DKSH (Malaysia)

DKSH Holdings (Malaysia) is a distributor which handles consumer goods, pharmaceuticals, and chemicals.  They handle the stocking, transport and billing of their customers' products over region-wide points-of-sale.

Companies use them to distribute and market goods into Asia.  They handle the logistics and provide a single point of contact/payment.  The goods they distribute are varied: instant coffee,  lego,  snacks,  CT Scanners, prescription drugs, specialty chemicals.

The company operates throughout Asia, but did not break down revenues by different countries in their 2017 annual report.

Competitive Advantage

Does DKSH have sustainable competitive advantage?  Looking at its market share:

   Source: DKSH Capital Markets day 2015.

Even though it is among the top 3 players, the competitive landscape means it will be a price taker.  So no sustainable competitive advantage.  I see this as buying a reasonable company for a cheap price, not a Buffet-like investment that will compound for years and years.

Financials

Revenue and profits have grown, in line with the economy:

Why did profits drop in 2014 and 2015?  They attributed it to:

• 2014: Due to investments in Healthcare distribution centre, costs from relocation of distribution centre, and new rental costs from the group's offices which they no longer own.
• 2015: "difficult market conditions", with some infrastructure and one-off costs.

Distributors earn a tiny cut of profit when moving their customers' inventories.  DKSH has very small margins - between 0.7% and 1.5% in the last ten years.  They rely on high turnover.  So they have tremendous working capital requirements - in any particular year, Cashflow from Operations (CFO) is unpredictable, due to the change in working capital.  In most 'normal' years - years showing healthy growth - CFO is below income, due to new working capital requirements for continually expanding revenue/income.  In bad years, CFO spikes up:

Because of unpredictable WC, we cannot use cashflows to check the quality-of-earnings for a distributor.  But we can try to estimate if they are sustainable.

Long term I estimate CFO to average 50% of income in a normal year of healthy growth (averaged from 2011 to 2018).  This includes some exceptionally good years where CFO was negative.  It excludes bad years like 2008-09, when profit drops and CFO shoots up.

The Balance Sheet is normal for a distributor: low fixed assets, low long term debt.  

In summary, in 2018 they had:

• Profits of RM 32m.  Profits are leveraged to the economy.
• LT debt of RM 32m.  ST debt of 29m.  Total: 61m  Interest payments were 8.2m, already included in CFO.
• Dividend payments were 16m, not part of CFO.

I estimate long-term CFO roughly at 16m (50% of profits) when things are going well. CFO increases sharply when the economy goes down.

Auric Acquisition

DKSH announced they are buying Singapore's Auric for RM 490m (SGD 157m).    Might be a good price, as Auric was previously privatised at SGD 207m.

From what I can make out:

• They are paying 18X earnings for it.  Auric's annual profit is estimated around RM 20m.
• Lets say they take a (SGD) loan at 7%, that would give additional interest payments of 34m.  Assuming those earnings are backed by cashflow, we have an additional 14m/year left to pay off.
• They can still pay this out from their CFO.  Though theres a chance they have to cut dividends.

Risks

Main risk is cyclical - if a recession occurs, revenue decreases and profits drop like a rock.

The longer term risk for its consumer goods distribution is e-commerce.  DKSH says that they currently sell to or partner with leading online retailers, such as Tmall, JD.com, Qoo10 and Lazada.  They have invested in 2 e-commerce companies: eSweets (a China online seller of sweets) and aCommerce (a Thai eCommerce service provider).

Valuation

A price of MYR 2.50 would give it a trailing PE of 9.1.

Why is it so cheap?

• Falling profits in 2014 and 2015
• Market may be wary of the expensive Auric acquisition announced in December.
• The stock was removed from the Sharia Compliant List in Nov 2018, forcing Islamic funds to sell.

I think most of the risks are priced in.  The main risk remaining is a recession - that could see the stock drop 50%.  If I buy, I'd probably sell at a PE of 15 - which is a 50% upside.

Bought 16000 shares at average price of MYR 2.483.  Total cost SGD 13385