Is Dutch Lady an investment opportunity?
Value Investing Case Study 85-1: Is Dutch Lady's new state-of-the-art facility the key to an investment upside?
Dutch Lady Milk Industries Berhad (Dutch Lady or the Group), Malaysia’s leading dairy company, is undergoing one of the most significant transformations in its history.
With an investment into a state-of-the-art manufacturing facility in Bandar Baru Enstek, the Group is gearing up to redefine operational efficiency, sustainability, and profitability.
This transformation is not just about producing more milk. It is about leveraging cutting-edge technologies like IoT and automation to revolutionize dairy manufacturing. This will set the stage for higher margins, reduced costs, and greater market dominance.
Add to this strong market share, low per capita milk consumption, and the lucrative halal segment, and Dutch Lady’s story becomes even more compelling.
So, what does this mean for the company’s future and its shareholders? Join me as I dig into the details to uncover why Dutch Lady is a stock to watch in 2025 and beyond.
Should you go and buy it? Well, read my Disclaimer.
Note that in this article, the 2024 results were based on the LTM Sep 2024 performance.
Contents
- Background
- Operating performance
- Financial position
- Valuation
- Conclusion
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Background
Dutch Lady was established in 1963 as Pacific Milk Industries (Malaya) Sdn Bhd and was the first milk company listed on Bursa Malaysia. The company is a subsidiary of Royal FrieslandCampina N.V., one of the world’s largest dairy cooperatives.
The Group has grown from producing sweetened condensed milk to offering diverse dairy products, including liquid milk, powdered milk, and yogurt.
It has been operating at its facilities in Petaling Jaya, Selangor, Malaysia for several decades. However, in 2019, it announced its plans for a new plant in Bandar Baru Enstek, Negeri Sembilan. This was part of its strategy to secure long-term growth and strengthen its manufacturing footprint in Malaysia.
The new plant is planned on a land area of 30 acres. In comparison, the existing facilities in Petaling Jaya are spread over approximately 10 acres. The Group invested about RM 56.8 million to acquire land and planned a further investment of RM 340 million for the construction of the plant.
As of Sep 2024, the Group reported that the new plant is nearing completion, with operations expected to commence within the year. The company has already begun transitioning resources and adapting processes, including workforce and supply chain adjustments.
Overall, the Bandar Enstek plant is expected to play a transformative role in improving Dutch Lady’s operational efficiency, sustainability, and profitability. As I will show later, this is important for the Group.
- The facility will utilize advanced technologies such as IoT, big data analytics, and automation. These innovations aim to enhance productivity with on-time and first-time-right production, reduce material losses, and minimize the use of chemicals, waste, and energy in production.
- There will also be enhanced sustainability measures, including energy-efficient utilities, zero-loss processing, and rainwater reuse. These are projected to reduce production costs while maintaining high quality.
The Petaling Jaya facility has been sold and handed over to a new owner following the cessation of production there in Q3 2024.
- Disposal and leaseback arrangement. Dutch Lady sold it for RM 200 million in a prior arrangement. This transaction included a leaseback of the premises for a term of 27 months, allowing operations to continue temporarily while transitioning to the new plant.
- Accelerated depreciation and transition costs. The Group applied accelerated depreciation to assets at the Petaling Jaya plant that were non-transferable to the new Bandar Enstek facility. These costs were significant but ceased by Q2 2024, indicating the final stages of the transition.
- Handover to new owner. Production ceased at the Petaling Jaya facility in Q3 2024, and the premises were handed over to the new owner as planned. The Bandar Enstek facility became fully operational during this period, with construction on a new distribution center expected to conclude by mid-2025.
Market demand
Reading in between the lines, this new plant is because the Group is bullish about its prospects in Malaysia.
In its 2023 Annual Report, it stated that it is the leading dairy company in Malaysia. It has a 42.7 % market share in the liquid milk segment and 24.7 % in the formula and toddler nutrition segment.
Over the years, the Group has consistently increased its market share. For example, in 2022, its share in the liquid milk category was 40.2 %. In 2020, it reported a 1.2 percentage point increase in its market share within the liquid milk category.
The Group’s products have a high penetration rate. It reached 3.7 million Malaysian households annually as of 2022. This translates to approximately 57.7% of households consuming Dutch Lady products.
In its 2023 Annual Report, the Group has projected that the Malaysian dairy market is expected to grow by 5.1% in 2024, with strong demand for drinking and liquid milk.
- Malaysian milk consumption is currently about one litre per capita, compared to 40 litres in developed regions like Europe. This indicates the substantial potential for growth in the domestic market.
- The Group is collaborating with the Malaysian government to achieve 100% self-sufficiency in fresh milk production by 2030, supporting local dairy farmers to increase the quantity and quality of milk.
- Malaysia's halal dairy market is valued at RM4 billion, presenting a lucrative opportunity for Dutch Lady to expand its market share. 2022 Annual Report
The Group’s projection is consistent with the picture that this is a mature sector with a single-digit growth rate.
“The dairy products industry in Malaysia is…estimated to be worth RM17 billion in 2023. The local dairy industry is expected to grow at a compound annual growth rate of more than 8.1% during the forecast period (2023-2027).” Malaysia International Food and Beverage Fair
“The Malaysia Dairy Products market will grow at CAGR 3% during 2020-2026.” 6WResearch
Operating performance
From 2017 to 2024, while revenue grew at 4.4 % CAGR, there was a decline in the PAT. Refer to the left part of Chart 1.
This was despite the profit spike in 2021 due to:
- The sale of the Petaling Jaya land boosted the profit before tax to RM 284.5 million.
- This was offset by the costs related to the start of accelerated depreciation for assets at the Petaling Jaya plant.
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Chart 1: Performance Index and Returns |
The declining profits led to declining returns as shown in the right part of Chart 2. Over the past 8 years, ROIC averaged 94% while ROE averaged 58%. These returns exceeded the cost of funds suggesting that despite the declining trends, the Group created shareholders’ value.
We can attribute the declining returns to the following.
- Rising dairy raw material prices that led to a declining gross profit margin.
- The transition to the new manufacturing facility involved significant one-off costs, including accelerated depreciation of non-transferable assets at the Petaling Jaya site.
- Increasing capital for the new plant without the corresponding increase in sales. This probably accounts for the declining gross profitability as shown in the left part of Chart 1. The total equity in 2024 was about 4 times that in 2017 whereas the 2024 PAT was ¾ that of 2017. You should not be surprised by the declining return.
But I think this declining return trend will be reversed.
In its 2023 Annual Report, the Group reported an accelerated depreciation that averaged RM 15 million per year for the past 2 years. Along this line, we can project a potential reduction of RM 15 million per year in 2025 compared to 2024. This means better bottom-line.
The other good sign is the margin decline may have reached the bottom in 2022. You can see this in both the gross profit and contribution margins shown in Chart 2.
With the completion of the new plant, I do not expect significant growth in capital.
Reinvestment
Growth needs to be funded and one way to assess this is the Reinvestment rate defined as Reinvestment/NOPAT.
Reinvestment = CAPEX & Acquisitions – Depreciation & Amortization + net increase in Net Working Capital.
Over the past 8 years, the Group had a 45% Reinvestment rate. This is a good sign as this included the investment in the new plant. Without the new plant, the rate would be lower.
The Reinvestment rate is linked to growth by the following equation:
Growth = Return X Reinvestment rate.
With 4.4 % revenue growth and 94 % historical average ROIC, we have a Reinvestment rate of 0.044/0.94 = 5 %.
This low rate meant that there would be a lot of the NOPAT that could be returned to shareholders.
Peer comparison
I compared Dutch Lady’s performance with some of Bursa's F&B companies. You can see that Dutch Lady is a mid-sized player in terms of the 2023 revenue with about the average revenue growth rate over the past 8 years.
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Table 1: Peer revenue Note: Data from Farm Fresh was only available from 2019. |
I looked at the trends of 4 metrics to get a sense of how well Dutch Lady performed compared to its peers. Refer to Charts 3 and 4. I would assess its overall performance as follows:
- Strengths. Its recent improvements in free cash flow margin and recovery in EBIT margin suggest it is on track for stabilization after the transition.
- Weaknesses. Dutch Lady underperforms its peers in return on capital, EBIT margin, and EPS. These highlight the challenges it faces in cost management and capital utilization.
- Opportunities. The new Bandar Enstek plant is expected to drive long-term productivity and margin improvements, potentially helping it close the gap with peers like Nestlé and F&N.
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Chart 3: Bursa Peer Return on Capital and EBIT Margin |
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Chart 4: Bursa Peer Levered Free Cash Flow Margin and EPS |
Overall, Dutch Lady's performance appears to be below average compared to its peers. This is particularly when benchmarked against leaders like Nestlé Malaysia and Fraser & Neave.
- Dutch Lady's return on capital shows a sharp decline, particularly after 2021, whereas peers like Nestlé and F&N maintain stronger and more stable returns.
- Dutch Lady’s EBIT margins are lower and more volatile than NestlĂ© and F&N, both of which exhibit consistent operational efficiency.
- Its free cash flow margin has been in the negative territory for much of the period.
- Dutch Lady’s EPS performance is weaker than NestlĂ©, both in terms of stability and growth.
Financial position
I would rate Dutch Lady's financial position as moderately sound based on the following:
- As of Sep 2024, it had RM 40 million cash. This is equal to 4 % of its total assets.
- As of Sep 2024, it had a debt-capital ratio of 14 %.
- I have already mentioned its low Reinvestment rate.
- Over the past 8 years, there was only one year when it failed to generate positive cash flow from operations.
- From 2017 to 2024, it generated RM 832 million cash flow from operations compared to the total PAT of RM 879 million. This is a good cash flow conversion ratio.
- It had a reasonable capital allocation plan. Refer to Table 2. The cash flow from operations was sufficient to fund its CAPEX with excess used for dividends.
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Table 2: Sources and Uses of Funds 2017 to 2024 |
I must mention that historically the Group paid out a larger part of its earnings as dividends. From 2002 to 2018, it had a dividend paid-out ratio of about 100%. During these 17 years,
- It paid out a total dividend of RM 1.37 billion.
- Its total PAT was RM 1.35 billion and total cash flow from operations was RM 1.61 billion.
This dividend payout ratio dropped over the past few years as the funds were channelled for the new plant. I expect that with the opening of the new plant, the Group will revert to its earlier high payout ratio. This is in line with my postulate that there will not be further significant growth in capital.
Valuation
I postulate that while its new plant would not provide any additional revenue growth, it will improve its margins. In valuing Dutch Lady, I assumed the following picture:
- It is in a mature sector with projected revenue growth at the long-term GDP growth rate of 4%. I assumed that the base revenue would be the 2024 revenue.
- The contribution margin would continue to improve annually at 3% per annum from its 2024 position to reach its 2015/16 high of 43% in the terminal year.
- The Reinvestment rate would decline from its 2024 rate to the rate given by the fundamental growth equation in the terminal year.
- Fixed cost in Year 1 would be the 2024 cost reduced by RM 15 million. This is to account for the reduction due to the accelerated deprecation of the old plant.
On such a basis, I obtained an intrinsic value of RM 42 per share compared to its market price was RM 31 per share (6 Jan 2025). There is a 35% margin of safety.
Note that the above projection is considered optimistic as it led to the following average performances:
- 27% ROIC compared to the past 2 years average 19 %.
- 16 % EBIT margin compared to the past 2 years average 7 %.
- 28% Reinvestment rate compared to the past 8 years average 45%.
Valuation model
I valued Dutch Lady based on a multi-stage valuation model as shown in Table 3.
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 right part of Chart 2.
Reinvestment was derived from the Reinvestment margin.
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Table 3: Sample calculation Notes a) Constant growth rate b) Pegged to growth rate c) Assumed proportionate improvement d) Starting cost reduced by RM 15 m. Assumed growth at a terminal rate e) Revenue X Margin and after accounting for Fixed costs. Tax based on 2017 to 2024 average f) Assumed proportionate improvement to achieve Reinvestment rate given by growth equation 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 |
The cost of funds was based on the first page results of a Google search for “Dutch Lady WACC”. Refer to Table 4.
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Table 4: Estimating the cost of funds |
Risks and limitations
I have assumed a very optimistic picture in valuing the Group as can be seen from Chart 5. You can see from that.
- The projected revenue is on an upward trajectory compared to those in the past few years.
- The projected Free Cash Flow has a much steeper growth trajectory than the historical one.
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Chart 5: Projections |
Furthermore, the margin of safety comes from the improvement in the margins and Reinvestment rate. This in turn, especially for the contribution margin, comes from improving efficiencies.
As of this juncture, there are no clear trends in the various operating and capital efficiency metrics as shown in Chart 6. You can see that from 2022,
- Operating efficiency. Only the inventory turnover improved.
- Capital efficiency. There were no improving trends.
In other words, I am depending on the Group's ability to extract the productivity and efficiency improvements from the new plant.
It is obvious that the margin of safety comes from the improving contribution and Reinvestment rate. If there was only half of the projected improvements, the intrinsic value reduces to RM 29 per share.
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Chart 6: Efficiency |
Conclusion
With a strong market share and an established household presence, Dutch Lady is well-positioned for long-term growth in a sector with moderate growth prospects.
The investment in the new Bandar Enstek facility marks a transformative chapter for the Group. The state-of-the-art plant is expected to drive operational efficiency, reduce costs, and enhance productivity.
Key financial indicators suggest the Group has navigated this transition well:
- The company remains moderately sound financially, with manageable debt levels and a good cash flow conversion ratio.
- The Group has maintained a 45% reinvestment rate over the past eight years, despite the investment in the new plant.
- Despite declining return, the historical ROIC and ROE far exceed its cost of funds, signalling its ability to generate value.
With a projected intrinsic value of RM 42 per share, Dutch Lady offers a potential 35% margin of safety compared to its current market price. This valuation hinges on assumptions of improved margins and operational efficiency as the new plant ramps up.
However, challenges remain. Dutch Lady's performance has lagged behind its peers like Nestlé and Fraser & Neave in return on capital, EBIT margins, and EPS growth.
In conclusion, the Dutch Lady's historical performance reflects the pressures of a maturing market and significant capital investment. However, the transition to the Bandar Enstek plant represents a pivotal opportunity for operational revitalization.
Investment thesis
While the Group experienced declining returns over the past 8 years, its relocation to the new plant has a turnaround potential. Dutch Lady offers a compelling investment opportunity based on its market leadership, transformative manufacturing upgrades, and commitment to operational excellence.
The new plant positions it for margin improvement, enhanced cash flow generation, and renewed dividend payouts. For investors seeking exposure to a resilient consumer goods company with sustainable growth and a margin of safety, Dutch Lady is a stock to consider for your value investment portfolio.
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Disclaimer & DisclosureI 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.
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.
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