Want Want China Holdings Limited

Founded in 1962, Want Want has come a long way from being just a manufacturer of canned agriculture products. Today, Want Want is a household name in Asia synonymous with their Hot Kid line of products. Since 2008, Want Want’s publicly listed vehicle – Want Want China Holdings Limited has been listed on the Hong Kong Stock Exchange as a pure play food & beverage (F&B) player in the key segments of rice crackers, dairy products and beverages as well as snack foods!

STOCK INFORMATION

TICKER SYMBOL: 0151.HK
MARKET CAP: HKD 109 Billion (Updated 20 July 2015)
MARKET PRICE / SHARE: HKD 8.40 (Updated 20 July 2015)
INDUSTRY: Consumer Staples

What many might not know is that prior to this, Want Want holdings Limited was listed on the Singapore Exchange with operations spanning from F&B to hospitals, hotels and even other property business. In 2007, management might have thought that a focus on the F&B business was better for their listed arm and the rest was history!

THE BUSINESS

Want Want is in the business of manufacturing, distributing and sale of food and beverage.

Although Want Want’s operations are split across three core segments of:

1. Rice Crackers (US$0.81 billion | 21.5% of FY2014 Rev)
2. Snack Foods (US$0.96 billion | 25.5% of FY2014 Rev)
3. Dairy Product and Beverages (US$1.99 billion | 52.8% of FY2014 Rev)

The mechanics of how they generate cash is broadly the same. If I could oversimplify things, this is how their business works:

Want Want goes out to the marketplace and buys up all the raw materials they require, for example milk powder, sugar, rice, palm oil and other packaging materials and proceeds to put them through their production line and ‘Ta-Dah’ out comes their famous line of Want Want Sen Bei, Snow Crisps, Hot Kid Milk and many others!

Now that we have the product, the next step is to sell it. Want Want then sells their products to distributors and customers (Over 90% of the Group’s Rev and business activities for FY2014 was within PRC) both within PRC as well as countries like Taiwan, Japan, Hong Kong and Singapore and even as far as places like Canada.

KEY OPPORTUNITIES

1. Strong Branding and High Margins

Although not all of us might know of Want Want’s mascot – Hot Kid, once Want Want is mentioned or when the above picture of Hot Kid is shown, everything will click in place. That’s how powerful their marketing influence has been in the past and the Group has also taken advantage of this by branding the bulk of their goods under the Hot Kid brand. This is especially evident in their Dairy products and beverages where Hot Kid made up over 90% of this segment’s rev (US$1.8 out of 2billion) for FY2014. There was even a full page in their FY2014 Annual Report explaining in detail how Want Want’s management philosophy and goals are embodied within the Hot Kid.

This strength in branding could have contributed towards their strong profitability over the years. Over the past 3 years, Want Want’s GPM and OPM averaged approximately 40% and 20% respectively, pretty impressive margins. Over the past few years, the other 2 big players Tingyi (Caymen Islands) Holding Corporation and Uni-President China Holdings Limited have OPM in the sub 10% region but some might argue that its due to Tingyi’s and UPC’s lower margin instant noodle business might have pulled them down.

So let’s narrow it down to just their beverage segment to see how Want Want stacked against Tingyi and UPC. From a GPM standpoint, Want Want still stood as the clear winner. However some reasons for this might be the intense competition in the RTD tea, bottled water and juice drinks segment that Tingyi and UPC compete in (and against each other). Also don’t forget the PepsiCo bottling business under Tingyi that contributed towards a lower GPM.

It is also appropriate to take into consideration competitors from the dairy segment like China Mengniu Dairy Company Limited. Even though their products might not be identical, it should serve as a rough gauge. Once again Want Want’s FY2014 GPM and NIM of 40% and 16% was a winner compared with China Mengniu’s FY2014 GPM and NIM of 31% and 5%.

From the observations above, Want Want appears to command a certain premium from their branding. From a brief channel check on Auchan’s (Auchan is under Sun Art Retail Group Limited, one of the largest hypermarket operators in China) online e-store, 6 cans of 245ML Hot-Kid Milk Beverage costs CNY27.80 (or ~CNY4.6 per 245ML can) whilst a 500ML UPC Qinlan Assam Milk Tea retailed for CNY3.80 and Tingyi’s Master Kong’s Classical Milk Tea (Original) retailed for CNY3.20. Even when Hot Kid Milk is sold at in packs of 6 at half the volume per can, Want Want’s retail price is more than that of Tingyi and UPC’s milk tea! This same phenomenon was also noted to be present in the premium that their rice crackers enjoy over other brands. A rationale for this could have also come from the company’s stringent quality control when it comes to their food, clearly detailed in their Annual Report.

When people said that strong brands are tough to find in China, it might be because they might not have come across Want Want yet.

2. Strong Balance Sheet

You would expect a company involved in such businesses to have a strong balance sheet and Want Want does not disappoint. Here are some of their numbers for FY2014:

Total Assets: US$4.3 billion
Total Liabilities: US$2.2 billion
Total Shareholder Equity: US$2 billion

What’s interesting in their amount of cash. Want Want has cash of US$1.6 billion or HKD 12 billion (~10% of their market cap!). Their cash alone could easily cover their total borrowings of US$1.4 billion! You could also note that management with their issuance of their US$600 million 5Y term notes with an annual interest of 1.875% took good advantage of the low interest environment. This went towards Want Want generating a positive net finance income = Interest Income – Interest paid (Most people would have a cash outflow when they borrow).

This is also not to say that they have been hoarding cash. On the contrary, they have been paying out a fair bit of their net income in the form of cash dividends to shareholders of at least 50% of net income for the past 5 years, at an average payout of 66%. In my personal opinion, that seems to be a rather decent payout ratio.

3. Large Sales Team

Having a great product is one part of the equation. The other is to have a large distribution network. And among F&B companies in China, few can boast to have the extent of Want Want’s distribution network.

Just within PRC (As at 31 Dec 2014), Want Want had:

• 8,000 Distributors
• 359 Sales Offices
• 36 Production Bases &
• 87 Factories

In this case, a picture tells a thousand words. Just look at the map. Such an extensive distribution network doesn’t come by easily.

KEY RISKS

1. Increased Competition and Expenses

Like bees to honey, businessmen will always be attracted to high margin industries. And with GPM of ~40% and OPM of ~20% for all their three core operating segments, Want Want is such an industry. And things have heated up with traditional dairy companies like Mengniu, and Yili Group venturing into Want Want’s domain in the past few years. Not only have their dairy business been targeted, their snack business has also been under threat by foreign consumer product giants the likes of PepsiCo.

The silver lining we might find is that not only did Want Want’s GPM hold, they actually increased from 37.6% in 2010 to 40.2% in 2014 (Average 5Y GPM of 38.7%). This might have implied that Want Want was still able to command a degree of premium in the pricing of their products.

But a major risk looming in the background is non-other than the slowdown in Want Want’s phenomenal Rev growth. Rev grew from US$2.2 billion in FY2010 to US$3.8 billion in FY2014, a CAGR of 13% but in FY2014 Rev growth turned negative for the first time in 5 years. With the backing of China’s consumer story in the background, it is very possible that Want Want will continue to grow, but we should not place too much confidence in the high double digit Rev growth of past years!

Also notable was a yoy decrease of OPM to 20.6% for FY2014. And given management’s tone that they would be spending more on improving their distribution channels (Increase shelf space, increase visibility, increase in-house promoters), create new distribution channels (e-commerce, maternity channels), we should expect their distribution costs to increase in the coming year. But with that being that, we have to note that Want Want is on the lower end of the cost curve with Labour costs at 4%, Advertising and Promotional expenses at 3.7% and Transport expenses at 3.9% of FY2014 Rev. So the bear case could be to consider that costs might more likely go up than down. But you would essentially be betting against a management with not only a culture of striving for high margins (One of the management goals embodies by Hot Kid’s upward-looking eyes) but also one is a proven track record.

2. Susceptible To Raw Material Prices

This is a common risk to all F&B players and not specific to Want Want.

However, we do have to note that fluctuations in raw material prices really do affect Want Want on the GPM level. Although the past few years of GPM were close to 40%, raw materials actively hit the Group’s GPM to a low of 34.7% in 2011 due to price increases of sugar, potato starch, rice, palm oil and plastic packaging materials.

Since then, Want Want has been actively trying to counteract this increase in raw materials through various measures one of which is to raise product prices. Although this strategy worked to a certain extent, it might backfire where in 2014 management reported a slowdown in sales and increase in channel inventory which might have resulted in inventory days rising to a 5Y high of 97 days from an average of 80 in the last 5Y. We are also curious on the relatively high number of inventory days of Want Want compared to peers like Tingyi and UPC which are much lower in the region of 20-40 days.

3. Valuation

Likewise this point is addressed to consumer staples as a whole.

Business-wise, branded consumer players in the F&B industry have quite strong moats in the industry. One of the main concerns for an investor is that they do not come ‘cheap’ in the traditional sense. In normal conditions, a simple rule of thumb might be that most of these established brands do not frequently trade at less than 20x PE. Thus, anytime a big F&B name trades at sub 20x PE, it might be worth your time to find out why!

But at the end of the day, ‘cheap’ is relative. Valuation is none other than one’s perception of the future and if your personal estimates are much higher than the market, the world is your oyster!

TOP SHAREHOLDERS (As at 31 Dec 2014)

1. Hot Kid Holdings Ltd: 30.46%
2. Norwares Overseas Inc: 16.04%

Largest Shareholder (Including Deemed Interest) – Tsai Eng-Meng: 48.07% (Note: Both Hot Kid Holding Limited and Norwares Overseas Inc are beneficially owned by Tsai Eng-Meng)

Shares Outstanding: 13,196,026,135

FINANCIAL STATEMENTS

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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Mun Hong’s personal capacity and do not in any way represent those of his employer and other related entities. Mun Hong does not own any companies mentioned.

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