Is Mega First Corp an investment opportunity?

Value Investing Case Study 81-1: A fundamental analysis of Mega First Corporation Berhad to see whether it is a value trap or an investment opportunity.

Mega First Corporation Berhad (Mega First or the Group) has radically transformed over the past 3 decades

. It has evolved from its roots in limestone quarrying to becoming a significant player in the renewable energy and packaging sectors.

It has a diverse portfolio today that includes a successful hydropower project in Laos and a growing packaging division. Mega First has established itself as a company poised for sustainable growth.

However, its journey has not been without challenges. This article delves into the investment thesis for Mega First, examining its strengths, risks, and overall financial health. As the company continues to adapt to an ever-changing landscape, understanding this will be crucial for making informed investment decisions.

To be transparent, I invested in Mega First years ago when it was still involved in copper mining. I managed to achieve good returns and sold as it just began to invest in the hydro project in Laos. I am looking to see whether there is another round to make money.

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

Company background

Operating performance

Financial position

Valuation

Conclusion

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Company background

Mega First had a chequered history with the following as some of its notable ventures:

Before the 90s, Mega First was in the limestone quarrying and trading and distribution of industrial and petroleum-based products.

It ventured into copper mining in 1991 with the Mamut Copper Mine. The mine was closed down in 1999.

It acquired an associate interest in Rock Chemicals Industries (RCI) in 1992. Today RCI is a subsidiary of Mega First. RCI today is principally involved in the quarrying of limestone and the manufacturing of lime products.

Mega First also ventured into the palm oil business in 1991 when it acquired 26.7% equity interest in Palmco Holdings Berhad. But this was sold to IOI in 1997.

It ventured into China in 1996 in a joint venture for a coal-fired heat and power plant. This JV Agreement expired in 2017.

In 1997, Mega First expanded the Property Division’s development projects to cover Ipoh, Melaka, and the Klang Valley upon the acquisition of 100% equity interest in Gombak Land Sdn Bhd.

In 2004, it ventured into the labels and materials packaging business.

In 2008, it signed the Project Development Agreement with the Government of Laos to develop, build, own, and operate a hydroelectric power plant in Don Sahong. Laos.

In 2013, it obtained a land concession in Cambodia primarily for agricultural development and cultivation.

Over the years, there have been periodic corporate re-structuring so that currently Mega First has three main operating divisions:

Renewable Energy. This division builds and operates a 260 MW run-of-river hydropower plant in Laos (Don Sahong Hydropower Project) as well as undertakes solar photovoltaic investment business activities.

Resources. This division is engaged in the quarrying of limestone, manufacturing, and trading of lime products, calcium carbonate powder, and bricks.

Packaging. This division manufactures a wide range of printed labels and stickers, paper bags, and flexible packaging products for multiple industries.

Over the past 12 years, the Renewal Energy division was the biggest revenue and operating profit contributor. Refer to Chart 1. In 2023, this division accounted for half of the Group’s revenue and 88% of the Group’s operating profit. This division also accounted for most of the total equity deployed.

Chart 1: Segment Performance

A decade ago, the Property division was seen as a significant revenue contributor. However, this segment business has reduced since then such that by 2020, it was deemed not significant to be reported as a separate segment. Since 2020, it has been reported as part of the Investment Holdings & Others segment.

Similarly, before 2020, the Packing division results were reported as part of the Investment Holdings & Others segment. However, since 2020, its performance has been significant enough to be reported separately.

In this context, the food/agricultural business in Cambodia is still not significant to be reported separately.

Renewal Energy

The Group has a long history in the renewal energy business. I have already mentioned its venture in the heat and power plant in China that ended in 2017.

Mega First also had a concession to build, own, and operate a 36MW diesel-fuelled power plant in Tawau, Sabah with a concession period that ran from 1996 to 2017.

The Group ventured into the rooftop solar projects in Malaysia in 2020.

At present, the Group has completed three solar power projects with a combined installed capacity of 14.5MW. All the solar plants have now been successfully commissioned, energized, and operating smoothly.

According to the Group’s website, it has also “secured a 6.4MW solar contract where the solar PV plants are expected to be progressively installed and come on full stream in the 1st half of 2022.”

When you look at the revenue and earnings trend for the Renewal Energy division, you have to remember that there have been changes in the source of revenue over the past 12 years.

Initially the revenue and earnings came mainly from the China and Tawau projects.

When these ended in 2017, the revenue from the construction of the Loas hydro plant became a significant contributor.

In 2022, with the completion of the construction of the hydro project, power sales from the hydro project became the biggest revenue contributor.

“The Group received a certificate from the Ministry of Energy and Mines of Laos confirming the Project has achieved the Commercial Operation Date (“COD”) on 1 October 2020. The concession period shall end on the date occurring twenty-five (25) years after the COD, which is on 30 September 2045.” 2023 Annual Report

The sales of hydropower remain the main contributor in 2023 as the solar project sales are still relatively small. Refer to Chart 2.

Chart 2: Renewal Energy Division Source of Revenue

The large revenue and profit contribution, together with the significant equity deployment makes Mega First a power supplier tied to the economy of Laos. I am not sure whether there would be high growth from this source as the economy of Laos is not exactly a growing one.

According to Statista, Laos's real GDP growth rate is expected to decrease by 1.6 percentage points between 2024 and 2029. Yes, decrease!

Operating performance

I normally look at the past 12 years' revenue and profits to get a picture of how the company got to its present situation. This serves as a good basis for projecting future performance.

However, in the context of Mega First, there have been significant changes in the business segments over the past 12 years as shown in Chart 1. At the same time, the source of the revenue and earnings for the Renewal Energy division since 2020 is very different from that of pre-2020 as shown in Chart 2.

Thus, in looking at the historical operating performance, it is more appropriate to look at the 2020 to 2024 period. Note that the 2024 performance is based on the Sep 2024 LTM results.

As can be seen from Table 1, the Group achieved a revenue growth of 16% CAGR from 2020 to 2024. Operating profits grew at 9.3 % CAGR over the same period.

Revenue growth was driven mostly by the growth of the Packaging division. However, operating profit growth was contributed mostly by the Renewable Energy division.

In terms of returns, the Renewal Energy division delivered the highest return on assets. This is good as this division used up about 60 % of the 2024 assets.

Table 1: Division performance

Notes.

a) 2020 to 2024 average.

b) 2020 to 2024 average. Before finance cost and share of equity investments.

c) CAGR.

d) Sep 2024.

The good sign for the returns is that the performance post-2019 seems to be better than those pre-2020. Refer to the left part of Chart 3. An analysis showed that the better ROIC post-2019 was due to better capital turnover, offset by lower margins.

You will notice that there was a significant improvement in the tax yield post-2019. The average tax rate from 2020 to 2024 was 3.3 % compared to the 2012 to 2019 average tax rate of 21.9 %.

This is because according to the Group, the Loas subsidiary is “exempted from income tax starting from the date of incorporation until 1 October 2025… Thereafter, the subsidiary…would be subjected to the corporate income tax rate of 24%.”

From 2020 to 2024, ROIC averaged 14% compared to the current WACC of 9%. For the same period, ROE averaged 16 % compared to the current cost of equity of 9 %. These suggests that Mega First created shareholders value.

Chart 3: Returns and ROIC Drivers

Efficiencies

I have mentioned my concerns about Laos' GDP growth and its impact on Mega First’s Renewal Energy division revenue growth. In such a situation, efficiency improvement is important.

From the hydro plant perspective, the average Energy Availability Factor (EAF) is one metric to assess this. The EAF has improved over the years from its first year of operations in 2020. But while there is not enough operating history, the 2023 performance gives me some concerns.

2023 – 91.4 %.

2022 – 94.6 %.

2021 – 91.0 %.

2020 – 84.0 %.

From an overall company perspective, the efficiency picture was not so good.

Operating efficiency as per the left part of Chart 4. Looking from 2020 to 2024, there were no improving trends for the 4 metrics.

Capital efficiency as per the right part of Chart 5. Only the cash conversion ratio had some improving trend from 2020 to 2024. For the same period, asset turnover was stable while there were declines in the Reinvestment margins and Free Cash Flow.

Chart 4: Efficiency trends

Another troubling picture was the increasing Reinvestment margin post-2021. This metric measures the Reinvestment.

Reinvestment rate = Reinvestment / NOPAT.

Reinvestment = CAPEX & Acquisition – Depreciation & Amortization + net increase in Working Capital.

Over the past decade, Mega First had an average Reinvestment rate of 72 %. The high Reinvestment rate meant that there was not much NOPAT left to distribute to shareholders. I suspect that the high rate was because of the investments in the construction of the hydro plant.

The good news is that the average Reinvestment rate from 2020 to 2024 has come down to 51%. It is still a bit on the high side. I hope it can come down further.

Peer comparison

I found it challenging to find Bursa Malaysia peers for Mega First. Power companies such as Tenage, YTL Power, and Malakoff are not only dedicated power generation companies, but they have revenue that a very much larger than Mega First.

As such I focussed on the smaller companies where power generation is a part of their businesses. The peers are:

CyPark Resources engages in renewable energy, construction, engineering, green technology, environment, waste management, and waste-to-energy. It produces electricity from solar, biogas, biomass, solid, and organic waste.

Ranhill Utilities. The company offers water supply services. The company also owns and operates two 190 MW combined cycle gas turbine power plants with 380 megawatts total electricity production capacity in Kota Kinabalu Industrial Park.

Solarvest provides engineering, construction, and commissioning solutions for solar photovoltaic systems to residential, commercial, and industrial users. It owns, operates, and maintains a 1MW solar PV plant located in Pokok Sena, Kedah.

Table 2 compares the revenue of these 3 companies with that of Mega First. You can see that Mega First's revenue is much larger than Cypark and Solvest. Mega First also had the best revenue growth over the past 4 years.

Table 2: Peer revenue

Note: Solarvest was listed on ACE in 2019 and transferred to the Main Board in 2021. Its financial information was only available from 2016.

I looked at the trends of 4 metrics to get a sense of how well Mega First performed compared to its peers. Refer to Charts 5 and 6.

Mega First demonstrated exceptional performance compared to its peers in the post-2019 period. Its leadership in return on capital, EBIT margin, free cash flow margin, and EPS growth indicates robust operational efficiency, effective capital utilization, and a strong ability to generate shareholder value.

Chart 5: Bursa Peer Return on Capital and EBIT Margin

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

Note: Solarvest had an exceptionally high EPS in 2019. I left out Solarvest for the EPS as it made it difficult to see the performance of the other companies. But post-2019, Solarvest had the lowest EPS.

Case Notes

The renewable energy business offers substantial growth potential and aligns with global sustainability goals. But there are challenges for companies venturing into this sector:

High initial capital costs. Securing funding is critical.

Regulatory and policy uncertainty. Renewal projects are heavily influenced by government policies, which can change with new administrations or economic conditions.

Infrastructure limitations. Many regions lack the necessary infrastructure leading to inefficiencies and bottlenecks.

Technology. The renewable energy landscape is constantly evolving, requiring companies to stay updated with the latest technologies and innovations.

As you can see, fundamental analysis requires expertise and time. That is why I created the Fundamental Mapper to shortcut the process.

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Financial position

I would rate the Group as sound financially. While there were some negative points, they were more than offset by the positive ones. The positive points included the following:

As of Sep 2024, it had RM 599 million cash. This is equal to 13 % of its total assets.

Over the past 13 years, it generated positive cash flow from operations every year.

From 2020 to 2024, it generated RM 2.6 billion cash flow from operations compared to the total PAT of RM 2.3 billion. This is a good cash flow conversion ratio.

It had a good capital allocation plan. Refer to Table 3. The cash flow from operations was sufficient to fund its CAPEX and acquisitions. My only complain was that more could have been returned to shareholders.

Table 3: Sources and Uses of Funds 2020 to 2024

The negative points are:

Its Reinvestment rate was high.

Its Debt Capital ratio of 0.23 as of Sep 2024, although it has come down from this 2019 high of 0.30.

As mentioned earlier, I hope the Reinvestment will be reduced now that the hydro plant has been operating for several years. Furthermore, I would not worry too much about the debt as Table 3 shows that it has the cash generation ability to reduce this.

Valuation

I adopted the following picture in valuing Mega First.

This is a mature company. While the Group delivered double-digit revenue growth from 2020 to 2024, this was not the case over a longer period. From 2012 to 2024, revenue grew at 6.4 % CAGR.

As such I valued it as a mature company with a 4% perpetual growth rate.

I assume the base revenue to be the 2024 revenue.

I assumed that while there is no improvement in the operating margins, it would be able to reduce its Reinvestment rate. I took the average 2020 to 2024 contribution margin as the long-term margin and assumed a Reinvestment margin that would result in a 51% Reinvestment rate.

There will no longer be any tax incentives from Loas. I assumed a nominal 24% tax rate for my valuation.

On such a basis, I obtained an intrinsic value of RM 4.00 per share compared to its market price of RM 4.39 per share (6 Dec 2024). There is no margin of safety.

I think that my valuation is a reasonable one. Based on the valuation model,

The ROIC would be 11 % compared to the past 5 years average of 14 %.

The average EPS would be RM 0.49 per share compared to past 5 years average of RM 0.43 per share.

I would also like to think that my assumptions are not aggressive ones as illustrated in Chart 7.

Chart 7: 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.

Valuation model

I valued Mega First based on a single-stage valuation model as shown in Table 4.

The basic equations used in the model are:

FCFF = EBIT(1 – t) - Reinvestment.

EBIT = Revenue X Contribution margin – Fixed cost. The earning was based on the business model shown in the left part of Chart 7.

Reinvestment was derived from the Reinvestment margin.

Table 4: Sample calculation

The cost of funds was based on the first page results of a Google search for “Mega First WACC”. Refer to Table 5.

Table 5: Estimating the cost of funds

Risks and limitations

2 key parameters are driving the valuation.

Reinvestment rates.

Tax rates.

The FCFF is dependent on the Reinvestment rate. If the Reinvestment rate could be reduced to 40%, the intrinsic value would increase to RM 5.00 per share. I suspect that a big part of the Reinvestments would depend on the hydro plant operations. There is not enough information at this stage to see the direction of the replacement CAPEX for this.

Next, while the tax rate for 2025 would still be negligible for the Laos subsidiary, I have ignored this and taken the long-term view. My Malaysian experience is that there is a chance for the extension of the tax incentives. But I have not bet on this. A reduction in the effective tax rate would translate into a higher intrinsic value.

Conclusion

Mega First is fundamentally sound based on the following:

Over the past 13 years, it has delivered revenue growth of 6.4 % CAGR. This was despite changes in the business profile. For example,

The declining property development activities were replaced by the growing packaging business.

It managed to offset the end of the power supply business in China and Tawau with the construction revenue from the hydro project.

On completion of the construction, the revenue was replaced by the energy supply revenue.

Over the past 5 years, the “new” business profile has enabled the Group to achieve returns that were greater than the current cost of funds. This implied that it created shareholders’ value. Mega First has also outperformed its peers and I would rate it as financially sound.

The only thing holding me back from investing in Mega First was the lack of any margin of safety.

Investment thesis

Mega First demonstrates a fundamentally sound business model with strong performance in renewable energy and packaging.

The Laos hydro plant serves as the main driver of revenue. This long-term concession (until 2045) provides stable cash flows. The Packaging division has shown significant revenue growth. This diversification mitigates risks associated with reliance on energy revenues.

The Group has delivered good returns and is financially sound. However, the lack of a margin of safety and dependence on the Laos economy are key concerns. I would wait for a more favourable margin of safety or significant operational improvements before investing.

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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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