Category: Sectors

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.

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.

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.

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.