Delfi

Defli is an Indonesian chocolate manufacturer and distributor listed on SGX.  They are by far the largest player, with over 40% market share.  75% of their revenue is from Indonesia, the rest from the Philippines.

The Industry and Competitors

An Oct 2019 DBS report covers this well:

• Delfi's distribution is strong in rural areas ("General Trade"):

• Distributors in General Trade are largely exclusive to Delfi, creating a moat.
• The Modern Trade channel has been growing faster than General Trade, but has recently been slowed due to unhappiness.  New modern outlets can only be set up a certain distance from existing traditional outlets.
• Delfi has the largest market share in Indonesia.  They mainly compete with Mayora in the value segment, while the global brands (Nestle, Cadbury, Mars) compete in the premium segment.

• Indonesia has laws protecting local manufacturers: "Under the Ministry of Trade (MoT) Regulation amendment No. 56/2014 for traditional markets, shopping malls, and modern stores and outlets, at least 80% of sales must come from domestic products, and private labels may account for a maximum of 15% of SKUs."
• Delfi's market share is around 10% in the Philippines.

This article says that Petra and Mayora have a combined market share of 80%.

Financials

Before starting, when looking at historical numbers, note that the company sold its cocoa ingredients division in 2013, but some effects can still be seen on the income statement up to 2015.  Where the results of both divisions - two very different businesses - are merged together.

Around 60-65% of revenue is COGS.  Selling and Administrative costs make up another 20%.  Leaving pre-tax operating margins at 8-9%.

So COGS has the largest impact on profits.  DBS Vickers estimates that cocoa/sugar/milk make up 30%/15%/15% of total costs respectively (p6).  These commodity prices were very low in 2015/16.  Gross margin has varied from 32 to 38.5%:

The other determinant of gross profit margin is the proportion of own-brand products sold:

Clean balance sheet with zero net debt and minimal operating leases (p6).

CFO swings around wildly, due to working capital.

CFO is usually more than CFI.

Inventories and receivables have been steadily rising, which is a bit of a worry:

• In the 2018 and 2019, management stated that increased receivables are because of a greater proportion of sales to Modern Trade customers, who have longer settlement terms.
• In 2018, the group changed to the direct shipment model, where they took over the distribution function form their regional distributors, to their Modern Trade customer.  This caused an increase in inventories
• The spike in 2017 inventories was caused by "a Government-imposed transportation disruption which necessitated the deferment of some deliveries to January 2018."

Macro

If I buy this, I am paying SGD (or USD) to buy an asset in Rupiah (IDR).  And the company is operationally leveraged to IDR/USD exchange rate (product prices in IDR, costs in USD).

In the current part of the economic cycle, where there is a USD shortage, EMs like Indonesia are particularly vulnerable.  May be better to wait for a crisis first.

Conclusion

Good company starting to turnaround.  Good financials, has growth potential after the crisis is over, and seems to have a moat.  Valuation is reasonable, but not cheap yet.

With so many moving parts affecting their profitability (Indonesian consumer demand, exchange rates, raw material prices, proportion of own-brand products), its hard to know how to value it.  The stock price has been falling for 6 long years.  Would I be willing to catch a falling knife?  Maybe at a single digit PE ratio.  6 to 8 times earnings would be SGD 40 to 50c.  Without currency fluctuations.

A better way is to wait till this crisis is over, and EMs start to be back in favour again.  Indonesia is a dirt poor, politically unstable country and we don't know how bad things can get.  You need a different strategy when buying in a place like that. Wait till things are getting less worse - there will still be a lot of time to make money and ride the trend up.  Don't catch a falling knife in a rioting country.

Misc

Starting this year, they no longer report quarterly results.  Next results are for June 2020.

They paid a dividend of SGD 3.22 in 2019 (2.57c in 2018), with a 50% and 55% payout ratios respectively.  This is important, as a way of rewarding shareholders so that the share does not become a "value trap".  I could not find a dividend policy.

Short Notes on Petra

Article from The Edge (Singapore) Dec 26th. Short points:

• Petra accounts for 11% of worlds cocoa grinding capacity, fourth after ADM and Cargill (14% each) and Barry Callebaut (12%)
• In Petra's Indonseia market, they sold cheap chocolates. The Top Wafer bar comntains 12% cocoa powder, while normal chocolate contains 30% chocolate butter. They used wafer instead, and did everything possible to bring the price to IDR500 (7c).
• Worldwide, chocolate companies are vertically de-segregating. Nestle focuses on consumer brands. Barry Callebaut is the largest chocolate maker in the world - has economies of scale.
• Analysts (on cocoa grinding): Petra is a small player in Europe, may lack necessary economies of scale. Claudia Lenz, who covers barry Callebaut for Bank Vontobel: In Asia, the demand for compounds and fillings [cocoa powder based products] is much higher than for 'real' chocolate [cocoa butter]. In Europe, the market consists more of real chocolate and I'm not sure whether Petra foods has fully adapted to that.
• John Chuang (CEO): Petra's board has debated on whether to seperate the consumer and ingredients business, but a decision has yet to be made.
  

Cargill to set up cocoa grinding plant in Indonesia

From BT, Tues 22 Sep 2011, p11.

Cargill plans to spend U$143m setting up a 65-70,000 tonnes/yr cocoa grinding plant in June 2013.

Indonesia has a 10% export tax on cocoa beans to ensure domestic raw-material supply. Tax allowances also given for the plant.

Petra foods

Consists of 2 businesses:

• Branded consumer division, which manufactures their own branded confectionery products and distributes 3rd party products in SEA (mainly Indonesia).
• Cocoa ingredients division, which processes cocoa into chocolate ingredients used by chocolate manufacturers (e.g.: Mars, Cadbury, Meiji)

The Consumer division is well established, the Cocoa Ingredients is still starting up. In 09, Cocoa Ingredients accounted for 70% of EBITDA, despite both divisions having similar revenue.


Cocoa Ingredients
------------------------

Involves processing cocoa beans into cocoa powder, cocoa liquor and cocoa butter. The last two are commodity products, the last may have some value add (by customizing to different customers needs).

Business Model:

High capex, high volume, low margins. Borrow money. Build processing plant. Borrow more. Buy large quantities cocoa beans, process them, and sell the resulting commodity products at a slight profit. The low margin nature of the business is shown by single digit margins for EBITDA (No Gross & Nett margins were provided by business segment).

	04	05	06	07	08	09
Revenue (U$ mil)	266	302	328	597	874	945
EBITDA	22	26	28	27	22	28
Margin (for EBITDA)	8%	8%	8.5%	4.5%	2.5%	2.9%

They use derivatives to hedge against cocoa price movements. Management says they consider "the cocoa market to be a forum for managing risk rather than an opportunity for profit." [p5 09AR] i.e.: no trading profits. Gross cocoa grinding margins are not provided by Petra and its competitors for comparison.

Compeditive Advantage:

[From Apr 2010 S&P report, SGX research scheme]
One of the largest cocoa grinders in the world, based on grinding capacity:

• 14%: ADM - publicly listed.
  
• 14%: Cargill - private
  
• 12%: Barry Callebaut - publicly listed, vertical integrated chocolate provider.
  
• 11%: Petra
  
• 5%: Blommer

Petra is large enough to stay around... but in this sort of market, the top players are evenly matched: everyone is a price taker.

Its top three customers, Nestlé, Cadbury and the Mars Group each account for about 5%-7% of revenue.



Cyclical:

Cocoa grinding margin is affected by the difference in the price of unprocessed cocoa beans and the finished product. This seems cyclical - there was a glut of grinding capacity in 2002, and there was some margin compression last year after ADM and Cargill added capacity before the 2008 crisis.

(Wikipedia) If the combined butter and powder price is less than 3.2 times the bean price, grinding becomes uneconomical. Historical average is 3.5. See 'combined cocoa ratio' - grinding cocoa beans produces equal amounts of cocoa powder and cocoa butter (cocoa liquor is an intermediate produce, irrelevant here).

High cocoa bean prices per se do not affect their profit margins, as it is run on a cost-plus basis. Cocoa beans are bought (or secured through futures) after receiving an order. However record high prices increase working capital requirements, which hit Petra's cashflow in 2009.

The industry is highly cyclical, depending on the grinding capacity and the demand for it. I cannot predict the cycle, but Petra should be large enough to ride it out.

Industry Trends:
Continued increase in outsourcing trend expected. Attractive for chocolate makers to outsource the capital-intensive production of ingredients.

Branded Consumer
------------------------

Business Model:
Manufacture and distribute their products (48% 09 revenue). Distribute 3rd party products (52% 09 revenue).

Competitive Advantage:
Petra has a more than 50% share in Indonesia's confectionery market. Closest competitor is PT Mayora Indah’s Beng-Beng (14.5% market share). Combined mkt share of MNCs is less than 10%.

Large distribution network, with 110 air-conditioned stock points and a fleet of delivery vehicles delivering directly to 70,000 outlets.

Cyclical:

May be affected by:

• cocoa, sugar, milk price.
  
• general economy. Branded Consumer revenue dropped 11% yoy in 4Q08, after rising
  

Whole Company
--------------------

Free Cashflow

Petra has been consuming cash for the last 6 years:

	04	05	06	07	08	09	1H10
CFO	7.3	41	29.5	-29	18	-64	-55
CFI	-14	-45	-35	-50	-78	-81.9	-19

Notes on CFI:

• 07: 28m PPE (15.8m brazil + europe, and 12.1m upgrade indonesia production capacity). Remainder 22m: acquire 70% Hamburg plant
  
• 08: Almost all PPE: 76m to cocoa processing. 59m of that to Hamburg.
• 09: Half PPE: 41.3m for cocoa processing. 26m of that to Hamburg. Hamburg finished.
• 1H10: 70% is for purchase remainder of Hamburg plant.
  

Capex has dropped significantly in 2010 - management stated that have stopped all 'non-critical' capex.

In 09 and 1H10 CFO ballooned due to inventories. Inventories rose due to:

• rising cocoa prices (25% in 2009):
  

• Increased volume:

Cocoa Ingredient division - Volumes processed (000's mt)

05	06	07	08	09	1H10
114	136	148	160	234	119 (up 12% yoy)

Balance Sheet

High debt. Long term debt may be 5 to 10 times 2010 earnings. And it may increase more.

Total debt at 1H10 is U$514m. Of which 314m is current and 200m is long term. For comparison, FY09 earnings were 19m, earnings for 1H10 (alone) were 17.8m

Three things to watch:

1) Inventories. During 1H10, Cocoa inventories (for Cocoa Ingredients) rose 16%, while Cocoa processing volume rose only 12% yoy (search for 'mt' in Financial Results). Cocoa prices fell over this period:

From http://tfc-charts.w2d.com/chart/CC/W

Why are inventories rising faster than production, when the price of cocoa has fallen? It may make sense as they are ramping up production, and I do not know the exact time the inventories were bought. Not a red flag yet, but something to watch for.

2) Debt Maturity

Most of the 314m current debt is funded by short term borrowings:

For the U$200m non-current debt, $US130m of it is due between 2011 and 2014. They will have to refinance in the next few years:

• 45m MTN due between 2011 and 2014
• 25m MTN due between 2011 and 2013
• 20m Term loan due 2011
• SGD 60m (approx U$45m) MTN due 2012

Management said they are starting to fund inventories using medium term funding, I have not seen this appear in the numbers yet.

3) When can they start generating free cashflow to pay off their debt? Thev'e stopped capex, any remaining cost is working capital.

A simple back-of-the-envelope calculation... As most WC is for inventory, this would depend on their processing volume and the cocoa price. Assume their inventory level in 1H10 at 400m was for the 87% utilization that period. Assume they increase to 98% utilization, then another 10% is needed: 40m at current prices. If cocoa prices change, this affects the all the inventory (i.e.: the 400m, not just the 40m):

Worst case, if Cocoa prices go up another 100%, they may need U$500m. Best case if they drop 50% then reduced by 180m.
Others
---------
This stock is very illiquid. Mkt Cap @ $1.00 is 525m. Approx 82% held by insiders (those with > 5%), gives free float of 105m. Fund managers cannot buy. Not trade-able, even by retail investors. Suitable for long term fundamental buy only.

Indonesian family owned business.

Conclusion:

Consumer business is a cash cow, with high barriers to entry. I like it.

Ingredients processing is a cyclical, commodity business, with high capex and working capital requirements. I don't like it. They have spent heavily since listing in 03 to become one of the largest cocoa processors in the world (processing capacity up from 7% (2003) to 14% (2010) of worldwide capacity). However they will never gain pricing power in such a fragmented market which has several strong players. Capital expenditure is now over after 1Q10, but more working capital may be required if cocoa prices rise (40m to 500m).

From comparing the two divisions, we can see why the chocolate makers are outsourcing their production....I wonder why Petra is doing the opposite? Well... if they didn't raise money to do this then they would never have listed in the first place...and we wouldn't have a chance to buy in.

Wait to see:

• Inventories vs utilization vs cocoa prices
  
• When can they start generating free cashflow?
• Then do they pay off their debt?
• How do they refinance their remaining debt?

And lastly... wait a while, years if need be... for the market to drop...