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Dividend Stocks

Wesfarmers’ Christmas Spoilt by COVID-19, however recovery is expected

Business Strategy and Outlook:

Wesfarmers hasn’t been immune to the recent rise in Australian coronavirus cases and the retail trading restrictions which were in effect in the first half of fiscal 2022. Subdued foot traffic to retail outlets has presented a challenging start to the fiscal second half but we expect recovery during the period. Although Wesfarmers’ discount department store segment, Kmart Group, is relatively small in relation to Bunnings, and only accounted for 20% of group operating profit in fiscal 2021, it is the chief culprit in the pronounced decline in first half fiscal 2022 NPAT.

Government mandated store closures and waning foot traffic heading into the key Christmas trading period weighed heavily on sales. While Kmart Group had shored up sufficient inventory in anticipation of shipping constraints, once stores reopened isolation policies resulted in staff shortages and empty shelves. The impact of operating deleverage on Kmart Group’s cost structure from the 10% decline in sales at the Kmart and Target chains was exacerbated by rising freight fees, as well as greater warehousing expenses to accommodate the elevated inventory levels.

Financial Strength:

The fair value estimate of Wesfarmers given by the analysts remain unchanged, driven by the recovery which is expected during the period which witnessed challenges earlier. The stock offers attractive dividend yields.

The conglomerate estimates profits declined by between 12% and 17% in the first half of fiscal 2022, versus the previous corresponding period. For the full fiscal year 2022, our underlying NPAT estimate of AUD 2.2 billion is unchanged- a decline in EPS of 10% versus fiscal 2021. And it is still expected that a strong 11% rebound in earning in fiscal 2023, driven by a post-pandemic recovery at Kmart Group and earnings growth at the core Bunnings business. From fiscal 2024, solid earnings growth in the mid-single digits are expected, underpinning our unchanged fair value estimate of AUD 39.50.

Company Profile:

Wesfarmers is Australia’s largest conglomerate. Its retail operations include the Bunnings hardware chain (number one in market share), discount department stores Kmart and Target (number one and three) and Officeworks in office supplies (number one). These activities account for the vast majority of group earnings before taxes, or EBT. Other operations include chemicals, fertilisers, industrial and medical gases, LPG production and distribution, and industrial and safety supplies. Management is focused on generating cash and creating shareholder wealth in the long term.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Funds Funds

Robeco QI Global Conservative Equities I: A strong option for investors looking for downside protection

Process:

The strategy’s robust foundation, high repeatability, discipline, and consistent execution remain attractive features. The team’s relentless efforts to implement new elements to the process, these also make the approach more complex and have led to a slight change of portfolio characteristics, which is appreciated. This rules-based, quantitative process is built on extensive academic research demonstrating that investing in low-risk stocks leads to better risk-adjusted returns. After an initial liquidity filter, Robeco’s quant model ranks the 4,500-stock universe on a multidimensional risk factor (volatility, beta, and distress metrics), combined with value, quality, sentiment and momentum factors. In recent years, the team has introduced several enhancements to refine the model, including short-term momentum-driven signals that can adjust a stock’s ranking up or down by maximum 10 percentage points. This should prioritize buy decisions for stocks that rank high in the model and score well on short term signals, and vice versa. Since 2020 the team also allows liquid mega-caps to have a higher weight in the portfolio. Top-quintile stocks are typically included in an optimisation algorithm that considers liquidity, market cap, and 10-percentage-point country and sector limits relative to the MSCI World Index. A 200-300 stock portfolio is constructed with better ESG and carbon footprints than the index, while rebalancing takes place monthly, generating modest annual turnover of about 25%. Stocks are sold when ranking in the bottom 40% of the model. 

Portfolio:

The defensive nature of the strategy currently translates into a higher allocation to low-beta and high yielding stocks in the consumer staples and communication services sectors, while industrials, energy and technology stocks are a large underweight. The valuation factors embedded in the model have steered the fund clear from MSCI ACWI index heavyweights Amazon.com AMZN, Tesla TSLA, and NVIDIA NVDA, while Microsoft MSFT and Apple AAPL were underweighted. Valuations make the fund lean towards European stocks while the U.S. stock market was an 8.8% underweight versus the index per November 2021. The model does like U.S. consumer defensives though, with larger positions for Proctor & Gamble PG, Walmart WMT, and Target TGT. The quant approach gives management wide latitude to invest across the market-cap spectrum, and the diversified 200- to 300-stock portfolio has long exhibited a small/mid-cap bias compared with the index.

People:

The team running this strategy is large, experienced, and stable. As such, it earns an Above Average People rating. This fund follows an entirely quant-based approach, an area where Robeco has extensive experience and expertise, and where it has invested heavily in human resources over the years. Robeco’s quant team runs various strategies: core quant equity, factor investing, and conservative equity, but there is significant interaction between them. The conservative equity team that runs this fund is led by Pim van Vliet, whose academic work has laid the foundation of the fund’s philosophy.

Performance:

This defensive strategy has generally offered good volatility reduction during turbulent markets. Robeco QI Global Conservative Equities’ C € share class absorbed 67% of the losses of the MSCI ACWI Index since inception. However, its results versus the MSCI ACWI Minimum Volatility Index have been less consistent. Disappointingly, it did not live up to its expectations in the corona-dominated markets of 2020, though the strategy’s failure can be explained by market dynamics in relation to the fund’s strategy. The portfolio lagged during the subsequent recovery that again benefited tech and ecommerce stocks, and while the value rally in the final quarter did help, cyclical value stocks that are not favoured here rallied the most.

(Source: Morningstar)

Price:

Analysts find it difficult to analyse expenses since it comes directly from the returns. Analysts expect that it would be able to deliver positive alpha relative to its category benchmark index.


(Source: Morningstar)                                                                       (Source: Morningstar)

About Funds:

Robeco’s quant-based conservative equities range is managed by a stable and experienced six-member team led by Pim van Vliet. They are supported by a group of 10 quantitative researchers led by David Blitz and a similarly sized group of data scientists. This credentialed team is vital to the fund’s success as it constantly refines the models used in the funds. It is also reassuring that Robeco’s broader quantitative team has successfully groomed quantitative researchers in its talent pool, allowing them to add people with complementary skills to the teams. The strategy’s academic foundation, repeatability, discipline, and consistent execution give us confidence. The rules-based, quantitative process is built on empirical research demonstrating that investing in low-risk stocks leads to better risk-adjusted returns. It goes beyond traditional low-volatility investing, combining a multidimensional risk factor with value, quality, sentiment, and momentum factors. Top-quintile-ranked stocks are included in the portfolio after running an optimisation algorithm.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

Masimo Still Seeing Solid Growth; F.D.A. Approval of Opioid SafetyNet Likely in 2022

Business Strategy and Outlook

Masimo has been a leading provider in pulse oximetry since developing signal extraction oximetry in the late 1990s, a technology that offered better accuracy and reliability. The firm’s business strategy depends on maintaining product advantages in core pulse oximetry, expanding its installed base of monitors, and developing innovative technologies to grow its footprint in the hospital setting, such as remote monitoring and hospital automation.

Further revenue and market share growth for Masimo will primarily come from one of two sources: winning business from Nellcor customers seeking a technology upgrade and expanding the use of oximetry beyond the critical-care environment with greater penetration in the general ward. In critical care, where pulse oximetry is often necessary for good patient outcomes, Masimo has a saturated position. However, on the general floor, Masimo is continuing to make the case that pulse oximetry can improve patient care and reduce hospital costs.

Apart from its core pulse oximetry business, Masimo has also prioritized the expansion of its hospital automation program, which involves integrating central monitoring with bedside vital-sign aggregation systems. This program is being established as a software-as-a-service business, with a per-bed cost for hospitals of $1,000 to $5,000, depending on services offered. We like the potential here, and we think Masimo is poised to significantly expand revenue from the program, despite having less than 100 hospitals currently under contract.

Masimo’s Opioid SafetyNet is another pipeline product that could have a material impact on the business over the coming decade. This product, a modified version of the company’s remote monitoring Patient SafetyNet system, is designed to monitor for Opioid overdose risk and alert emergency contacts if needed. Masimo was selected as one of eight companies to receive expedited development and regulatory approval support from the U.S. Food and Drug Administration to help with the ongoing opioid crisis, and Masimo expects to receive product approval in 2021. We see potential for Masimo to rapidly scale up this business.

Financial Strength

Masimo has excellent financial strength. The company operates without leverage and has consistently been able to generate strong free cash flow. In December 2018, Masimo established a credit facility for $150 million, with an option to increase borrowing to $555 million based on meeting certain lending conditions. Considering the strong free cash flow of the business, which we estimate will exceed $200 million in 2021, it’s clear Masimo has significant financial flexibility. While we don’t anticipate large-scale litigations like the ones Masimo fought against Nellcor and Phillips, the firm’s strong financial position would be advantageous in a lawsuit or settlement requiring significant legal fees or settlement funds. Given the many lawsuits in the pulse oximetry space over the past two decades, another major court action within the next 10 years is certainly possible, but we don’t think Masimo faces any major litigation risk.We expect Masimo to pursue several smaller acquisitions, and while the firm can make a larger acquisition if one is found that makes sense, we don’t expect material acquisition activity in the near term. Over the 2014-2015 time period, Masimo borrowed over $150 million, primarily using the funds to repurchase shares. This debt was fully paid down by year-end 2016. If Masimo draws from its credit facility at some point to acquire a business, we would likely expect quick repayment based on management’s accelerated debt paydown last time the firm used leverage

Bulls Say’s

  • The potential in Masimo’s product pipeline is underappreciated. An estimated $10 billion opportunity for products in development would provide diversification to a strong pulse oximetry business,
  • As Masimo continues to take share, the firm’s superior oximeters could become a de facto necessity for clinicians. Masimo could leverage this position to push pricing, generating a tailwind for revenue.
  • Masimo’s strong balance sheet and cash flow generation give the company resources to maintain high levels of investment and to explore accretive acquisition opportunities

Company Profile 

Masimo is an Irvine, California-based medical device business that focuses on non-invasive patient monitoring. It began by developing superior signal processing algorithms to measure blood oxygenation levels through pulse oximetry and has expanded this expertise into a wide range of measurements and applications. The company generates revenue globally, with the United States the largest market (67% of 2020 sales), followed by Europe, the Middle East, and Africa (21%), Asia and Australia (9%), and North and South America excluding the U.S. (3%).

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

JD.com Going Towards Asset-Heavy Model Bulls For Now

Business Strategy and Outlook

JD.com has emerged as a leading disruptive force in China’s retail industry by offering authentic products online at competitive prices with speedy and high-quality delivery service. JD’s mobile shopping market share has increased from 21% in 2016 to 27% in 2020 on approx. JD adopted an asset-heavy model with self-owned inventory and self-built logistics, while Alibaba has more of an asset-light model. 

JD is a long-term margin expansion story driven by increasing scale from JD direct sales and marketplace, partially offset by the push into JD logistics in the medium term. JD is the largest retailer in China by revenue. Among listed Chinese peers, JD’s net product revenue in 2020 was two to three times higher than for Suning, the second-largest listed retailer. JD’s increasing scale in each category will allow it to garner bargaining power toward the suppliers and volume-based rebates. Since 2016, JD no longer fully reinvests its gains from improving scale and is committed to delivering annual margin expansion in the long run. Gross margin improved yearly from 5.5% in 2011 to 15.2% in 2016, and following the consolidation of JD Finance in second-quarter 2017, gross margin improved year over year from 13.7% in 2016 to 14.6% in 2020. 

In the medium term, it is foreseen the investment into community group purchase, JD logistics and the supermarket category will hold back some of the margin gains. JD is unlikely to have non-GAAP net margin increase in 2021. Starting in April 2017, the logistics business became an independent business unit that will open its services to third parties. Management is squarely focused on gaining market share instead of profitability at this point, and to do so, it has invested heavily in supply chain management, integrated warehouse, and delivery services to penetrate into less developed areas. As the logistics business gains scale and reaches higher capacity utilization, it is foreseen for, gross profit margin improvement. Management believes it is not time to turn profitable in the supermarket category in order to be a category leader in China.

Financial Strength

JD.com had a net cash position of CNY 135 billion at the end of 2020. Its free cash flow to the firm has continued to generate positive FCFF at CNY 8.1 billion in 2020. JD has not paid dividends. JD.com has invested heavily in fulfilment infrastructure and technology in recent years, leading to concerns about its free cash flow profile and margin improvement story. It is contemplated management will put more emphasis on growing revenue per user, expansion into lower-tier cities and the businesses’ profitability. Therefore, JD will not invest in new areas as aggressively as before, so it is alleged think JD will be able to maintain positive non-GAAP net margin versus being unprofitable before. its financial strength will improve in future. Most of the initial investments in the third-party logistics business have been carried out, and utilization of the warehouses has picked up. Its technology team is already in place without the need to add substantial headcounts. JD will also be cautious in its investment in the group-buying business and new retail, given a profitable business model has not been established in the market. JD has tried to improve its asset-heavy model by transferring a portfolio of warehouses to establish a CNY 10.9 billion logistics property core fund in partnership with the sovereign wealth fund of Singapore, GIC. JD will own 20% of the fund, lease back the logistics facilities and receive management fees for managing the facilities. The deal will be completed in phases with the majority of them completed in 2019.

 Bulls Say’s

  • JD.com’s nationwide distribution network and fulfilment capacity will be extremely difficult for competitors to replicate. 
  • The partnership with Tencent could allow JD.com to gain significant user traffic from Tencent’s dominant social-networking products in China. 
  • JD is now the largest supermarket in China, the high frequency FMCG categories have attracted new customers from less developed areas and can drive purchase of other categories.

Company Profile 

Trip.com is the largest online travel agent in China and is positioned to benefit from the country’s rising demand for higher-margin outbound travel as passport penetration is only 12% in China. The company generated about 78% of sales from accommodation reservations and transportation ticketing in 2020. The rest of revenue comes from package tours and corporate travel. Prior to the pandemic in 2019, the company generated 25% of revenue from international business, which is important to its margin expansion. Most of sales come from websites and mobile platforms, while the rest come from call centers. The competes in a crowded OTA industry in China, including Meituan, Alibaba-backed Fliggy, Toncheng, and Qunar. The company was founded in 1999 and listed on the Nasdaq in December 2003. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

New Oriental Education: Restructuring Impact Remains Unclear

Business Strategy and Outlook:

New Oriental Education, or EDU, is a large-scale leading provider of private tutoring in China. EDU offers a diversified portfolio of educational programs, services, and products to students in different areas. Not only does EDU offer K-12 after-school tutoring, but EDU also offers other test preparations for both overseas and domestic examinations. In non-academic fields, EDU offers adult English and other languages, and it also provides services in vocational training, such as corporate training, marketing, accounting, human resources, IT and PRC Bar. EDU has been able to raise its fees via new students or new programs to cover rising costs, driving an improving margin as utilization and operational efficiency continues to improve.

A key tenant of EDU’s strategy is to improve operational efficiency in the near term. EDU is guiding 20%-25% year-over-year growth per year for its learning center capacity for the next three years and we believe that offline classes should gradually open as the impact of the coronavirus gradually fades. Also, EDU will continue to close down underperforming centers, which also implies improving operating efficiency. EDU is aiming to raise its student retention rate to 65% from 63% in fiscal 2021.

Financial Strength:

The company’s financial status has been healthy over the past years, with a clean balance sheet and steady cash inflows. EDU has been generating net cash since 2011 with steady cash flow. However, uncertainty is expected to be ahead before the end of 2021, when businesses are required to restructure–with the estimation of 62% of their business being required to be spun off.

Bulls Say:

  • Well-established reputation and dominant position in China. 
  • Successful expansion with strong student enrolment in China should drive growth. 
  • Likely to benefits in the longer term as one of the first movers in online education known as Koolearn.com.

Company Profile:

EDU, founded in 1993, is the largest well-established one-stop shopping private educational services provider in China. EDU has had over 52.8 million student enrollments, including about 8.4 million enrollments in fiscal 2019. As of third-quarter fiscal 2020, EDU had a network of 1,416 learning centers, including 99 schools, 12 bookstores and access to a national network of online and offline bookstores through 160 third-party distributors and over 38,400 highly qualified teachers in 86 cities. EDU offers a diversified portfolio of educational programs, services and products to students in different age groups, including K-12 after-school tutoring for major academic subjects, overseas and domestic test preparations, nonacademic languages and services in vocational training, and so on.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Currencies Trading Ideas & Charts

Wallmart plans to enter the metaverse with crypto and NFTs

The retail behemoth would be the latest corporation to enter the nascent market of virtual worlds, sometimes known as the metaverse. Offering digital replicas of products in the form of NFTs through virtual, metaverse experiences, all paid for with a Walmart token, may be one example.

Walmart plans to expand into digital assets and virtual experiences, according to at least three applications with the USPTO on Dec. 30.

The trademark filings include the provision of a Walmart virtual currency, in addition to cryptocurrency exchange services using blockchain technology. A separate application to the USPTO describes downloadable software for uses ranging from e-commerce to augmented reality as well as managing a portfolio of cryptocurrencies.

Another filing details the possibility of a virtual reality game or online retail service featuring a marketplace of digital goods authenticated by NFTs. These goods could range from  home appliances to sporting goods, beauty products, patio furniture, and musical instruments—all listed in the trademark application.

All of these cryptocurrencies are non-fungible tokens (NFTs). NFTs are an option for Walmart’s digital offering. This ensures that the ownership of these items is documented on the blockchain. Such records are both timeless and enticing to a new generation of listeners.

(Source: The street)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

Affirming USD 188 per HKD 182 Alibaba FVE; Revised Near Term Outlook Due to Weak Macroeconomics

Business Strategy and Outlook

Alibaba is a Big Data-centric conglomerate, with transaction data from its marketplaces, financial services, and logistics businesses allowing it to move into cloud computing, media and entertainment, and online-to-offline services. We think a strong network effect allows leading e-commerce players to extend into other growth avenues, and nowhere is that more evident than with Alibaba.

Alibaba has an unparalleled source of data that it can use to help merchants and consumer brands develop personalized mobile marketing and content strategies to expand their target audiences, increase click-through rates and physical store transactions, and bolster return on investment. Alibaba’s marketplace monetization rates have generally been on an upward trend despite recent macro uncertainty, indicating that sellers are increasingly engaging with Alibaba’s marketplaces and payment solutions, although increased compliance of antitrust laws and more competition will put pressure on monetization in the near to medium term. 

Morningstar analysts  view the Taobao/Tmall marketplaces as Alibaba’s core cash flow drivers, also believe AliCloud and globalization offer long-term potential. While AliCloud will remain in investment mode in the near term, accelerating revenue per user suggests a migration to value-added content delivery and database services that can drive segment margins higher over time. On globalization, third-party merchants are successfully reaching Lazada’s users across Southeast Asia, something that should continue as the company rolls out incremental personalized mobile marketing and content opportunities. 

Affirming USD 188/HKD 182 Alibaba FVE; Revised Near-Term Outlook Due to Weak Macroeconomics

Morningstar analyst fine-tuned  estimates for wide-moat Alibaba’s fiscal 2022 China retail gross merchandise volume, revenue, and adjusted EBITA down by 300 basis points to 7%, by 370 basis points to 20%, and by 230 basis points to CNY 142 billion, respectively, due to weak macroeconomics and competition. These changes were offset by the increase in fair value estimate after rolling  model, so analysts are maintaining USD 188/HKD 182 fair value estimate. Morningstar analyst anticipate an economic recovery resulting from loosened monetary policies and fiscal policies in calendar 2022. These will help recovery in fiscal 2023, which ends March 2023. Morningstar analyst continue to believe that wide-moat Alibaba is materially undervalued.

Financial Strength

Alibaba is in sound financial health. As of December 2020, the company had CNY 456 billion in cash and unrestricted short-term investments on its balance sheet against CNY 117 billion in short- and long-term bank borrowing and unsecured senior notes. Although Alibaba remains in investment mode, Morningstar analysts believe the strong cash flow profile of its e-commerce marketplaces offers it the financial flexibility to continue investing in technology infrastructure and cloud, research, marketing, and user experience initiatives through its current balance sheet and strong cash flow profile. Additionally, Morningstar analyst believe the company has the capacity to add leverage to its capital structure, which could allow it to take advantage of low borrowing rates to fund growth initiatives, introduce a cash dividend when it sees limited investment opportunities with good returns on investment, or repurchase shares. Morningstar analyst expect the company to pursue acquisitions that could further improve its ecosystem, including online-to-offline, physical retail, and increased logistic capacity or capabilities

 Bulls Say 

  • Monthly gross merchandise volume per annual active user was CNY 770 for the year ended March 2021 for Alibaba, higher than CNY 176 in 2020 for Pinduoduo and CNY 461 in 2020 for JD. 
  • Core annual active users on Alibaba’s China retail marketplaces had a retention rate of over 90% for the year ended September 2021. 
  • Alibaba’s core commerce (which includes China marketplace-based businesses and other loss-making businesses) adjusted EBITA margin was 26.2%, higher than JD retail’s 2.3% non-GAAP EBIT margin and PDD’s 15.2% non-GAAP EBIT margin.

Company Profile

Alibaba is the world’s largest online and mobile commerce company as measured by gross merchandise volume (CNY 7.5 trillion for the fiscal year ended March 2021). It operates China’s online marketplaces, including Taobao (consumer-to-consumer) and Tmall (business-to-consumer). Alibaba’s China commerce retail division accounted for 63% of revenue in the September 2021 quarter. Additional revenue sources include China commerce wholesale (2%), international retail/wholesale marketplaces (5%/2%), cloud computing (10%), digital media and entertainment platforms (4%), Cainiao logistics services (5%), and innovation initiatives/other (1%).

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Key Catalyst For Trip.com: International Business A Hand In Recovery

Chart

Business Strategy and Outlook

Narrow-moat Trip.com competes in China’s crowded online travel agent (OTA) industry by leveraging the largest selection of both domestic and international hotels in China on its platform and relying on user stickiness as a one-stop shop for travel ticketing, accommodations, and packaged tours. The platform is now also generating revenue from advertisement in which it hopes to take 3-5% of the ad market, but nearly all its revenue streams are travel-related, and COVID-19 lockdowns in China has cratered demand due to the inability to travel or unwillingness to quarantine. 

It is anticipated 2022 to be another challenging year for the travel industry as it is valued Trip.com’s revenue to recover to only 65% of 2019 levels. The company believes it can reach long-term non-GAAP operating margins of 20-30% on the back of its international, outbound, and high-star hotel businesses given their higher monetization rates, but the lack of demand has impacted these businesses, and total international revenue has declined to less than 5% of the mix and caused operating margin to be negative. Prior to the pandemic in 2019, international revenue was 25% of the mix and non-GAAP operating margins were 19%. It is alleged that reaching its long-term margin will rely heavily on the recovery, but the pandemic has been a significant headwind and has delayed its progress. It is supposed that outbound international travel should eventually recover but visibility is still limited, and further COVID-related setbacks could add to the uncertainty and possibility that the company could fall short of its long-term outlook. 

The other key business that will drive margins is its high-star domestic hotels which generates the highest take-rate on its platform at 9-10%. Trip.com charges low rates for its budget hotels to attract new users and directs them to its high-star hotels for future bookings as its traffic acquisition strategy, where it hopes to retain users through its wide selection of hotel, ticketing, and packaged tour options. Currently, this business has already recovered to 62% of 2019 levels, and thus it is alleged that the imminent key catalyst for Trip.com will be its international business.

Financial Strength

Trip.com operates as an asset-lite company and tends to not commit heavy resources to capital expenditures other than acquisitions for its operations. As of third-quarter 2021, net debt was almost 0 as Trip.com had nearly identical CNY 57.414 billion of debt against CNY 57.411 of cash and investments. Short-term liquidity is also safe with a quick ratio of over 1 time which should reflect some margin of safety and is representative of Trip.com’s financial strength. Trip.com has CNY 45 billion of short-term debt due, and should COVID-19 headwinds continue, it is seen the company issue debt in order to cover short-term expenses to navigate through COVID-19 but given history of low net debt and 15%-20% EBITDA margin, it is not expected to be an issue. The online travel business is not capital-intensive and has historically generated positive free cash flows. The exceptions to Trip.com was mostly due to acquisitions and capitalized operating expenses. In 2014, negative free cash flow for Trip.com was mainly due to its large investment in fixed assets of CNY 4.8 billion, mostly due to its new office building of CNY 3 billion. In 2016, negative free cash flow was mainly due to the merger with Qunar, and Trip.com returned to free cash flow positive from 2017 to 2019. It is projected cash flow to be negative in 2021 due to COVID-19 but should be positive in 2022 even as revenue recover to only 65% of 2019 levels as given in our base-case scenario.

 Bulls Say’s

  • The company can eventually reach its 20%-30% long-term operating margin target as COVID-19 subsides.
  • International and outbound business will eventually recover and drive margins upwards. Margin expansion will be dictated by its higher-margin businesses, including international air and hotels. 
  • The industry will see less competition in the future than before due to current headwinds faced, and thus lesser disruptions to its long-term business plan.

Company Profile 

Trip.com is the largest online travel agent in China and is positioned to benefit from the country’s rising demand for higher-margin outbound travel as passport penetration is only 12% in China. The company generated about 78% of sales from accommodation reservations and transportation ticketing in 2020. The rest of revenue comes from package tours and corporate travel. Prior to the pandemic in 2019, the company generated 25% of revenue from international business, which is important to its margin expansion. Most of sales come from websites and mobile platforms, while the rest come from call centers. The competes in a crowded OTA industry in China, including Meituan, Alibaba-backed Fliggy, Toncheng, and Qunar. The company was founded in 1999 and listed on the Nasdaq in December 2003. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Robust balance sheet and ample liquidity support Pilgrim’s Pride Corp endure market volatility

Business Strategy and Outlook

Although Pilgrim’s Pride is the second-largest poultry producer in the countries in which it operates, we don’t believe it has carved out an edge. About 70% of Pilgrim’s products are undifferentiated and therefore have difficulty commanding price premiums and higher returns. Further, its profit margins can be quite volatile, as several factors outside the firm’s control affect costs (weather, flock disease, global trade). Prices of feed ingredients can be quite volatile, surging in 2008 and leading to Pilgrim’s bankruptcy. Since then, the industry has moved to new pricing strategies, which are helping protect the processors from revenue/cost mismatches. However, despite Pilgrim’s size, we don’t believe this affords it a scale cost advantage, underpinning our no-moat rating. 

In August, JBS, which owns 80% of Pilgrim’s, proposed to buy the remaining 20% for $26.50 per share. The board is reviewing the deal, and if approved, it will be put to a shareholder vote (excluding JBS). The offer appears light, at a 20% discount to our $34 fair value estimate and at 6.5 times adjusted EBITDA, compared with the 9.1 times for which Sanderson Farms was acquired one week prior to the offer. 

As 50% of Pilgrim’s sales stem from food service, the pandemic impaired sales and margins in 2020; organic sales were down 2.4%, and adjusted operating margins fell 240 basis points to 3.7%. But trends are recovering as vaccines become more widely available, and we expect no lasting effects. We are optimistic on the long-term global demand for chicken, as developed market consumers have been shifting consumption of red meat toward poultry, and in emerging markets, a growing middle class is driving higher per capita consumption of protein. Pilgrim’s should benefit from strong demand in China, as the country eliminated its ban on U.S. chicken in late 2019. Further, China has a shortage of protein after a 2019 outbreak of African swine fever resulted in a 40% reduction in the country’s hog population. The disease is still not fully contained, so this supply shortage should support global protein prices once the pandemic subsides and should result in strong export demand.

Financial Strength

Pilgrim’s strong balance sheet (net debt/adjusted EBITDA at a very manageable 2.2 times as of September 2021) and sufficient liquidity ($1.5 billion cash on hand and available cash through its credit facilities) should help the firm withstand market volatility. Pilgrim’s has no debt maturities until 2023, does not pay a dividend, and has sufficient liquidity and debt capacity to fund $400 million in annual capital expenditures. Even beyond the pandemic, the business is inherently cyclical with many factors outside management’s control, but we applaud changes that have improved the predictability of earnings. Chicken pricing contracts now link costs and prices. In addition, Pilgrim’s now maintains diversified exposure to fresh chicken across large, tray pack, and small bird segments, which helps stabilize margins. The firm also maintains geographical diversification, with 62% of 2020 revenue from the U.S., 27% from Europe, and 11% from Mexico. The firm has stated its optimal net debt/adjusted EBITDA range is 2-3 times, which we think is manageable, but we wouldn’t want it to move above that range on a sustained basis, given the unpredictable nature of profits despite improvements. We think it’s likely that over the next few years Pilgrim’s will make acquisitions that we have not modelled, we don’t think leverage will exceed its 2-3 times target over an extended horizon. However, given the unpredictable size, timing, and characteristics, we have opted instead to model excess cash flow being allocated to special dividends beginning in 2026, as the company prefers this approach instead of regular dividends and share repurchases are constrained by limited float. We model dividends beginning at $2.17 per share in 2026 and gradually increasing to $2.86 per share throughout our explicit forecast.

Bulls Say’s

  • The global protein shortage resulting from China’s African swine fever outbreak should support global protein prices, which should stabilize and enhance Pilgrim’s profit margins. 
  • Pilgrim’s has an opportunity to unlock value through structurally boosting the profits of its European operations by applying best practices from the U.S. and Mexico and using its key customer strategy to change the producer/customer dynamic. 
  • In November 2019, China eliminated its ban on imports of U.S. poultry, which should help boost Pilgrim’s exports.

Company Profile 

Pilgrim’s Pride is the second-largest poultry producer in the U.S. (62% of 2020 sales), Europe (27%), and Mexico (11%). The 2019 purchase of Tulip, the U.K.’s largest hog producer, marks the firm’s entrance into the pork market, which represented 11% of 2020 sales. Pilgrim’s sells its protein to chain restaurants, food processors, and retail chains under brand names Pilgrim’s, Country Pride, Gold’n Plump, and Just Bare. Channel exposure is split evenly between retail and food service, with most of the food-service revenue coming from quick-service restaurants. JBS owns 80% of Pilgrim’s outstanding shares.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

Challenging Scenario of Omicron, weak produce and Labour Scarcity create obstacles for Lamb Weston

Business Strategy and Outlook

Lamb Weston, the largest provider of frozen potatoes to North American restaurants, has secured a narrow moat, based on the firm’s cost advantages and entrenched restaurant relationships. The North American commercial potato market is highly concentrated with only four players: Lamb Weston (42%-43% share), McCain (30%), Simplot (20%), and Cavendish (7%-8%). Lamb Weston and Simplot both secure their raw potatoes solely from the Idaho and Columbia Basin region, an area ideally suited for growing potatoes, with very high yields. These firms secure potatoes at a cost 10% to 20% below the average price per pound. There is minimal unused land and water resources in this fertile area, so it is expected this advantage to hold for at least the next 10 years. Further, as the dominant player, Lamb Weston maintains a scale advantage. Given the high fixed costs in this capital-intensive industry, scale benefits are meaningful. Lamb Weston’s long-standing strategic partnerships with its customers provide another facet of the firm’s competitive edge. French fries are the most profitable food product for restaurants, and a key menu item. 

Lamb Weston is facing many headwinds that will dampen its earnings near term, but its long-term prospects should remain intact. The omicron variant will cause the traffic recovery in full-service restaurants (19% of sales) to pause, but consolidated sales should return to prepandemic levels in fiscal 2022, given resilience in quick-serve restaurants (58%) and retail (16%). Inflation, shortages, and a poor-quality potato crop should impair margins the next several quarters, but profitability should be fully restored by fiscal 2024. 

French fries are an attractive category, as consumers across the globe are increasing consumption, with volumes up low single digits in developed markets and up mid to high single digits in emerging markets. Lamb Weston is investing in additional capacity in China and the U.S. to meet this growing demand. While capacity utilization was uncharacteristically low during the pandemic, as herd immunity increases, French fry demand should recover, absorbing additional supply.

Financial Strength

When Lamb Weston separated from Conagra in November 2016, the firm initially reported net debt to adjusted EBITDA of 3.7 times, but leverage fell to 3.0 times last year (even considering the impact from the pandemic), and it will moderate to a very manageable 2.1 times by fiscal 2024. In addition, it can be guaranteed about the Lamb Weston’s ability to service its debt, with interest coverage (GAAP EBITDA/interest expense) averaging 7 times the past three years, and our forecast calling for a 8 times average over the next five years. As Lamb Weston’s business is capital intensive, the primary use of cash is capital expenditures, which averaged 9% of sales the three years before the pandemic, as the firm expanded capacity to meet strong customer demand. The industry began to operate at a more level utilization rate (mid-90s expected even before the pandemic hit in 2020, after 100% experienced the previous two years) causing capital expenditures to moderate to 4%-5% of sales during the pandemic. Investments should increase to 11% and 17% of sales in 2022 and 2023, respectively, as Lamb Weston expands capacity in China and the U.S. and range from 5.5% to 6.0% over the remainder of the decade. Dividends should be another significant use of cash, and It is expected for dividends to increase at a high-single-digit rate annually, generally maintaining a long-term pay-out ratio in the low-30%s, in line with management’s target. Lamb Weston has made a few small tuck-in international acquisitions in recent years, and is suspected that this may continue, but analyst have not modelled future unannounced tie-ups, given the uncertain timing and magnitude of such transactions. Instead, Analyst have opted to model excess cash being used for share repurchase, which is viewed as a prudent use of cash when shares trade below our assessment of its intrinsic value.

Bulls Say’s

  • Lamb Weston’s geographical and scale-based cost advantages should help ensure the firm remains a dominant player in the industry. 
  • Lamb Weston is a valued supplier of restaurants’ most profitable food product, and restaurants are hesitant to switch so as not to disrupt supply and quality. 
  • French fries are an attractive category, as per capita consumption is increasing in both developed and developing markets.

Company Profile 

Lamb Weston is the world’s second-largest producer of branded and private-label frozen potato products, such as French fries, sweet potato fries, tots, diced potatoes, mashed potatoes, hash browns, and chips. The company also has a small appetizer business that produces onion rings, mozzarella sticks, and cheese curds. Including joint ventures, 52% of fiscal 2021 revenue was U.S.-based, with the remainder stemming from Europe, Canada, Japan, China, Korea, Mexico, and several other countries. Lamb Weston’s customer mix is 58% quick-serve restaurants, 19% full-service restaurants, 8% other food service (hotels, commercial cafeterias, arenas, schools), and 16% retail. Lamb Weston became an independent company in 2016 when it was spun off from Conagra.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.