based on my fundamental analysis:
  • The base revenue would be the average 2019 to 2023 revenue and it would continue to grow at 4% in perpetuity. I consider this a mature business. 
  • The contribution margin and capital efficiency would be based on the 2019 to 2023 average values. This is to account for the post-2018 improvements in operating efficiencies and capital efficiencies. However, I do not see further improvements in these metrics.

I used a single-stage Free Cash Flow to the Firm model to determine the intrinsic value.
  • I estimated Harrisons' Asset Value to be RM 6.96 per share based on its Book Value as of June 2024. It does not have substantial goodwill in its books. As such its NTA came to RM 6.85 per share.
  • I broke down the Earnings Value into the Earnings Power Value ignoring growth (EPV) and Earnings Value with 4 % growth. I obtained an EPV of RM 8.78 per share and an Earnings Value with 4% growth of RM 13.60 per share.
  • The market price as of 6 Sep 2024 was RM 8.30 per share. 

Chart 7 illustrates the valuation relative to the market price and the past 5 years' high and low prices. You can see that there is no margin of safety under the Asset Value

However, there is a 64 % margin of safety for the Earnings Value with growth. 

Harrisons Chart 7: Valuation
Chart 7: Valuation

Valuation model

I valued Harrisons using a single-stage Free Cash Flow to the Firm model.

Value to the firm = FCFF X (1 + g) / (WACC – g).

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

EBIT = Revenue X Contribution margin – Fixed cost. This was based on the operating profit model as shown in the right part of Chart 3.

The reinvestment rate was derived from the fundamental growth equation g = Return X Reinvestment rate.

For the EPV case, I assumed g = 0. For the EV with growth case, I assumed g = 4%.

Table 3 illustrates the calculation for the Earnings value with growth.

The WACC was based on the first-page result of a Google search for the term “Harrisons WACC” as shown in Table 4. 

Harrisons Table 3: Sample calculation
Table 3: Sample calculation

Harrisons Table 4: Estimating the cost of funds
Table 4: Estimating the cost of funds

Case Notes

When looking at trading and distribution companies, you should focus on the following

Supply Chain Management
  • Logistics efficiency. Assess how well the company manages its supply chain and logistics, as efficiency can significantly impact profitability.
  • Inventory management. Look at inventory turnover rates to gauge how effectively the company manages stock levels.

Distribution Channels
  • Channel diversity. Evaluate the variety of distribution channels used (e.g., online, retail, wholesale) and their effectiveness.
  • Partnerships. Consider relationships with suppliers and partners, as strong networks can enhance distribution capabilities.

Technological Integration
  • Automation and innovation. Investigate the adoption of technology in logistics and inventory management, which can lead to cost savings and efficiency.
  • E-commerce capabilities. Assess the company's readiness and effectiveness in e-commerce, which is increasingly important in distribution.

By focusing on these sector-specific factors, you can gain a deeper understanding of the unique challenges and opportunities faced by trading cum distribution companies.

If you are starting in a sector that you are not familiar with, looking at how others have analyzed companies in the sector can provide good insights. A site like Seeking Alpha* is a good source of such information. Click the link for some free stock valuation examples. If you subscribe to their services, you can tap into their business analysis and valuation.




Risks and limitations

I generally look at 3 different valuation approaches to get a sense of the margin of safety. This is summarized in Table 5.
  • I have already stated that there is more than a 30% margin of safety based on the Earnings Value with growth.
  • Harrisons had an Acquirer’s Multiple of 7.4. Generally, a value less than 10 is considered cheap although Tobias Carlisle would consider a value under 6 to be cheap.
  • A Free Cash Flow yield of 10% is considered good. Generally, I look for a yield greater than 6% (based on the average EPF dividend yield).

With all the 3 different valuation metrics pointing in the same “safe” direction, I would consider Harrisons a low-risk investment. 

Harrisons Table 5: Comparative valuation metric
Table 5: Comparative valuation metric

Conclusion

I would summarize the positive aspects of Harrisons as follows:
  • Revenue growth. The company has demonstrated consistent revenue growth, with a 4.7 % CAGR since 2012.  
  • Profitability. ROIC and ROE are above the respective costs of capital, indicating value creation for shareholders. 
  • There are post-2018 improvements in operating and capital efficiencies 
  • Valuation. The stock is trading below the estimated Earnings Value with growth, offering a good margin of safety. The Free Cash Flow yield of 10% is also attractive. Harrisons is also cheap from the Acquirer’s Multiple perspectives.

My main concern is its volatile cash flow. Despite profitability, cash flow from operations was volatile. There were 4 years of negative cash flow from operations over the past 12 years. This indicates potential challenges in converting profits into cash.

But this cash flow position is not dire. As such I would consider Harrisons an investment opportunity. 

AI response 

I asked Stock Market GPT 2 questions:
  • Is Harrisons Holdings fundamentally sound?
  • Is Harrisons Holdings an investment opportunity from a value investment perspective?

The main difference between the AI and my analysis is the time frame. I looked at the past 12 years' performance before narrowing to 2019 to 2023 for my valuation. While the AI did not specify the period it covered, it seemed to focus on the LTM data.

As for the second question, the AI seemed to focus on relative valuation whereas I looked at the DCF method triangulated with the Acquirer’s Multiple and Free Cash Flow yield. 

Q1

Its response to the first question was as follows:

Based on the financial data provided for Harrisons Holdings (Malaysia) Berhad, the company appears to have a mixed financial position. Here is a detailed analysis:

Positives:
  • Profitability: The company's profit margins are relatively low, with a net profit margin of 2.64% and an operating margin of 3.41%. However, the EBITDA margin of 3.94% indicates that the company's core operations are generating reasonable profits.
  • Liquidity: The company has a current ratio of 1.93, indicating it has sufficient current assets to cover its short-term liabilities. The quick ratio of 1.39 also suggests the company has good short-term liquidity.
  • Solvency: The debt-to-equity ratio is 53.21%, which is a relatively high level of leverage, but still within a manageable range.
  • Cash Flows: The company's operating cash flow is negative, but this is offset by positive free cash flow, indicating the company is generating cash from its operations.

Negatives:
  • Revenue Growth: The company has experienced a revenue decline of 6.4% over the past year, which is a concern.
  • Profitability: While the profit margins are positive, they are relatively low, suggesting the company may need to improve its operational efficiency.
  • Valuation: The stock price is trading at a trailing P/E ratio of 9.65, which is lower than the industry average, suggesting the stock may be undervalued.
  • Dividends: The company has a high dividend yield of 6.03%, which may indicate a relatively high payout ratio and potential concerns about future dividend sustainability.

Conclusion:
Based on the available financial data, Harrisons appears to have a mixed financial position. The company has good liquidity and solvency, but its profitability and revenue growth are areas of concern. Investors should carefully consider the company's long-term prospects and growth potential before making an investment decision.

It is important to note that this analysis is based solely on the financial data provided and does not take into account other factors such as industry trends, competitive landscape, and management quality, which are also important considerations for a comprehensive evaluation of the company's fundamentals.

Q2

It answered the second question as follows:

From a value investment perspective, Harrisons Holdings (Malaysia) Berhad could be considered a potential investment opportunity, based on the analysis of the available financial data:

Valuation Metrics:
  • The company's trailing P/E ratio of 9.65 is significantly lower than the industry average, suggesting the stock may be undervalued.
  • The price-to-sales ratio of 0.26 is also quite low, further indicating the stock may be trading at a discount.

Dividend Yield:
  • The company has a high dividend yield of 6.03%, which is attractive for value-oriented investors who prioritize income generation.

Balance Sheet Strength:
  • The company has a relatively strong balance sheet, with a current ratio of 1.93 and a debt-to-equity ratio of 53.21%, indicating a manageable level of leverage.
  • The company has a significant amount of cash and cash equivalents on its balance sheet, which could provide financial flexibility and stability.

Profitability and Efficiency:
  • While the company's profit margins are relatively low, the EBITDA margin of 3.94% suggests that the core operations are generating reasonable profits.
  • The return on assets of 5.58% and return on equity of 12.74% are positive indicators, although they could be improved.

Growth Potential:
  • The company has experienced a revenue decline of 6.4% over the past year, which is a concern and may limit the short-term growth potential.
  • However, the company's long-term growth prospects may depend on its ability to improve operational efficiency and capture market share in its industry.

Conclusion:
From a value investment perspective, Harrisons appears to present a potential investment opportunity due to its low valuation metrics, attractive dividend yield, and relatively strong balance sheet. However, investors should carefully consider the company's growth prospects, profitability, and competitive positioning in the industry before making an investment decision.

It is important to note that this analysis is based solely on the financial data provided and does not take into account other factors such as management quality, industry trends, and macroeconomic conditions, which are also crucial in evaluating the overall investment potential of the company.






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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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