D&L Industries, Inc. (DNL): Capturing the heart of the consumer sector

Transcription

1 WEDNESDAY, 30 JANUARY 2013 D&L Industries, Inc. (DNL): Capturing the heart of the consumer sector Company Background. Established in 1963, D&L (DNL) is the holding company of the Lao Family, with subsidiaries engaged in the development, manufacture and sale of various raw materials and components predominantly used by consumer companies in producing their end products. It has four wholly owned subsidiaries namely Oleo-Fats, First in Colours, D&L Polymer & Colours, and Aero-Pack Industries, and a 34% owned affiliate Chemrez. Given its focus on consumer companies, DNL is considered an indirect play on the consumer sector. A market leader. DNL s various subsidiaries are leaders in their respective industries, each boasting of a market share of at least 50%. DNL s leadership position has numerous benefits. A major benefit is greater efficiency. This allows DNL to remain competitive, especially for its low margin commodity products such as its refined vegetable oils and bio diesel where price is a determinant of sales. Based on our estimates, DNL s commodity products accounted for around 50% of its revenues and 32% of its profits in 7M12. Focus on innovation drives higher margins and earnings growth. DNL s focus on innovation has allowed it to earn higher margins. Compared to commodity products, innovative products earn higher margins. For example, D&L s margins for specialty oils, specialty ingredients and food safety products range from 15% to 30%, while its margin on refined vegetable oil products is only 3%. With DNL s increasing focus on innovative products, gross margins have been on an uptrend, rising from only 5.7% in 2009 to 15.0% as of 7M12. Attractive relative valuation. According to DNL management, it expects net income to reach Php1.38Bil in Based on its current price of 5.87/sh, DNL s implied FY13E P/E is only 15X. This is a substantial discount compared to other listed consumer stocks which are currently trading at an average 13E P/E of 25X. It is also cheaper compared to the PSEi, which is currently trading at a 13E P/X of 17.5X. SHARE DATA Rating Ticker DNL Fair Value (Php) Current Price 5.86 Upside (%) SHARE PRICE MOVEMENT Dec-12 DNL PSEi ABSOLUTE PERFORMANCE 1M 3M YTD DNL PSEi MARKET DATA Market Cap 20,928.57Mil Outstanding Shares Mil 52 Wk Range Mo Ave Daily T/O Forecast Summary (PhpMil) Year to Dec Revenues 9,153 9,947 12,835 Gross Profit 521 1,223 1,706 Gross Profit Margin (%) EBITDA ,404 EBITDA Margin (%) Net Income Net Income Margin (%) Source: DNL GEORGE CHING george.ching@colfinancial.com KERVIN SISAYAN kervin.sisayan@colfinancial.com

2 Company Background an indirect play on the consumer sector Established in 1963, D&L (DNL) is the holding company of the Lao Family, with subsidiaries engaged in the development, manufacture and sale of various raw materials and components predominantly used by consumer companies in producing their end products. It has four wholly owned subsidiaries namely Oleo-Fats, First in Colours, D&L Polymer & Colours, and Aero-Pack Industries, and a 34% owned affiliate Chemrez. Given its focus on consumer companies, DNL is considered an indirect play on the consumer sector. Oleo-Fats Inc. (OFI) is engaged in the manufacturing of industrial fats and oil, specialty fats and oils and food ingredients. Products include refined palm and coconut oil, margarines, pancake mixes and seasoning mixes. Its customers include leading food manufacturers and fast food chains such as Jollibee, McDonalds, Universal Robina and Krispy Kreme. OFI accounts for the bulk of D&L s revenues and profits, at 80% and 43% respectively. First in Colours (FIC) and D&L Polymer & Colours Inc.(DLPCI) manufacture custom designed and formulated pigment blends, color and additive materbatches and engineered polymers for a wide range of applications in the plastics industry. An example of FIC s product is Biomate, an additive which makes plastic biodegradable. FIC and DLPCI together account for around 18% of DNL s revenues and 30% of net income. Aero-Pack Industries (API) is the first and only company in the Philippines to design and develop customized aerosol products. Its products include insect killers, body sprays, and spray paints. API accounts for around 2% of DNL s revenues and 4% of net income. Chemrez (COAT) is a publicly listed company that manufactures coco-biodiesel and other chemicals derived from vegetable oil. It also manufactures and sells powder coating and resins. COAT accounts for around 10% of DNL s net income. Exhibit 1: Organizational Structure source: D&L page 2

3 In December 2012, DNL went public by selling 1.07 Bil shares (all primary shares) at Php4.30 each. The IPO allowed DNL to raise Php4.4Bil in fresh capital, bulk of which will be used for acquisitions, capital expenditures and debt repayment. Following its IPO, the Lao family remains the majority owner of DNL, with a share of 66.6% (direct and indirect ownership through Jadel Holdings). The family continues to actively run the business with first and second generation family members occupying senior management positions in both the holding company and the various subsidiaries Beneficiary of strong macroeconomic tailwinds DNL is considered an indirect consumer play since 84% of its revenues come from ingredients and components used in the manufacture of food and other home or personal care products. DNL s focus on the consumer industry should allow it to benefit from the favorable outlook of the industry. Consumer spending has been very resilient in the Philippines, increasing consistently by a CAGR of 5.7% during the past 4 years, notwithstanding the weakness of the global economy. The resiliency of domestic consumption is attributable to numerous factors including the country s young and growing population, resiliency of OFW remittances and the continuous growth of the BPO sector. Household consumption also accounts for a sizeable portion of the Philippine economy at around 73%. Consumer spending is expected to be very strong in 2013 given that it is an election year. According to a study conducted by the NSCB, GDP grew by an additional 0.34% during 2007 due to campaign spending. Exhibit 2: Household Consumption Expenditure 7500 Household Consumption Expenditure in Bil Pbp Source:NSCB A market leader DNL s vision is To excel and be the leader in the industries (they) serve. True to its vision, DNL s various subsidiaries are leaders in their respective industries, each boasting of a market share of at least 50%. page 3

4 Exhibit 3: DNL s market share per segment Market Share in Refined and Specialty Fats Others 10% Comp 2 10% Market Share in Colorants, Additives, Etc Others 21% Competitor 1 30% Oleo -Fats 50% C2 10% C1 15% FIC & DLCPI 54% Market Share in Aerosol Market Share in Oleochemicals C1 46% Aerosols 54% C1 46% Chemrez 54% DNL s leadership position has numerous benefits. A major benefit is greater efficiency. This allows DNL to remain competitive, especially for its low margin commodity products such as its refined vegetable oils and bio diesel where price is a determinant of sales. Based on our estimates, DNL s commodity products accounted for around 50% of its revenues and 32% of its profits in 7M12. Focus on innovation drives higher margins and earnings growth Innovation is one of DNL s core values. Its subsidiaries are constantly looking for ways to produce better quality products at cheaper prices for the benefit of its customers. For example, it was able to create a replacement for expensive imported milk fat used for the production of ice cream, leading to higher profitability for its customers. It was also able to create a flavored specialty vegetable oil to substitute animal fats such as pork. As a result, customers were able meet specific religious requirement (ex. Halal) and reduce the saturated fat level of its product. DNL boasts of 50 years worth of experience, expertise and strong R&D capabilities. It has technologies that are among the most advanced in Asia, supported by 69 researchers, product development and engineering employees. DNL s focus on innovation has allowed it to earn higher margins. Compared to commodity products, innovative products earn higher margins. For example, D&L s margins for specialty oils, specialty ingredients and food safety products range from 15% to 30%, while its margin on refined vegetable oil products is only 3%. With DNL s increasing focus on innovative products, gross margins have been on an uptrend, rising from only 5.7% in 2009 to 15.0% as of 7M12. page 4

5 Exhibit 4: DNL s Gross Margins Gross Margins 16.50% 14.50% 12.50% 12.30% 13.30% 14.50% 15.00% 10.50% 8.50% 6.50% 5.70% 4.50% 2.50% M11 7M12 The focus on innovation has also allowed DNL to strengthen its relationship with clients. Companies that are focused on selling commodities or unremarkable products encounter difficulties in gaining client loyalty as price is the major driver of sales. Given DNL s focus on innovation, it has customers with more than 20 years of relationship. These include URC, Nestle Philippines, Sharp, Sumitomo and Boysen. Growing orders from loyal clients coupled with higher margins are the major drivers of DNL s profit growth. From 2009 to 2011, DNL s profits have increased by a CAGR of 60%. Exhibit 5: DNL s various customers Customers Years Examples of Products Purchased San Miguel Corporation 15 Specialty Fats Blends, Vegetable Oil Universal Robina 20 Specialty Fats Blends, Vegetable Oil, Shortenings Jollibee 16 Flavores Mixes, Pancake Mixes, Specialty Frying Pans Krispy Kreme 5 Specialty Oils, Doughnut Mixes Sumitomo Electric 21 Plastic Colors, PVC Compounds Sharp Philippines 24 Plastic Colors, Compounds Petron Corporation 7 Coconut Methly Ester Boysen Paints 30 Emulsion, Colorants, Additives Debt payment to lead to 4.8% increase in pretax profits As discussed earlier, DNL was able to raise Php4.4Bil in fresh capital due to its IPO. Around 40% of the proceeds will be used to repay its debt obligations which amounted to Php1.5Bil as of 7M12. Based on our estimates, the debt repayment would result to Php62Mil in annual savings in terms of interest expense which is equivalent to 4.8% of 2011 pre-tax profits. page 5

6 Attractive relative valuation According to DNL management, it expects net income to reach Php1.38Bil in Based on its current price of 5.87/sh, DNL s implied FY13E P/E is only 15X. This is a substantial discount compared to other listed consumer stocks which are currently trading at an average 13E P/E of 25X. It is also cheaper compared to the PSEi, which is currently trading at a 13E P/X of 17.5X. Exhibit 6: Comparable P/E of peers Consumer Companies FY13 P/E JFC URC RFM PIP DNL Average P/E excluding DNL 24.96, Bloomberg, COL estimates Risks: Volatile commodity prices As discussed earlier, commodity products still account for around 50% of revenues and 32% of profits. As such, DNL is still negatively affected by falling commodity prices. During 7M12, consolidated revenues fell by 10.6% to Php6.8Bil as Oleo Fats, which accounts for bulk of revenues, registered a 19% drop in revenues. This was partly due to the drop in food prices, which led to lower selling prices of refined vegetable oils. DNL s 34% owned subsidiary COAT also registered weak interim results. During 9M12, net income of COAT fell by 38% as it was negatively affected by falling biodiesel prices. However, as far as its refined vegetable oil business is concerned, DNL disclosed plans to deemphasize the business. This should make DNL less sensitive to volatility in commodity prices over the longer term. Admittedly though, the shift could lead to some pain in the short term. The 10.6% decline in revenues during 7M12 was partly due to the said move as sales volume fell. Management said that it expects sales from the refined vegetable oil business to bottom this year. Meanwhile, the mandated biodiesel blend in the Philippines could increase from 2% to 5% as soon as end This is two years ahead of schedule. Aside from boosting sales volume, the increase in the mandated biodiesel blend would lead to higher biodiesel prices as the country s requirement more than doubles. Few customers account for a sizeable portion of revenues The three major customers of its largest subsidiary Oleo-Fats account for 32% of its total revenues, making the company highly vulnerable to a steep drop in sales assuming that any of the three customers stops doing business with the company. However, compared to companies that are not market leaders or companies that are highly dependent on commodity products, DNL is less vulnerable given its highly specialized products and its focus on innovation. As discussed earlier, DNL constantly looks for ways to produce better quality products at cheaper prices for the benefit of its customers. This is responsible for the loyalty of its clients. page 6

7 Investment Rating Definitions BUY HOLD SELL Stocks that have a BUY rating have attractive fundamentals and valuations, based on our analysis. We expect the share price to outperform he market in the next six to twelve months. Stocks that have a HOLD rating have either 1.) attractive fundamentals but expensive valuations; 2.) attractive valuations but near term earnings outlok might be poor or vulnerable to numerous risks. Given the said factors, the share price of the stock may perform merely inline or underperform the market in the next six to twelve months. We dislike both the valuations and fundamentals of stocks with a SELL rating. We expect the share price to underperform in the next six to twelve months. Important Disclaimers Securities recommended, offered or sold by COL Financial Group, Inc.are subject to investment risks, including the possible loss of the principal amount invested. Although information has been obtained from and is based upon sources we believe to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the judgment of COL s Equity Research Department as of the date of the report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. COL Financial ans/or its employees not involved in the preparation of this report may have investments in securities or derivatives of securities of securities of the companies mentioned in this report, and may trade them in ways different from those discussed in this report B East Tower, Philippine Stock Exchange Centre, Exchange Road, Ortigas Center, Pasig City, 1605 Philippines Tel: Fax: Website: page 7