Why I avoid: Apollo Food Holdings?

Company Introduction

Apollo Food Holdings Berhad is listed in Bursa Malaysia Main Board. The Company's wholly owned subsidiaries include Apollo Food Industries (M) Sdn Bhd and Hap Huat Food Industries Sdn Bhd. Apollo Food Industries (M) Sdn Bhd is engaged in manufacturing of compound chocolates and chocolate confectionery products and cakes. Hap Huat Food Industries Sdn Bhd distributes and markets compound chocolates and chocolate confectionery products and cakes.

1. Declining earnings
Apollo has been profitable since its listing in 1997. It thrived in its early years from '97 - '02 as revenue almost doubled from RM55m to RM 100m while its earnings after tax grew 43% from RM14m to RM20m. However, its performance has been lacklustre thereafter though its revenue continued its uptrend from RM100m to RM124m from '02-'05, its net profits dropped from RM20m to RM 14m.


2. Inability to raise prices amid inflation
Not only has the company failed to increase its earnings in tandem with its revenue, earnings has dropped. In its latest Annual Report, its chairman has cited increased raw materials as reason for its decreasing profit margins. Profit margins have almost halved from its high of 25% in 1997 to its current 14%. The entry of other products of similar nature from local and overseas manufacturers has posed a threat to Apollo. Fierce competition has suppressed its ability to raise prices. Looking forward, even increasing topline will not translate into satisfactory bottomline.

3. Investing in quoted securities
Apollo has a history of making investments in Bursa Malaysia quoted securities since 2001. Generally, I would avoid companies that invest in area outside their circle of competence. In this context, Apollo is an expert in making compound chocolates and chocolates confectionary products and cakes. Its founder has more than 30years of experience in this industry. Why does it venture into areas as diversify as banking, construction and gaming? What do these and chocolate cakes have in common?

Of course there are succesful examples where companies invest in areas outside their core business and yet still thrive. Remember the textile company that invest in industry as diversify as insurance, furniture, utilities, chocolates, newspapers and etc yet prospered? Of course that is helmed by none other than Warren Buffett, the greatest investor of all time. He has outperformed the market with more than 22% ROI per year over the past 37 years!

Now back to Apollo, let's see how its investments performed:
2001: Invested RM 3.13M, lost RMo.14M
2002: Invested RM 0.27M, gained RM0.01M
2003: Invested RM10.60M, lost RM0.67M
2004: Invested RM 1.49M, gained RM0.29M
2005: Invested RM 8.80M, lost RM0.83M
Total= lost RM1.34M
The above gain/losses are before the costs of money. Assuming 4% risk free bank interests. Total investments of RM 24.29M over 5 years, company has forgone interests earnings of RM 1.00M. Therefore, the total losses includes interests are RM 2.34M!
Why would the management spend 5 years of effort making these investments that resulted in losses and distracted them from the day to day operation of making chocolate cakes?

4. High capital expenditures over operating cash flow
If a company needs to use RM1 of capital expenditure to generate RM1 of earnings, then effectively it doesn't generate any value. Earnings is an important yardstick to value a company, however it is equally important to look at its capital expenditures to see how much cash could the company keep from the earnings it makes.

Throughout the past 6 years, Apollo's capital expenditures range from RM0.08 - RM0.20 per share (see table above) while its operating cash flow range from RM0.15 - RM0.35. The average capital expenditures is roughly 50% of earnings. In the other words, out of every RM1 it earns, it needs to spend RM0.50 to maintain the plants and equipments. Comparing with Eurospan Holdings which requires RM0.25 for RM 1 it earns, Apollo capital requirements is high.

5. Valuation
It curently trades at 16xPE and 17xFCF. With its earnings dropping year to year over the last 4 years, it is surprising to see it being valued at this price. In my opinion, at its current valuation investors can acquire other more stable businesses aka 'blue chips' that grow at a reasonable rate of 15% per year. Just to name a few, eg. YTL Power-12.5xPE, CAGR=15%(over last 5 years); QL Resources-11.3xPE, CAGR=20%(over last5 years).

Disclaimer: This report is provided for general information only, is not to be considered as investment advice and should not be relied upon for investments decision. Visitors please exercise your own judgements for investments decision.

My Million Dollar Goal : How do I plan to achieve it?

In order to achieve my million dollar goal by the age of 35 with a yearly Return on Investment of 30%, I would need to end the year with at least $72,800. I created a spreadsheet above to determine my target for net worth each year. To achieve 30% returns every year is a difficult task, but it is a target that I strive to achieve. My strategy is to emulate Warren Buffett's strategy in investment. Warren Buffett said "I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that." For me, I know I won't be able to match Warren Buffett's achievement. However, considering 60% efficiency in my 'imitation' I should be able to target 30% returns.

In the early years if returns for investments is not satisfactory, it could be easily made up by savings. But once my net worth gets bigger, savings would not be able to cover poor investment returns. Therefore the critical factor to achieve my million dollar goal is satisfactory invesment returns.

I set out to put my investments reasoning in this blog to see how I perform and at the same time track my net worth to ensure that I do not get distracted in my pursue of my Million Dollar dream. The benefits of recording our reasons for stock selection is manyfolds. Besides ensuring that I do not sway away from Warren Buffett's strategy of 'Intelligent Investing' (Investing is intelligent when it is most business-like.); I could take advantage of falling prices as and when Mr. Market is depressed. Fluctuation in the market is volatile in the short-term, prices can fall drastically even when the underlying business is doing well and vice-versa. We are not right or wrong because of the stock prices but because of our reasoning.

Why I like : Eurospan Holdings ?

Company Introduction
Eurospan Holdings is listed in Bursa Malaysia 2nd Board. It is a major export oriented manufacturer of wood based products, the Group produces a wide range of Ready-To-Assemble (RTA) as well as Fully Set-up/Assemble (FA) dining tables, desk, dining chairs, floor chair, coffee tables, corner tables and baby chairs. The Group utilizes wood materials combined with modern furniture accessories and advance technological process to produce quality furniture to meet the high expectations of overseas customers.

Reasons I'm loving it:

1. China is not a threat

China has now become the factory of the world with globlalisation. With their abundance supply of cheap labour and property, big amount of cheap China exports are making their way to every corner of the world. There is no way we could compete with them in price. Therefore, I avoid investing in businesses that provide goods/services that China can provide. Furniture is of course no rocket science, every layman can produce his own furniture with little skills and imagination. How can Eurospan compete?

It specialises in making Ready-To-Assemble(RTA) furnitures which could be shipped more cheaply to overseas market compare with China products that are Fully Set-up which incur higher shipping costs due to the requirements for bigger space for shipping.

Besides, it is expanding downstream activities to produce more value-added features. The company will be spending more than its current allocation of 1.3% of its revenue to research and development next year. More focus will be put on differentiation strategy of penetrating new markets with a range of affordable to premium quality wooden dining sets as well as cabinets.

Furthermore, it had reduced reliance on rubber wood by using different types of wood and non-wood materials. Currently rubber wood content makes up of about 20% to 30% of the materials used for furniture manufacturing which makes it competitive in light of the escalating rubber wood prices.

2. The institutions don't own it and the analysts don't follow it

'If you find a stock with little or no institutional ownership, you've found a potential winner. Find a company that no analyst has ever visited, or that no analyst would admit to knowing about, and you've got a double winner.' Peter Lynch.

If you browse through the analysis of shareholdings in the Annual Reports, you will find that the biggest institutional shareholder is Lembaga Tabung Angkatan Tentera (LTAT) with shareholdings of 2.45% which they held since listing in year 2000. And if you google this company for analyst's report, you could find none! What better company to invest than this which is under-researched and with no competition for stocks accumulation at cheap price?

3. Low PE/High Earnings Yield

Eurospan made a full year profit after tax (PAT) of 14.45cents, and at its current price of 94.5cents it is selling at 6.6times historical earnings. This is about 15% earnings yield. What is more impressive is its ability to generate Free Cash Flow of 18cents, which makes its Price / Free Cash Flow a mere 5.25 times. (Free Cash Flow or Owner's Earnings in Warren Buffett's term is the Earnings + Depreciation - Capital Expenditures.) In the other words, it is cold hard cash generated by company that can be used to benefit shareholders by raising dividends and/or buying back its own shares. Over the last 3 years, it has generated Free Cash Flow substantially higher than its accounted earnings. (eg. Year 2004 FCF of 14 cents vs PAT of 4 cents, 2005 14 cents vs 12 cents and 2006 18 cents vs 14 cents.)

4. Cash cow

As a result, it has accumulated a cash hoard of 60cents and NO DEBT even after paying out average 50% of yearly earnings. This year Eurospan is paying out handsome dividends amounting to 8cents per share gross, which is an impressive 8.5% yield! It has steadily increased its dividends for the past 3yrs from 2cents to 8cents last year in tandem with its growing earnings. The stock will be traded ex-dividend on 20th Nov 2006.

5. Ability to pay out handsome dividends

Looking at its fat cash hoard and its ability to extract cash from its operation with its low capital expenditures requirements(see attached picture for figure), it should have no problem keeping or even increasing the dividends next year and for the years to come. We like management that reward shareholders instead of using the cash for 'diworsification'. And so far the company has not (mis)used any of the cash for investments outside their core competency of furniture. Instead they have been ploughing the money back into research & developments in expanding downstream activities in producing more value added features.

6. Great upside, no downside!
This stock offers a valuation that is too hard to ignore. Just imagine that the company generates FCF even at NO GROWTH of 18cents/yr for the next 2 years, it would accumulate 36cents. Add this to the cash hoard, it will have 96 cents. Which will be more than the share price now. Unbelievable!

Which company can provide you the safety of capital which in the worst-case-scenario of NO GROWTH, in 2 years time will trade around your purchase price? (Under the most persismistic market, companies usually trade around its cash hoard) And in the normal-case-scenario, assuming a conservative estimation of 10x FCF plus cash, it shall trade around RM1.80+RM0.96=RM2.76 which is a whopping 200% gain in 2 years!

Disclaimer: This report is provided for general information only, is not to be considered as investment advice and should not be relied upon for investments decision. Visitors please exercise your own judgements for investments decision.