QAF’s Business Model
QAF Ltd has several business segments- Bakery, Primary Production, Trading and Logistics, Cold Store Operations and Others. Because QAF’s profit and revenue are significantly influenced by only its bakery and primary production segments, this initiation report would only focus on these 2 segments.
Its bakery segment is primarily engaged in bakery manufacturing and distribution of familiar brand names such as Gardenia and Bonjour.
Its bakery segment has a presence in Malaysia, Singapore, Philippines and Australia. It is a market leader in Malaysia, Philippines and Singapore. Specifically, its main competitor in Singapore is owned by another listed company in Singapore, Auric Pacific, which distributes bread under the Sunshine and Top One brands.
The other critical business segment is Primary Production where QAF owns the largest fully integrated pork production business in Australia under the Rivela brand. Rivela has up to 17% of Australia’s pork production. A simple supply chain can explain how the fresh pork, ham and bacon that we see in supermarkets are derived from farm to table.
Diagram 1: QAF’s Rivela Pork Production Supply Chain (Source: OCBC Report)
QAF owns stockfeed mills that produce all of Rivela’s stockfeed requirements and will send the stockfeed to feed the pigs in its farms and third party farms. Its slaughterhouse will debone, pack and send trays of pork to supermarkets and to be exported. Therefore, it is not difficult to understand how having control over the entire supply chain allows QAF to control operating efficiency, cost and selling price. Let’s assess how QAF fare in terms of Fundamental Analysis.
Investment Merits of QAF
Solid financial track record
QAF has a proven track record of turning in slow and steady increase in profits underpinned by stable revenue. Maybe this can be attributed to the fact that people would always eat bread and pork, regardless of the economic situation. Some may think that its results are boring and unspectacular, but they are deemed attractive enough to have caught Heartland Boy’s eyes. In particular, since 2014, its primary production has turned in higher profits due to increased sales volumes and selling prices, as well as lower operating costs.
There is evidence that shareholders can expect this to continue as QAF has turned in another set of commendable results for 1Q2016, with net profit increasing 25% year on year as it further entrenches its leadership in the markets that it operates in.
Table 1: Stable Revenue, Increasing Net Profit and Net Operating Cashflow of QAF
Increasing Gross and Net Margins
Perhaps, it is most pleasing to realise that QAF’s gross and net margins are on an uptrend since 2013. Furthermore, QAF’s gross and net margins are also superior to its most direct competitor, Auric Pacific.
Growing Return on Equity
Heartland Boy is only prepared to accept an ROE of 12% for any of the stocks that he has invested. QAF has recently crossed this threshold by registering an ROE of slightly over 12% in 2015. For other financial ratios, readers may refer to Yahoo Finance.
Table 2: Improving Gross and Net Margins and Growing ROE of QAF
Negligible Net Debt Situation
With interest rates forecast to increase in 2016 and beyond, QAF is in an enviable position of having the flexibility to utilize its cash to repay almost all of the loans it has undertaken. Its net debt position is a negligible S$ 100,000. Peanuts for a company with a market capitalization of over S$600 million!
High Dividend Yield
At a stock price of $1.1, it has a dividend yield of 4.6%. Generally, it pays dividends twice per fiscal year.
Sustainable Competitive Advantage
QAF’s competitive strengths, especially in the bakery segment, lies in its branding power as well as the extensive distribution network that it controls. This has allowed Gardenia to command 60% of the packaged bread category in Singapore. To further entrench its competitive advantage, Gardenia Foods was also the first local bakery to be awarded the prestigious Platinum Award by Agri-Food & Veterinary Authority Singapore (AVA) for achieving Grade A status in the Food Safety Excellence Scheme for 20 consecutive years!
It is also important to note that its dominance and brand equity is not just restricted to the Singapore market. For instance, its subsidiary, Gardenia Bakeries Sdn Bhd was once again voted the “Most Preferred Brand” in a nationwide survey on Malaysian consumers.
Good Growth Story
QAF recently constructed a new factory in Philippines and this could not have come at a better time as its existing factory in Philippines is already running at full capacity. This allows QAF to bring in its premium brand, Bakers Maison, into Philippines as it rides on the growing middle class’s aspirations for artisanal bread. The increased capacity will allow QAF to penetrate deeper and wider into the expanding modern grocery retail channels in Philippines.
Investment Risks of QAF
Susceptible to fluctuation in prices of raw materials
With regards to the rearing of pigs, Rivela is particularly susceptible to fluctuation in prices such as wheat, barley and grains that are all necessary to produce the pigs’ stockfeed. While Rivela attempts to mitigate this by directly purchasing them from local growers, it will be prudent to observe the prices of these raw materials in light of the El Nino phenomenon. Heartland Boy often refers to the Australia Bureau of Agricultural and Resources Economics to check out feed outlook for grain prices, as well as global wheat prices, another critical raw material needed for QAF’s bakery segment.
As a company that operates in several markets, it is inevitable that QAF is subject to foreign exchange risk. For instance, it recorded lower revenue in 2015 in Singapore Dollars terms although it actually achieved higher sales in Ringgit for its bakery segment. This is due to the drastic decline in the Malaysian Ringgit vis-à-vis Singapore Dollar. Therefore, it would be mindful to pay attention to both Malaysian Ringgit as well as Australian Dollar.
Conclusion of QAF
Everybody eats bread and QAF is indeed a good defensive stock to have in one’s portfolio in today’s highly volatile market. Heartland Boy is an extremely satisfied and loyal customer of Gardenia brand and is always impressed by the new products rolled out on a frequent basis. For instance, the recent chia seed wholemeal bread should be a winner, especially with the recent negativity surrounding refined carbohydrates as well as the clamour for superfoods. Heartland Boy cannot help but think that he is contributing to QAF’s coffers every single time he buys a loaf of Gardenia wholemeal bread for his weekly breakfast. Guess it is still possible to have your bread and eat it too.
Heartland Boy has a share price target of $1.4 on QAF Limited.
Vested in QAF shares at 1.05 cents since May 2016
This article was written on 12 June 2016.