Traded Tsit Wing for Food Junction on 28th August 2009

With this, I officially threw in the towel on Tsit Wing, making a meagre 8.5% (taking dividend into account) over 3 years. I could either continue to wait for their restructuring efforts to pay off (assuming they aren't taken private successfully) or look somewhere. I chose the latter given the lack of visibility on how long the wait could be amid deteriorating performance, beginning even before the financial crisis started.

Food Junction

As the world economies embark on the uneven road towards recovery, opportunities to invest in cyclical businesses trapped in cyclical doldrums get harder to come by. After SPC, Courage Marine and CH Offshore, I had to look elsewhere and turned my attention towards stable, recovering businesses that is still thinly traded to signify lack of interest... yet. Re-investment into Super Coffeemix marked the beginning to this change of approach and Food Junction is the second one.

Business performance


If profit after tax (excluding other income) for 4Q exceed $595,000, I will be quite confident they are on the road towards a more convincing performance in 2010 and beyond, riding on the wave of economic recovery in Singapore and the region.

Reasons to be optimistic

Mass market food provider

Despite its effort to upgrade its existing food courts into lifestyle food courts, it is nonetheless a mass market food provider. However, I don't really see anything wrong with such a business plan. Food courts are a natural successor to hawker centres in Singapore. Given the current inflation level and upgrading of coffee shops (means rental to increase), the price to pay for a 'simple' meal is almost the same everywhere.

Friendly neighbours

Food junction, along with other major operators, Kopitiam, Food Republic seems friendly to one another, I seldom see food courts from different operators locating in the same building or beside each another. If they do, the crowd in the area will justify it. Thus, during meal times, all major food courts are always packed with people.

Renovation mostly completed.

Most of the renovation works were already completed and without further disruptions to operations, revenue and profit for forward quarters should be better compared to preceding ones.

Risk

One of the few risk I see is its attempt to venture overseas. Food Court culture (born from hawker centre style of eating) is still quite a Singaporean thing. Replicating this concept to the region is not so smooth sailing, as seen from their failure in Hefei Food Court in 2007. Thus I view their acquition of Malone’s American Cafe & Restaurant chain in Shanghai, China as a risky one. Incidentally, they had to delay their Malone expansion plan in Suzhou until market condition improve.

Conclusion

Signs are pointing that many businesses are picking up from their doldrums in the last few quarters. However, judging from the volume and jumps in prices in many counters in general, the market consensus seems to be pointing to a remarkable economic recovery. Refusing to subscribe such irrational optimism, I'm still looking out for neglected businesses trying to stand up from recent injuries.

Downside to Value Investing?

The story

The controlling shareholder, Wong's Brothers, decided to delist Tsit Wing at an offer price of 27 SGD cents. The rationale behind the delist is due to poor interest in its stock (low market valuation that does not reflect its worth) and to facilitate restructuring by easing capital investment into the business as a private status.

Downside to value investing

Entering my 4th year of investing, I finally experienced a downside to value investing - voluntary delisting of an undervalued company. I have myself to blame (or at least someone, or something to blame) if I wrongly valued a company and overpay for the business. I will be glad to analyse what went wrong and avoid making similar mistakes.

But when a company is to be delisted just because its value is not recognised (that's precisely the reason why I invest in it), then I really feel like banging the wall all these years for nothing.

Delisting unvalued firms not equivalent to value trap

I must stress here that such misfortune is not tantamount to a value trap. Value trap occurs when an investor overpays for a business with the wrong assessment that it is undervalued.

The risk

Thus I just realised another risk of value investing - voluntary delisting. Though I did not suffer any loss on Tsit Wing, in fact I made a meagre profit of a few hundred dollars after factoring the lucrative dividends all these years, I am obviously not please to make a few percentage gains after these years of patience - the ROI is too low!

Lesson

I pondered with the idea of not investing into companies with low liquidity and/or those whose controlling shareholder holds a unfair majority, but after cooling my head and thinking it through, I rejected this idea.

Firstly, one common attribute of an undiscovered gem is low liquidity. If many know about it, the volume will not be so low and the potential upside (or rather the margin of safety) will not be so high.

Secondly, even if the majority shareholder does not delist an undervalued stock, there is no stopping them from selling the business if an offer is deemed good enough.

Conclusion

I can only control what I can control. Those that I can't, I leave it to my two trusted aides, margin of safety and diversification to help me.

Tsit Wing's 2Q 2008 results - a worrying disappointment

At first glance

While sales improved by 8.1%, or HKD 7.3m, this is more then offset by:

• a huge jump in cost of sales: -10.8m
• other operating income (loss): -2.7m
• distribution costs: 2.0m
  

This resulted in Q2's profit to plunge by 7.9m or 83.7% to 1.5m from 9.4m a year ago.

Worrying signs

Poor performance in China

While sales in first half of 2008 rose by 77%, operating profit dropped by 50%, a result of high material and operating costs. Looks like the expansion into China is far from successful yet. Ever since Tsit Wing ventured into China, the segment had been loss making and they had successful narrowed their loss year after year. This segment finally posted a marginal gain in 2007. But now, the marginal gain could easily be eroded and a segmental loss could be posted this year.

Closing down of small independent tea bistros

With high inflation, rising cost in both materials, labour, rental etc, small bistros are struggling to survive. Tsit Wing anticipated many to close down and hence impacting their sales even further.

Piling inventory

Inventories shot up significantly from 74.9m from 55.5m in 1Q 2008. Thus there is a sudden built up of 19.4m. This stockpiling could be management's answer to the rising cost of raw materials. Like any other commodities, the prices of tea and coffee had been very volatile lately. Such stock piling (locking-in at current prices) could back fire if the cost of commodities are to plunge in near future.

To manage the cost of raw materials, the management reported that they had engaged in hedging and trading activities. While rising demand due to growing global economies and population in the long term could lead to increase prices, however, commodity prices could be subjected to short term irrational, unpredictable forces depicted by Mr Market. The following tables illustrated how volatile the prices can be:

• Monthly coffee prices from 1998 to 2008
• Daily prices in August 2008

Thus, in my opinion, such hedging and trading actions is very dangerous. Indeed, Tsit Wing had incurred a marked-to-market loss of 2.2m since 30th June 2008. Fortunately, 1.7m is unrealized and are reversed in July.

Encouraging developments

Strengthening USD

Raw material cost is not a one way street. Commodity prices are ultimately subjected to supply and demand changes. With rising cost, demand will have to go down ultimately, resulted in over supply and a resultant drop in prices. The cycle repeats.

Part of the reason of the rising inflation and cost had to do with the weakening HKD. Hong Kong dollar is pegged to USD, about 7.75-7.85 HKD to a USD and the recent depreciating USD takes a toll on the inflation of Hong Kong in general where most items are imported.

I had already highlighted the reversal in fundamental for USD in my earlier post in May 2008 that the strengthening of USD is expected in the horizon, just that I don't know when. Thus the recent jump in USD against major currencies is not surprising.

A strengthening USD, and hence HKD, will bring a much needed respite to the inflation problem to HKD. Hopefully for Tsit Wing, the 20% increase in cost of sales (mainly due to raw materials) in the past quarters could be reduced in the coming quarters.

Strong balance sheet

They had little or no debt and huge cash horde of about 71m HKD. While the road ahead is challenging, at least they are in good financial shape to tackle the storm. Given the past boom in the Chinese markets in almost every sector, many companies had over expanded on increase leverage. During crunch times with falling demand, tight liquidity and rising interest, their eventual exit from the market should bode well for conservative and sound companies like Tsit Wing. However, until then, there is no foreseeable recovery for Tsit Wing in sight.

Going forward

The near future is dismal. Sales will definitely be hit and falling profits ahead is no longer surprising. Fortunately, they are in a strong financial shape to weather the storm ahead and hopefully, they can emerge stronger.

Tsit Wing's 4Q results on 27th February 2008 - Something positive finally?

Past, present and future results?

I've gathered and compiled Tsit Wing's past segmental results by regions over the last 5 years and reproduced them below.


Tsit Wing had tried to enter the PRC market and had been making losses over the years. It finally turned around in 2007, in line with my earlier prediction in 2006.

Graphical representation


Simplied assumptions in forecast

1. Sales in Hong Kong will increase by 5% annually due to the mature market nature
2. Sales in PRC will increase by 35% annually (on average) due to the competitive but emerging market nature (extrapolating using the last 5 years' trend)
3. Profit margin will trend towards 7% (arbitrary number, so long as its below 10%)

Potential

As can be seen from the chart on gross profits, the blue line clearly shows the turning point in overall gross profit. If Tsit Wing can replicate its logistical competitive advantage in Hong Kong to the major Chinese cities, the potential PRCmarket should allow Tsit Wing to make record profit within the next 5 years.

The falling profit margin, though undesirable, is a nature of diversifying away from a tea, coffee beverage distributor. Its foray into distributing groceries products improve its bottom line, but at the expense of profit margin.

Risk factors

1. Intense competition in PRC markets
2. Profit margin squeeze from rising cost of business, especially raw materials and pricing pressure
   

Comparing Super Coffeemix, Food Empire and Tsit Wing on 26th June 2007

My love for coffee spurred my interest in coffee counters. Hence I decided to compare and contrast the three listed in SGX. Though I buy into companies on individual merit, regardless of sectors they operate in, my portfolio coincidentally hold 2 out of the 3 counters.

Overview

1) Food Empire operates primarily in Russia, Ukraine, Central Asia and Eastern Europe. Its main brands are MacCoffee, Klassno, FesAroma, Bésame, OrienBites, MacCandy, Zinties and Kracks.

2) Super Coffeemix operates primarily in Singapore, other parts of Southeast Asia and China. Its main brands are Super, Owl and Nova.

3) Tsit Wing operates primarily in Hong Kong and a lesser extent in China and Canada. Its main business is actually distribution of coffee and tea products to restaurants and hotels.

Business comparison


Figure 1 - Revenue from 2003 to 2006

It is clear from 2003 that Tsit Wing was running far behind Super Coffeemix and Food Empire in terms of sale. Tsit Wing had closed to 80% of market share in Hong Kong and due to limited expansion success overseas (esp. China), their sale basically stagnated across the years. Super Coffeemix expanded well in Southeast Asia and to a limited extent, China. The growth in Southeast Asia (incl. Singapore) already improved sales by a large margin. Food Empire seemed to have even a better success in Russia, Ukraine, Central Asia and parts of Eastern Europe. It's sale was a little behind Super Coffeemix in 2003 but caught up quite significantly by 2006.

Profitability



Figure 2- Profit Margin from 2003 to 2006

Coffee distribution business is a very competitive business. Competitive business environment without perceivable barriers to entry will ultimately drive down profits to zero for all players. As can be seen from the chart above, Tsit Wing was enjoying high profit margin but competition erodes the margin significantly. Super Coffeemix, profit margin after is no better off after 2005. In stark contrast, Food Empire's profit margin, though showing signs of erosion, kept above 10%.



Figure 3- Earnings per share from 2003 to 2006

Comparing earnings per share, it is clear Food Empire is a runaway success.


Figure 4- Return on equity from 2004 to 2006

Comparing return on equity, unsurprisingly, Food Empire lead the pack. However, Tsit Wing earned better returns on equity than Super Coffeemix.

Comparing the numbers

	Food Empire	Super Coffeemix	Tsit Wing
Revenue (Sale)	234,124	210,690	64,341
Cost of goods sold	117,509	135,161	36,827
Selling & distribution expense	56,746	27,211	10,886
General & administrative expense	23,904	24,440	8,520
Other expense	5,041	898	205
Efficiency
Cost of goods sold to sales	50.19%	64.15%	57.24%
Selling & distribution expense to sales	24.24%	12.92%	16.92%
General & administrative expense to sales	20.34%	18.08%	23.14%
Other expense to sales	2.15%	0.43%	0.32%
Profitability
Net income (excl. non-operating income)	26,319	17,159	6,874
Profit Margin (after tax)	11.24%	8.14%	10.68%
Return on Assets, ROA	17.08%	6.34%	13.02%
Return on Equity, ROE (incl. minority interest)	21.70%	9.17%	15.25%
Earnings per share, EPS
Earnings per share (Cents)	6.42	3.48	3.56
Valuation (As at 26 June 2007)
Historical P/E	20.47	22.43	7.31
Intrinsic Value (SGD)	1.04	0.72	0.30

Table 1 - Business performance across the 3 companies

Comparing their price

From the above figures, it is without doubt that the better performer is Food Empire. The only company amongst the 3 that can maintain a high, double digit ROE, a relatively high, double digit profit margin and yet speculator sales growth is Food Empire. Hence it is not surprising to note that's share price is traded at $1.05, above $0.97 and $0.28 for Super Coffeemix and Tsit Wing respectively.

One interesting fact to note is that the market valued Food Empire and Super Coffeemix relatively the same (97 cents is not that far off $1.05). However, Tsit Wing's ROE, ROA, profit margin and EPS was so much better than Super Coffeemix, yet Tsit Wing traded at only less than 30% of Super Coffeemix's share price.

One possibility was that the market might have anticipated a speculator growth in profitability of Super Coffeemix to justify current price valution. Hence, assume that Super Coffeemix is fairly valued, is there a possibility that Tsit Wing is actually unvalued, given its strong performance indicator? That its trading at such price because it is largely ignored, under researched, compared to Super Coffeemix?

Valuation

I decided to investigate for myself. Taking into consideration their current business prospects and factoring anticipated future earnings, I estimated their intrinsic value using the Residual Income Model. Using a Expected Rate of Return of 10%, I found that Food Empire and Tsit Wing was actually trading at fair value while Super Coffeemix was trading above its intrinsic value. Maybe I underestimated the potential earnings growth of Super Coffeemix.

Tsit Wing 1Q 2007 results on 14th May 2007, pleasant surprise

Tsit Wing's first half in 2006 was good. When the 2nd half took a beating, I thought its 1Q 2007 will follow the downward trend due to intense competition in the food and beverage market in Hong Kong and PRC. Hence the profit growth in 1Q 2007 (a negligible increase of 2.2%, better than negative) came as a pleasant surprise.

However, this came amid a dramatic increase in sales by 63.5% in PRC. But why did the profit only edge up 2.2%? Two things came to my mind:

1. Hong Kong accounted profit dropped dramatically?
2. PRC sales involved mainly high volume low profit margin sales?

These questions can only be answered either at the AGM, or taken from its Annual Report's segmental breakdown next year.

On a separate note, the general erosion of profit margin came as no surprise due to the diversification in business into groceries.

One interesting point to note in the results statement was the line, quoted here: "...Some of the coffee and tea bistros who had switched to cheaper suppliers in 2006 began to revert to us as the use of lower quality products were hurting their business...". The question I had was then, how many of them amonst the those lost and is that sustainable? Only time will tell and I'm prepared to give Tsit Wing more time (for now).

Tsit Wing's Annual Report, April 2007

Tsit Wing's Q3 2006 and Q4 2006 shows that it was enduring a slow profit margin squeeze (attributable to lost business of high margin tea distribution), I noticed an indication of possible recovery in Tsit Wing dismal performance in the face of intense competition in coffee, tea distribution and catering business.

Comparing segmental results of its 2005 and 2006 Annual Reports, I noticed that its China segment was all along making loses. In year 2004, its China segment suffered a loss of 6.7 million HKD. In year 2005, it the lost was reduced down to 5.2 million HKD. In year 2006, it was further cut down to 1 million HKD. Extrapolating this trend, I expect its China segment to venture into the black, or at least break even this year. This meant that there will be possible stronger showing by Tsit Wing this year, 2007 compared to last. Finger crossed!

First purchase after refined understanding, Tsit Wing in October 2006 and Food Empire in November 2006

With refined understanding about investing, most importantly in how to understand and value a business, I made new purchases, two stocks trading above NAV this time.

In October 2006, I bought Tsit Wing (coffee and tea distributor) at 30 cents. I estimated its intrinsic value to be about 60 cents, cost of capital at 10%. Tsit Wing was able to conquer a substantial market share of Hong Kong and was venturing into China. I thought then that if Tsit Wing could survive so well in Hong Kong, there must be something it did right to maintain its market share, something considered as competitive advantage? I would realise later there wasn't much competitive advanage about Tsit Wing.

In November 2006, I bought Food Empire (coffee distributor) at 53 cents. I estimate its intrinsic value to be about 75 cents, cost of capital at 10%. This business was brought to my attention by a fellow value investor. By then it was trading at 53 cents, its nearly 1.7 times NAV. However, the fact that it operated in emerging market in Russia, Ukraine, Eastern Europe (not popular China, India) fascinated me. There were so many brands in these countries, yet the coffee provider, Food Empire (foreign to the market it operate in) could conquer a substantial market share showed that it should possess some competitive advantage over rivals, at least in term of branding.