Thursday, 11 May 2017

QAF LIMITED'S STRATEGIC REVIEW



Last Friday, QAF announced that it would be conducting a strategic review of its Primary Production business, which may include a listing in Australia or a sale of the business in its entirety. I decided to write about my analysis of QAF's business segments, as well as the potential impact of the strategic review. 



Company Information


QAF Limited is a multi-industry food company with three main business segments - Bakery, Primary Production and Trading & Logistics. Most of the profits come from the Bakery and Primary Production segments. After reaching an all-time high of $1.58 in February, QAF's share price has been on the downtrend. 


Segment EBIT
($'000)
BakeryPrimary productionTrading & LogisticsInvestments & othersConsolidated
201632,26342,1402,9462,54479,893
201560,11916,7773,559(560)79,895
201454,02410,2472,9282,49869,697
201352,1372,2832,52591857,863

I have summarised QAF's earnings before interest and tax expense (EBIT) for the past four financial years. In 2016, as Gardenia Bakeries KL became a joint venture, it contributed an additional $6.39 million in profits to the Group.

Strategic Review of Primary Production business


QAF's Rivalea Group has a 17% market share in Australia. Based on QAF's 2016 Annual Report, the Primary Production segment accounted for $248 million in assets and $54 million in liabilities. As QAF is currently trading at around 1.4 times of its net asset value, the sale of the Primary Production business could potentially bring in around $300 million, assuming that it is sold at a 10% premium. As for whether a special dividend would be declared, we would have to factor in QAF's capital expenditure of about $130 million this year, mainly for the expansion of bakery production capacity.

Earnings before interest and tax (EBIT) from the Primary Production segment surged to $41 million in 2016, compared to $16.8 million in 2015. The management has explained that this huge increase was mainly because to the increased profitability in Rivalea, QAF's meat producer located in Australia. Rivalea increased its revenue through higher average selling prices and increased sales volumes. Operating costs were also reduced through productivity gains and lower feed costs. 

Looking at the past four years' of EBIT for the primary production segment, I doubt the surge in earnings can be sustained. QAF's management has highlighted near term challenges, including higher feed costs, which would increase Rivalea's operating expenses, and heightened competition from both local producers and importers, which may result in lower sales volumes and lower profit margins. Going forward, Rivalea would be subjected to a 30% corporate tax, which would further reduce its net profit. 


Expansion plans for Bakery Segment


If the Primary Production Segment is sold off, QAF's bakery segment would account for nearly all of its profits. The Bakery segment used to be the largest contributor to its profits, up till 2016, when regulatory reasons meant that QAF had to sell its 20% stake in Gardenia Bakeries KL (GBKL) to its joint venture partner. 

Together with the sale, a new Licensing Agreement for the joint venture had been made, which reduces the licensing fee payable by GBKL to QAF from 5.25% to 1.5% of the gross sales of each bakery GBKL operates. This is a rather critical negative development for QAF, as assuming the agreement had been effective form the beginning of 2015, it would have reduced QAF's earnings per share in 2015 by 10.9%.

With its reduced profits from GBKL, QAF's bakery segment would have to seek further growth opportunities in other countries. Their bakery segment operates in Singapore, Australia and the Philippines, distributing bread under its Gardenia and Bakers Maison brands. To meet growing demand from consumers, plans to expand its production capacity are in place. QAF is constructing a new $56 million bread plant in Johor, which is expected to commence operations by the first half of 2017. Gardenia Philippines would be setting up a new $25 million production plant in Mindanao, and has acquired a large plot of land in Luzon to set up a new bread manufacturing plant in the future. When the new plants are completed, the Group’s total number of bakery plants would increase to 16. These long- term expansion plans would fuel growth and increase QAF's revenue. I believe that QAF's bakery segment is a defensive business, given that sales of bread products is non-cyclical.


Trading & Logistics



Trading and Logistics is the smallest contributor to QAF's net profit. This segment involves the wholesale distribution of household staples including Cowhead milk and dairy products, Farmland and Haton. QAF also operates a cold store Jurong for storage of fresh fruits and vegetable, which has a capacity for 14,000 pallets.

EBIT from this segment has been stable for the past few years, but only makes up a small proportion of total profits.


Conclusion


QAF Annual Report 2016


I think that the sale or listing of its Primary Production business would benefit QAF, as it would allow QAF to focus on expanding its Bakery segment, which is a relatively defensive business. Overall, QAF is a stable, long term consumer staples company which I would like to add to my portfolio. Its sources of revenue are diversified across different geographical regions, and QAF has been consistently paying an annual dividend of 5 cents, which translates into a yield of 3.68% based on its current price of $1.36. I view any further downside as an opportunity to accumulate QAF's shares, as I believe that it is a company which has potential for long-term growth.

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