Is Malayan Flour Mill an investment opportunity?

Value Investing Case Study 79-1: A fundamental analysis of Malayan Flour Mill Berhad to see whether it is a value trap or an investment opportunity.  

Malayan Flour Mill Berhad (MFM or the Group) is a major player in Malaysia's flour milling industry. In addition to flour, MFM has expanded into the poultry business, creating a system that includes everything from making animal feed to processing chicken. 

The flour and poultry sectors are mature ones. As MFM continues to operate in these sectors, it faces exciting opportunities and challenges that will influence its future. 

This article delves into MFM's operational performance, market position, and strategic initiatives. It provides a comprehensive overview of the company's current standing and outlook in the food and agriculture sector.

Join me as I show why I consider it fundamental sound and an investment opportunity. 

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

Contents

• Company background

• Operating performance

• Financial position

• Valuation

• Conclusion

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Company background

Incorporated in 1961, MFM is a pioneer in Malaysia's flour milling industry, operating mills in Lumut and Pasir Gudang. The company has expanded regionally, with operations in northern Vietnam (Cai Lan and Ha Long since 1994) and southern Vietnam (Phu My, Vung Tau since 2000). 

Additionally, MFM has a presence in Indonesia at three locations—Cilegon, Medan, and Makassar—through a tri-partite joint venture established in 2011. MFM's regional operations produce and sell over 1.7 million metric tons of flour annually.

Since 2010, MFM has also been trading raw materials for animal feed in Malaysia through a joint venture with Toyota Tsusho Corporation Group, holding a 51% stake.

In 1983, MFM diversified into the poultry industry in Malaysia. Today, its vertically integrated poultry business includes feed milling, hatchery, breeder farms, broiler farms, and a poultry processing plant. The poultry division can produce approximately 60 million broilers each year.

MFM operates one of the largest closed-house broiler farms in the country and plans to enhance these facilities with climate control and precision farming technologies to boost efficiency and reduce costs. The upgraded poultry processing plant in Sitiawan, Perak, can slaughter up to 280,000 birds daily.

On May 31, 2021, MFM sold a 49% equity interest in Dindings Tyson Sdn Bhd (DTSB) to Tyson International Holding Company, initiating a strategic partnership in the poultry sector. 

Note that although the Group has majority voting rights in DTSB, substantive rights are shared with the other shareholders under the shareholders’ agreement. Accordingly, DTSB is classified as a joint venture of the Group. In other words, the post-2021 revenue for the Group does not include those from the Poultry integration business. 

The Group reports its performance under 3 operating segments:

• Flour and grain trading. This segment focuses on milling and selling wheat flour and trading grain and other allied products.

• Poultry integration. The segment activities include the manufacture and sale of animal feeds, processing and sale of poultry products, poultry grow-out farm, breeding and sale of day-old chicks, and contract farming activities. 

• Others. This segment includes the manufacture and sale of aqua feeds.

In 2023, customers in Malaysia accounted for 58% of the Group’s revenue. The balance came from Vietnam.

The post-2021 revenue from the Poultry integrated segment is not consolidated into the Groups’ revenue or operating profit as mentioned earlier. However, for some analyses, such as the one shown in Chart 1, I have carried out my own Performa analysis where I have treated it as part of the Group’s operation. Refer to the Operating Performance section for the details.

Chart 1: Segment Performa profile

Notes

1) The 2024 performance was based on extrapolating the Q3 2024 results.

2) I assumed that segment EBIT for the Poultry integration segment was the same as the segment PBT.

3) The 2024 Poultry integration segment performance was based on 100% ownership ie before accounting for the 49% owned by Tyson International Holding Company.

On a Performa basis, the Flour and grain trading segment is the biggest revenue and earnings contributor compared to the Poultry integration segment. Refer to Chart 1. As can be seen, the profit contribution from the Poultry integration segment has been more volatile than for the Flour and grain trading segment.

The Flour and grain trading segment had also larger assets deployed compared to the Poultry integration segment, with a better ROA. Refer to Table 1.

Table 1: Segment Performa returns

Notes

a) Average of 2022 to 2024. The 2024 performance was based on extrapolating the Sep YTD 2024 performance. 

b) Average EBIT of 2022 to 2024.

c) Based on Sep 2024.

d) This is based on looking at the Poultry integration business as a part of the Group operations. In the Annual Report, the Poultry integration business is treated as a joint venture. 

Operating performance

I normally looked at the past 12 years' revenue and profit trends to get a sense of the Group’s performance trend. However, in the case of MFM, there was a change in the revenue and profit presentation format post-2021 due to the DTSB joint venture. As such the post 2021 revenue and operating profits excluded those from the Poultry integration segment. 

To get around this accounting treatment, I looked at the Performa revenue and PBT where I assumed that the Poultry integration business was part of MFM’s consolidated revenue and PBT. I did by:

• Adding DTSB revenue to the Group’s revenue from 2021 to 2024.

• Adding DTSB's full PBT and subtracting MFM’s share of DTSB’s PBT from the Group’s PBT for 2021 to 2024.

You can see from the left part of Chart 2 that the Group experienced significant revenue and PBT growth over the past few years. From 2012 to 2023, the Performa revenue grew at 6 % CAGR while the Performa PBT grew at 5.4 % CAGR.

The extraordinary PBT performance in 2022 was due to the good performance of the Poultry integration business,

“…attributable to multiple factors, including our continued success in penetrating the Quick-Service-Restaurant chains, improved margins from economies of scale as a result of increased plant utilisation, better sales mix with increased average selling prices, and government subsidy.” 2022 Annual Report

Chart 2: Performa performance

To get a sense of the returns, I estimate the Performa ROE as shown in the right part of Chart 2. The PAT was assumed to be the Performa PBT multiplied by the (1 – tax rate) for the year. 

You can see that notwithstanding the growth in the Performa PBT, there was hardly any growth in the Performa returns. From 2012 to 2024, MFM achieved an average 6% Performa ROE compared to the current cost of equity of 12 %. This implied that shareholders’ value was not created.

You may argue that from a shareholders’ perspective, the focus should be on the accounting returns as the market pays more attention to this. The left part of Chart 3 shows the accounting returns over the past 13 years. The accounting ROE averaged 7 % over the past 13 years. Again, this is less than the current cost of equity. 

Chart 3: Accounting returns and ROE drivers

Apart from the spike in 2021 due to the RM 174 million gain from the sale of the 49 % interests in the Poultry integration business, there has been no improving ROE trends over the past 13 years. The ROIC also did not show any uptrend averaging about 5 % over the past 13 years.

Both the ROE and ROIC trends implied that the Group had yet to use the proceeds from the sale of the Poultry integration business to generate better returns. 

• The better returns in 2024 compared to that of 2023 can be attributed to better performance of the Flour and grain trading sector. This was due to “improved contribution margin from the decrease in commodity prices on the back of higher sales volume.”

• The Poultry integration segment performance declined in 2024 compared to that in 2023. This was due to “lower market price amidst higher sales volume and discontinuation of subsidy income, coupled with higher reversal of deferred tax assets, but partially set off by higher fair value gain on biological asset.”

Note that as of Sep 2024, the Group had used RM 120 million of the divestment proceeds to repay bank loans.

To get a sense of what drove the accounting ROE, I broke it down into the following components:

ROE = (1- tax rate) X (PBT / Revenue) X (Revenue / Equity).

= Tax yield X PBT margin X Equity turnover.

As can be seen from the right part of Chart 3, the decline in the ROE was mainly due to the declining equity turnover. Apart from the 2021 to 2022 spike resulting from the 49 & sale of DTSB, the tax yield and PBT margin were relatively “stable”.

If nothing, it suggests that to improve its return, MFM has to improve its operating and capital efficiencies. This is especially critical for a company with low revenue growth.

Efficiencies

To see whether there are signs of efficiency improvement, I considered several operating and capital efficiency metrics. Refer to Chart 4. The results were not so clear-cut.

• Operating efficiency. The ROA and inventory turnover seemed to show a declining trend since 2012 with improving operating profit margin and operating expense ratio.  

• Capital efficiency. From 2012 to 2024, there seem to be improvements in the Reinvestment margin and cash conversion cycle. But starting from 2020, you could argue that there were better Reinvestments, asset turnover, and gross profitability, with a worsening cash conversion cycle.

I think there is still much work to be done if MFM wants to improve its returns.

Chart 4: Efficiency trends

Growth

The single-digit Performa revenue and profits growth suggest that MFM is a mature company. It is also in a sector with a single-digit growth rate as illustrated by the following market research reports.

“The South East Asia Flour market is projected to witness growth at a CAGR of 7.0% during the forecast period with a market size of USD 2,637 million in 2024.” Cognitive Market Research

The Malaysian consumption of wheat flour and poultry as per Chart 5 also suggests these to be mature sectors. 

Chart 5: Malaysian demand for wheat flour and poultry.  Source: Statista

The Group stated in its 2023 Annual Report that it “remains committed to growing our businesses of flour milling, poultry integration and aqua feed manufacturing.” However, I do not expect double-digit growth rates going forward.

Historically, the growth has been via organic growth or joint ventures. There was hardly any acquisition over the past 20 years. Growth needs to be funded and one way to measure this is the Reinvestment rate defined as Reinvestment / NOPAT. 

Reinvestment = CAPEX & Acquisitions – Depreciation & Amortization + increase in Net Working Capital

Over the past 13 years, MFM had an average Reinvestment rate of 118 %. This is a very high and unsustainable Reinvestment rate. I suspect that this was because of the low NOPAT.

In any event, the Group would have to either reduce the Reinvestment required or improve the NOPAT by getting better returns.

Peer comparison

I compared MLM's performance with several other Bursa companies in the flour and poultry businesses. Refer to Table 2. You can see that MFM had an average revenue in 2023 with the lowest revenue growth rates over the past 12 years.

Table 2: Peer revenue

I looked at the trends of 4 metrics to get a sense of how well MFM performed compared to its peers. Refer to Charts 6 and 7. 

The overall picture is that MFM had an average performance over the past 12 years. But you could argue that there were improvements over the past 2 years.

• MFM had an average return on capital and EBIT margin. 

• It had better than average EPS.

• MFM was one of the two companies with a very volatile levered free cash flow margin. 

Chart 6: Bursa Peer Return on Capital and EBIT Margin

Chart 7: Bursa Peer Levered Free Cash Flow Margin and EPS

Financial position

While there were some positive points when it came to the financial position, I have some concerns. The positive points included a good solvency position.

• As of Sep 2024, it had RM 330 million cash. This is equal to 14 % of its total assets. 

• Over the past 13 years, it generated positive cash flow from operations for 10 out of the 13 years. During this period, it generated RM 1.2 billion cash flow from operations compared to the total PAT of RM 0.9 billion. This is a good cash flow conversion ratio.

• It had a Debt Capital ratio of 0.39 as of Sep 2024. This has come down from its 2018 high of 0.56.

My concerns include the following:

• I had already mentioned that its Reinvestment rate was unsustainable.

• It did not have a good capital allocation plan. Refer to Table 3. The cash flow from operations was not sufficient to fund its CAPEX. 

Table 3: Sources and Uses of Funds 2012 to 2023

Overall, the company's financial standing is best categorized as moderately strong. The concerns regarding Reinvestment and capital allocation prevent it from being classified as strong. 

Valuation

I adopted the following picture in valuing MFM. 

• Its Poultry integration operations are treated as non-operating. 

• I assumed the 2022 to 2024 average revenue as the base. This is a mature company with a revenue growth rate at a long-term GDP growth rate of 4%.

• The Group Reinvestment rate would improve proportionately to be at a sustainable rate of 44% in the terminal year.

• The ROIC would improve from the 2022 to 2024 average of 3.5 % to the past 13 years average of 4.6 % in the terminal year.

• The tax rate would be based on the 2022 to 2024 average tax rate.

On such a basis, I estimated the intrinsic value of MFM to be RM 0.95 per share. The market price of MFM as of 22 Nov 2024 was RM 0.55 per share. There is more than a 30% margin of safety.

Valuation model

I valued MFM based on a 2-stage valuation model as shown in Table 4. The key assumptions here are:

• Revenue will grow so that the terminal revenue in Year 6 will be 42 % higher than that in 2024. 

• The terminal Reinvestment rate would be 42 %.

Table 4: Sample calculation 

Notes

a) Straight-line reduction.

b) Pegged to growth rate.

c) Assumed proportionate improvement.

d) Assumed growth at the terminal rate.

e) Revenue X Margin and after accounting for Fixed costs.

f) Assumed proportionate improvement to reach the sustainable Reinvestment rate in the terminal year.

g) b X f

h) FCFF for each year = e - g

j) Assumed constant D/E ratio. Refer to the WACC table.

k) NPV for each year = (h X j).

l) Terminal for the year discounted at terminal growth rate.

m) 5 years NPV + terminal value.

n) Inclusive of any excess TCE. Non-operating assets, MI and Debt. 

o) Based on the number of shares.

Table 5: Estimating the cost of funds

Case Notes When valuing a company, the Discounted Cash Flow (DCF) method is a powerful tool. However, when non-operating assets are involved, the process becomes intricate.  Non-operating assets are those not essential to the core business operations. They can include real estate, investments, or excess cash.  In a DCF model, we focus on the operating cash flows. Non-operating assets should not be included in the cash flow projections. Instead, we should assess their value separately. This ensures that the core business performance is accurately reflected. Non-operating assets can carry different risk profiles compared to the core business.  In the world of finance, clarity is key. Stay focused on the fundamentals, and let the numbers tell their story.  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 MFM as of 7 Jan 2025 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 MFM 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 into the Turnaround quadrant would clearly be worth considering if you carried out a detailed analysis.

Case Notes

When valuing a company, the Discounted Cash Flow (DCF) method is a powerful tool. However, when non-operating assets are involved, the process becomes intricate. 

Non-operating assets are those not essential to the core business operations. They can include real estate, investments, or excess cash. 

In a DCF model, we focus on the operating cash flows. Non-operating assets should not be included in the cash flow projections. Instead, we should assess their value separately. This ensures that the core business performance is accurately reflected. Non-operating assets can carry different risk profiles compared to the core business. 

In the world of finance, clarity is key. Stay focused on the fundamentals, and let the numbers tell their story. 

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 MFM as of 7 Jan 2025 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 MFM 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 into the Turnaround quadrant would clearly be worth considering if you carried out a detailed analysis.

Case Notes

When valuing a company, the Discounted Cash Flow (DCF) method is a powerful tool. However, when non-operating assets are involved, the process becomes intricate. 

Non-operating assets are those not essential to the core business operations. They can include real estate, investments, or excess cash. 

In a DCF model, we focus on the operating cash flows. Non-operating assets should not be included in the cash flow projections. Instead, we should assess their value separately. This ensures that the core business performance is accurately reflected. Non-operating assets can carry different risk profiles compared to the core business. 

In the world of finance, clarity is key. Stay focused on the fundamentals, and let the numbers tell their story. 

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 MFM as of 7 Jan 2025 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 MFM 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 into the Turnaround quadrant would clearly be worth considering if you carried out a detailed analysis.

Risks and limitations

Consider the following when looking at my valuation:

• Improving returns and Reinvestment rate.

• Poultry integration operations as non-operating assets.

I have assumed that MFM would be able to improve both its operating and capital efficiency to reach the target ROIC and Reinvestment rate by year 6 (terminal year). If there was no improvement, the intrinsic value would be negative.

Even with the improved ROIC, the ROIC at the terminal stage is still lower than the current WACC. In other words, this is a very low bar. The other more challenging assumption is the sustainable Reinvestment rate.   If you don’t believe that the Group can deliver both of these, you should not consider investing in MFM.

I would think that my assumptions are not aggressive ones as illustrated in Chart 8.

Chart 8: Projections

Note to Op Model. 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\

As shown earlier, the Poultry integration business generated about RM 1 billion in average revenue and RM 70 million in average profit over the past 3 years. This is sizeable and the better approach is to value this from an operating perspective.  

However, since 2021, the Group has not provided enough operating data to enable such a valuation. I thus had to value it as a non-operating asset based on the value of the investment in its books. 

Conclusion

MFM can be considered fundamentally sound for several reasons:

• MFM has been a key player in the flour milling sector since 1961, giving it a strong brand reputation and customer loyalty.

• By expanding into the poultry sector, MFM reduces its reliance on a single product line, which can protect it from market fluctuations.

• Although there are fluctuations, MFM has maintained profitability over the years, which is a positive indicator of its financial soundness.

Overall, while MFM has a solid foundation and a strong market presence, it faces challenges related to profitability and operational efficiency. 

• There were no improving return trends. With average returns less than the current cost of funds, MFM did not create shareholders’ value.

• The Group has an unsustainable Reinvestment rate.

• The company's recent performance highlights a need for improved operational and capital efficiencies. 

Despite the profitability challenges, MFM has demonstrated the ability to generate consistent positive cash flows, indicating underlying business stability. Its strong cash position allows for flexibility in funding future growth initiatives.

The current market price is significantly below its estimated intrinsic value. As such, MFM offers potential for investors who believe in its capacity to enhance operational and capital efficiencies.

Investment thesis

Investing in MFM offers exposure to a fundamentally sound company. The Group’s ongoing efforts to enhance operational efficiencies, coupled with favourable market dynamics, position it well for future profitability. 

As of November 2024, MFM’s market price is significantly lower than its estimated intrinsic value, providing a margin of safety. The potential for re-rating as operational efficiency improves and profitability stabilizes could yield substantial upside. If you believe that the Group can achieve the improvements, it would be an investment opportunity. 

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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.

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