Is Khind an investment opportunity?

Value Investing Case Study 77-1: A fundamental analysis of Khind Holdings Bhd to see whether it is a value trap or an investment opportunity.

Khind Holdings Berhad (Khind or the Group) is a prominent Malaysian appliance Group with well-regarded brands such as KHIND, MISTRAL, and MAYER.

The appliance sector is tough, especially since China started to export its appliances in the early 2000s. Khind's growth despite China's competitive challenges is a good sign of its resiliency.

This article delves into KHIND's financial performance over the past decade. It analyzes revenue growth trends, profitability, and operational efficiencies. It also explores the challenges faced in the post-pandemic landscape, where shifts in consumer behavior have prompted a reevaluation of strategies.

Join me as I lay out why Khind can be an investment opportunity. To be transparent, I dealt with Khind when i-Bhd was still in the appliance business. I thus have a bit more background knowledge about the sector than most people.

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

Company background

Operating performance

Financial position

Valuation

Conclusion

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. Learn more.

Company background

Established in 1961, KHIND has grown from a humble electrical appliance repair shop to become a successful Malaysian brand with a presence in over 58 countries around the globe.

The Group offers a wide range of appliances, comprising air-moving products, home appliances, and kitchen appliances, which are distributed under the brands KHIND, MISTRAL, and MAYER.

The Group reports its performance under 2 key segments:

Trading. The Group is involved in the trading of electrical home consumer appliances. KHIND’s products are mainly distributed via outright sales to dealers, departmental and chain stores, supermarkets, and e-commerce channels. The Group also has its own Rent-to-Own (R2O) channel.

Manufacturing. The Group’s flagship products, namely fans, rechargeable emergency lamps, and small appliances are manufactured at its plant located in Sekinchan, Selangor.

The Trading segment is the biggest revenue contributor accounting for 96 % of the Group revenue in 2023. The bulk of the business is in Malaysia. In 2023, Malaysia accounted for about 61 % of the Group’s revenue. Refer to Chart 1.

Chart 1: Revenue profile

Note: The Group did not provide a geographic breakdown of the non-Malaysian revenue in 2012.

Operating performance

Over the past 12 years, revenue grew at 5.1 % CAGR. But the bulk of the growth was in 2020 and 2021 with double-digit growth rates. Refer to the left part of Chart 2. The company attributed this to its e-commerce strategy benefiting from the COVID-19 lockdown.

“Driven by effective marketing strategies from the e-commerce team, the Group had boosted its traffic and doubled its online sales…The strong online presence enabled us to establish branding and also gain credibility as we expand our customer base.” 2020 Annual Report.

“During the year…many people still prefer to stay at home due to the emergence of new variants of the COVID-19 virus. This has contributed to the sustained demand for our home electrical appliances.” 2021 Annual Report

Unfortunately, with the opening of the economy, revenue growth declined. Revenue in 2023 even shrank when compared to that of 2022.

“As a result, we began to see shifts in consumer buying behaviour, slowly moving away from purchasing online and going back into physical retail outlets and malls” 2022 Annual Report.

Chart 2: Performance Index and Margins

While revenue grew from 2020 to 2022, gross profit margins declined. Refer to the right part of Chart 2. However, the Group was fortunate to have a corresponding decline in the Selling, General, and Administration (SGA) margin.

The conclusion was that the Group was able to ramp up its revenue from the combination of its e-commerce strategy with the ‘stay at home” impact of COVID-19. But with the end of endemicity, this tailwind went away. I would not expect double-digit revenue growth moving forward.

While there was revenue growth over the past 12 years, the same could not be said for profits. Profits declined from 2013 to 2019. While the e-commerce and COVID-19 tailwinds reversed this trend, profits have since declined so the 2023 profits were lower than those in 2012.

Given the profit picture, returns were volatile as can be seen from the left part of Chart 3. Over the past 12 years, ROIC and ROE averaged 8%. But there is a good sign as these averages were higher than the current cost of funds. This meant that Khind managed to create shareholders' value despite the volatile returns.

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 that excluded Depreciation & Amortization.
Contribution = Revenue – Variable Cost.
Contribution margin = Contribution/Revenue.

Apart from revenue growth, the other concern I have is the declining margins over the past few years. I have earlier mentioned the declining gross profit margin. This in turn led to a decline in the contribution margin as shown in the right part of Chart 3.

The company has acknowledged this declining trend:

“Our trading… segment has been experiencing deteriorating gross profit margin since early of the year due to rising material cost and freight charges.” 2021 Annual Report.

“…one of the biggest challenges we faced was reducing gross profit and margins caused by strengthening of USD, and the rising costs of materials and freight” 2022 Annual Report.

Efficiencies

But there seems to be a turnaround in the margin in 2023. To see whether this is sustainable, I look at several operating and capital efficiency metrics.

Operating efficiencies. Refer to the left part of Chart 4. While there was improving inventory turnover from 2020 to 2023, there were no improving trends for the other 3 metrics.

Capital efficiencies. Refer to the right part of Chart 4. While there was not much change in the capital turnover and asset turnover from 2020 to 2023, the cash conversion cycle got worse. But there was an improving Reinvestment margin.

Overall, I am not sure whether we would see sustained improvement in the margins moving forward. You can get a sense of this by looking at the gross profitability trend as illustrated in the left part of Chart 2.

According to Professor Novy-Marx, gross profitability has the same power as Price to Book Value in predicting cross-section returns of stocks. A “stable” gross profitability trendline meant that profit growth had to come from revenue growth rather than improving efficiency.

Chart 4: Operating and Capital Efficiency Trends

To be fair to the Group, it did focus on efficiency improvements as exemplified by the following.

“…will continue to embark on cost optimization exercises as well as improving operational efficiency…” 2021 Annual Report.

“We have begun with our investment in Khind IQ, a data and analytics platform that will provide greater visibility into our product portfolio and distribution channels. This will… ultimately drive greater efficiency and profitability.” 2022 Annual Report.

“Rightsizing exercises have also been carried out throughout FY2023 to further streamline operations…to objectively improve efficiency and competitiveness for the Group.” 2023 Annual Report.

Peer comparison

I compared Khind's performance with 3 other Bursa appliance companies as shown in Table 1. You can see that Khind is one of the larger companies in terms of the 2023 revenue.

It also had one of the better revenue growth rates over the past 12 years. The low growth rates experienced by the peers suggest that this is a mature sector.

Table 1: Peer Revenue

I looked at the trends of 4 metrics to get a sense of how well Khind performed compared to its peers. Refer to Charts 5 and 6. I would rate Khind's performance compared to its peers as follows:

Return on capital - Excellent improvement. Khind initially had an average return on capital. But since 2020, it delivered one of the better if not the best return on capital.

EBIT margin - Average, with recent decline. While there was an improving trend from 2020 it has since declined to below its 2012 level by 2023.

Levered free cash flow margin - Best in class. Khind's levered free cash flow margin seemed to have improved over the past few years to be the best in 2023.

EPS - Top performer among local companies.

Overall, while Khind has made notable strides in its return on capital and cash flow metrics, the decline in EBIT margin is a concern. However, its position in EPS highlights its competitive edge in the local market.

Chart 5: Bursa Peer Return on Capital and EBIT Margin

Chart 6: Bursa Peer Levered Free Cash Flow Margin and EPS

Financial position

I would rate Khind as financially sound.

As of Jun 2024, it had RM 66 million cash. This is equal to 18 % of its total assets.

It had a Debt Equity ratio of 0.37 as of Jun 2024. This has come down from its 2012 high of 0.74.

Over the past 12 years, it generated positive cash flow from operations for 10 out of the 12 years. During this period, it generated RM 135 million cash flow from operations compared to the total PAT of RM 137 million. This is reasonable cash flow conversion ratio.

From 2013 to 2024, it had a 23% Reinvestment rate. I defined Reinvestment rate = Reinvestment/NOPAT and Reinvestment = CAPEX + Acquisition – Depreciation & Amortization + increase in Net Working Capital. This meant that the company had sufficient funds to return to shareholders.

It has a good capital allocation track record. Refer to Table 2. A big part of the cash flow from operations was used to reduce debt, pay dividends, and build up its cash position.

Table 2: Sources and Uses of Funds 2012 to 2023

Valuation

In valuing Khind, I adopted the following picture:

I assumed that this is a mature company in a mature sector. Revenue growth would follow the long-term GDP growth rate of 4%.

The base revenue was derived from the 2023 revenue based on the best fit logarithmic line for the past 12 years revenue. This will smoothen the “random” component of the annual revenue. Refer to the left part of Chart 7.

There would not be any improvement in the operating and capital efficiency. Given the bigger role of e-commerce from 2020, I assumed the 2020 to 2023 operating and capital efficiencies as the long-term ones.

Chart 7: Projections

The projected picture based on these assumptions can be seen from the right part of Chart 7. You can see that they do not seem unreasonable.

On such a basis, I obtained an intrinsic value of RM 3.67 per share compared to its market price of RM 2.42 per share (as of 1 Nov 2024). As a sanity check, I considered other valuation metrics as illustrated in Table 3. You can see that:

Khind is trading below its Asset Value.

Based on the Acquirer’s Multiple, Khind is considered cheap.

Based on the past 12 years' Free Cash Flow yield, it is a good investment opportunity.

Table 3: Valuation metrics

Notes

a) EV / (average 3 years Op profit + Depreciation)

b) 2012 to 2023 Ave Free cash flow/market price.

Valuation model

In valuing Khind, I based it on the operating profit model shown in the right part of Chart 3. I valued it based on the single-stage Free Cash Flow to the Firm model.

FCFF = EBIT(1 – t) - Reinvestment.

EBIT = Revenue X Contribution margin – Fixed cost.

Reinvestment was based on the Reinvestment margin. I assumed this to be zero due to the negative historical rate.

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

Table 4 illustrates the calculation under Scenario 2. The WACC was based on the first-page result of a Google search for “Khind WACC” as shown in Table 5.

Table 4: Sample calculation

Table 5: Estimating the cost of funds

Case Notes

One effective strategy for improving free cash flow is through enhancing operational and capital efficiencies.

Operational efficiency involves optimizing processes to reduce waste and improve productivity. Companies can achieve this through process automation, lean management, and employee training. Furthermore, a well-managed supply chain can help improve cash flows.

Strategies to improve capital efficiencies include improving asset utilization, better capital allocation, and better debt management. For example, refinancing high-interest debt can reduce interest payments, freeing up cash for reinvestment. Maintaining an optimal debt-to-equity ratio also minimizes financial risk.

By streamlining operations, optimizing supply chain management, and enhancing capital efficiency, companies can improve cash flow.

As you can see, fundamental analysis requires expertise and time. That is why I created the Fundamental Mapper to shortcut the process. You can see the position of Khind as of 29 Nov 2024 in the Fundamental Mapper chart below.

Download the Fundamental Mapper app now on Xifu to get investment insights into Bursa Malaysia companies.

PS: The Fundamental Mapper gives you a first-cut picture. You probably would not consider Khind looking at just the Fundamental Mapper. But you may think differently following a detailed analysis as shown in this article. Along this line, a stock falling into the Goldmine quadrant would clearly be worth considering if you carried out a detailed analysis.

Risks and limitations

There are 3 issues to consider when looking at the valuation of Khind.

Revenue.

Reinvestment rate.

Relatively low WACC.

The valuation model is very sensitive to changes in revenue. For example, if the base revenue is reduced by 1.5 %, the intrinsic value reduces to the market price.

While revenue growth had contracted post-COVID-19, the Group has a history of revenue growth. Even if I valued Khind assuming no growth, I obtained an Earnings Power Value of RM 2.23 per share. This is close to the market price.

In a low revenue growth environment, improving efficiency has a bigger role in improving free cash flow. I hope I have shown that there is more than a fighting chance that Khind would be able to maintain if not improve its operating and capital efficiencies. Signs in support of these are

The “stable” gross profitability over the past 12 years.

The turnaround in the contribution margin in 2023.

The valuation model assumes the historical Reinvestment margin that resulted in a Reinvestment rate of 60%. This was because of the low NOPAT. This Reinvestment rate is higher than the historical rate. If I accounted for an improvement in this rate, there would be a bigger margin of safety.

Finally, I would not rule out the impact of the low WACC. With a WACC of 6.6 % compared to the 4% growth rate, there would be a bigger “multiplier” effect on the discount rate compared to if the WACC was much higher.

Conclusion

Khind has successfully leveraged e-commerce strategies, particularly during the pandemic, to drive substantial revenue growth. However, the post-pandemic landscape has presented challenges. This led to a decline in revenue and profit margins as consumer behaviours shifted back to traditional retail.

This is not a high-growth company in a mature sector. Profitability improvements would have to come from improving efficiencies. While the Group has been addressing this, there is no clear evidence of improvements.

Despite these hurdles, KHIND is financially sound with a strong cash position, manageable debt levels, and a commendable cash flow conversion ratio. The company's ability to maintain a competitive edge in earnings per share among its peers reflects its operational strengths. However, the declining EBIT margins warrant attention.

Looking ahead, I posited that the Group would have moderate revenue growth aligned with GDP trends. Coupled with sustained operating efficiencies, my valuation showed that KHIND is a potentially undervalued opportunity.

Investment thesis

KHIND's successful e-commerce strategy, particularly during the pandemic, demonstrated its ability to adapt to changing consumer behaviours. As online shopping continues to grow, KHIND is positioned to capitalize on this trend, sustaining future revenue growth.

The Group is financially sound with a history of returning capital to shareholders through dividends. While recent years have seen a decline in profit margins, KHIND’s focus on improving operational efficiencies could lead to margin recovery.

The stock is undervalued relative to its asset value and earnings value and offers a favourable free cash flow yield, suggesting potential capital appreciation.

END

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

How to be an Authoritative Source, Share This Post

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.

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.

Your link text

Search This Blog

Investing For Value