Short Dairy Farm update

Dairy Farm is one of two holdings I held more than 2 years, which still has a negative return. Previous poor management combined with Hong Kong protest and Coronavirus has made this (normally) defensive company perform very poorly over the past two years. In the more recent sell-off I even decided to add to my investment. This is so far been a fairly poor choice since the stock rebounded less than the market has. If you read all my post on the company I contemplated multiple times if I should give up on the company or stay the course. My very long term thesis is that the company is in a very strong position to capitalize on the growth of the Asian middle class. I decided to continue to stay the course long term. The reasons being is that I see plenty of signs that the CEO Ian McLeod is doing the right things. Ian took over as CEO in Dairy Farm around the time I invested for the first time. The outside world of protest and Corona is hard to control (and hopefully something that will pass) but what Dairy Farm can affect seems to be going in the right direction.

Dairy Farm’s supermarket division is a very large part of total revenue. Given that it’s groceries, the margins are much thinner than for example IKEA or Health & Beauty sales, producing less bottom line than the other areas. My thesis all along has been that Dairy Farm would be able to significantly increase margins for it’s grocery segment. So far it has not happened but I really think things will improve from here on on wards. The biggest reason for that is spelled Meadows.

Meadows

The trend that big grocery chains use own branded products has been particularly strong in large parts of Europe, as can be seen in the graph below:

 

The idea is pretty obvious, take control of the products sold and get a better margin. The reasons why a grocery chain would be hesitant to do so, would be that there are a number of branded products we consumers really want to buy. For example myself I really don’t want any other ketchup than Heinz. British grocery chains have been extremely successful in selling own brand products, take for example Tesco which has a very wide variety of Tesco branded products. Now Dairy Farm is going in the same direction, pretty much with a big bang launch of a huge set of products under the Meadows brand. Below is just an example of the economics of it, not necessarily exactly how it would play out for Dairy Farm.

Now getting to the above increase in margin is really a volume game. You need to be of a certain scale to be able to pull it off. Tesco for example has 56bn GBP of sales, so its not hard for them to have the scale to build a strong own brand portfolio. Dairy Farms grocery sales is not nearly as large, but how large it is depends a bit on how far they plan to roll out the concept. If it’s only to its fully owned supermarkets, the total sales is only some 5.2bn USD, if it also is to its Welcome stores its another 2.2bn of total sales there. Then we have the associates as Yonghui Superstores which has another 12bn USD in sales. I have not been able to find any info that the Meadows brand has been rolled out at Yonghui, perhaps someone in Mainland China is able to confirm this for me? This would be a big benefit if Yonghui would share in the Meadows brand but I don’t think that is the case. If we look at other smaller listed grocery companies, Swedish listed Axfood has revenue of 5bn USD and has managed to build a own private brand called Eldorado. Eldorado started as a ultra low price brand but is now complemented with multiple private brand products in higher price segments. So it is possible to build a private brand portfolio also within a smaller grocery network as Axfood.

My feeling here with the Meadows brand is that they for sure try to be a low cost option, but still with a little bit better quality than the cheapest stuff. The brand itself feels quite premium when you buy the products, but after trying a variety of products I would say only a few of the products actually are of equal quality as the branded examples. They do come with a big discount though and clearly the cheapest option, which I think matters to many.

Notice the pricing point of the Meadows peanut butter compared to Skippy (20 vs 27 HKD), also some blueberry jam to the left from Meadows and a cheaper price point than Smuckers. So to sum it up, I’m very happy with this development, the private brand trend has barely even started in Hong Kong and China in general. Now Dairy Farm is off to a strong start with the Meadows brand. It’s going to be interesting to evaluate over the coming 1-2 years if Dairy Farm can lift it’s grocery chain margins.

Greatview Aseptic kicker

I have equally large holding in Greatview Aseptic Packing listed in Hong Kong, where Dairy Farm is a large owner. Some milk products sold under the Meadows brand are using Greatview packaging which of course is a positive development for 468 HK. Although Dairy Farm’s milk sales is probably too small to make a big difference in Greaviews revenue, it’s still nice to see.

 

 

 

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Portfolio re-balancing and selling Diageo

The rationale for worries and opportunities in all my holdings are spelled out in my previous post. Today I will just briefly announce my portfolio decisions. One little obstacle in this extremely volatile market is that in the blog execute all trades on close, this might mean quite large deviations from the levels I would have been happy to enter or exit my positions on. Anyhow, that’s how its going to be, the blog NAV is just a proxy of performance.

Some quick thoughts around my investment philosophy in this market:

  • Classical defensive holdings not necessarily defensive in a Covid-19 situation. It’s somewhat of an all bets are off situation here. One would think that Diageo with liquor sales is a super defensive stable business, not so much in this situation. Philip Morris another holding is reporting that they have to close their factory in Spain. It doesn’t matter of how defensive cigarette sales are if you can’t produce cigarettes. This market is truly hard to navigate.
  • Don’t try to be a hero in this market – focus on surviving that will give you plenty of returns long term, permanent capital loss is what will really hurt returns. I will reduce/sell anything I see risk of permanent loss of capital or dilution to shareholders due to leveraged balance sheet.
  • My small cap strategy of investing in less discovered (overlooked) stocks makes sense in a normal market. In an highly distressed market, it might as well be a large cap which is wrongly priced. I will therefore consider all-cap companies going forward. When markets have normalized I plan to go back to my small/micro cap strategy.

Selling:

  • I will fully sell my holding in Diageo, the debt levels the company has is scary in a scenario where sales significantly drops, which is surely in the cards if this continue. It’s unfortunate when a holding you bought for it’s defensive characteristics fall even more than the general market, but here we are. I should have reacted earlier and it’s probably very late to sell, at least I will re-allocate the cash into other cheap companies.

Reducing:

  • Although company proved a turned around, due to debt load and total stop in business I will reduce my holding in Modern Dental Group to a 1.5% position.
  • Reduce position in Olvi to 4%, not due to company doing poorly but just that the business will be hurt, but the stock is not trading as cheaply as many other holdings with better prospects.
  • Reduce position in Tianneng Power to 1.5%, although the company is not doing badly, this was a speculative holding now I want to focus on building positions for the long term in strong companies.

 

All in all this raises about 11.5% of my portfolio in cash

Adding:

  • Greatview Aseptic is in my view a big winner on this, people will be buying packaged food as never before. The company is already super-defensive to begin with, being net cash and very non-cyclical business. I raise this fairly new holding to a high conviction position and take the position size from 6% up to 8%.
  • I choose to double down on my oil positions TGS is increased from 2.6% to a 4% position and Tethys Oil I will increase slightly from 2.3% to 3%. This is a real pain trade to do, since in this sentiment these stocks can probably quickly drop further. At the same time these type of extreme events is when you need to dare to go against the sentiment.
  • Dairy Farm is another company where I spelled out my thinking quite clearly for that this is way oversold and actually quite defensive. I will increase my position from 4.7% up to 7% here.

This takes some 6.4% of my cash, which leaves me with roughly net +5% cash (give or take depending on today’s close prices). These 5% + ~7% in BBI Life Science (if the takeover goes through) is left to be deployed at a later stage.

 

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Investing in challenger to dominant Tetra Pak – Greatview Aseptic (468 HK)

The history and development of the Liquid Packing Carton market, or aseptic packaging as it is also called, is a very interesting one. Although the industry is a huge global industry, it has over the years been almost totally dominated by one player.

In 1952 the Swedish businessman Ruben Rausing convinced a local dairy company that his peculiar tetrahedral shaped cardboard beverage carton was the way of the future. The rest as you say, is history. Aseptic packaging as it is called became the most popular way globally to sell milk products but also many other beverages, the packaging being superior in both preserving the drinks taste and ease of transportation. Later on the Tetra Brik was invented and the company Rausing created with these innovative products became Tetra Pak (part of Tetra Laval). The company today has 11.2bn EUR of Net sales. The case of Tetra Pak is interesting because the company has over the years had no to little competition in many markets – a dream situation for any company to be in. But how was it possible to be so successful and why did not more competition come in? Firstly it came down to patents, which gave the company a monopoly position in the early years. Secondly the company has and continues to be extremely well run with a clever sales strategy. Tetra Pak sell the filling machines that creates the packaging, to the beverages producers at a low price. Then making the margins on selling the cardboard box paper used by the machines, which of course will be continuously ordered. The contracts for the machines tied the customer to not buy the cardboard paper from anyone else. In this way the customers were tied to Tetra Pak and had to invest in new lines of machines, to switch to a competitor, obviously at high switching costs. In 2002 it was estimated that Tetra Pak still had 85% market share globally, but around this time things slowly started to change, partly due to regulatory intervention but also due to beverages producers who helped create companies like the one I want to present to you now.

For the interest reader here is some more history of Tetra Pak family: Tetra Pak, a Fortune Founded on a Clever Idea & The death of Eva Rausing and the decline of the Tetra Pak dynasty. For the very interested historian the story above is somewhat simplified. There was a american inventor that was even earlier than Rausing in creating a similar packaging in USA. The company, Cell-O was the beginnings of Elopak. Read the full story here: History of Elopak. 

Now moving on to my latest investment

Greatview Aseptic Packaging (468 HK)

 

+ Operating in a market with Tetra Pak as a dominant player. This creates an incentive from beverage producers to diversify supplier base.

+ Favorable shareholding situation. Company led by the founders who have large shareholdings. The largest shareholder is conglomerate Jardine Group.

+ Very compelling valuation at P/E 11 and EV/EBITDA 6, the company is net cash which de-risks it further. Swiss listed SIG is trading at almost twice the multiples for a very similar business.

+ 8.5% dividend yield with a stable track record of paying dividends.

– Price taker in the sense that they compete towards Tetra Pak on providing same product at lower price point.

– High dependency of few customers, mainly Mengniu Dairy has a very big portion of the companies sales.

– Negative trend of China profit margins and seems to struggle to grow further in China.

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