PPHB (8273) - Public Packages Holdings Berhad: Revisiting PPHB's Valuation
Introduction
While paper packaging businesses are seen as a sunset
economy in comparison with Malaysian industry generally, they prove
considerably more marvelous than many investors thought would be the
case only a few years ago.
The reason paper packaging businesses have been growing in
the past was not only physical growth, but also the increasing pricing power
that niche participants wielded. Most important of all, the number of paper
packaging manufacturers have substantially decreased. As a consequence, dollars
spent are more narrowly split.
Everyone now recognizes that the changes going on in the
paper packaging industry are largely due to the boom of e-commerce, industries,
and convenience consumption. In particular, Alibaba is aspired to make Malaysia
as its first offshore logistics hub and the platform for digital free trade
zone.
These economic changes materially increase the intrinsic
value of paper packaging companies, especially those who are transforming from
commodity-like businesses to quality franchises. The latter is attractive to
investors as franchises can tolerate mis-management.
In this letter, we revisit our valuation of PPHB using “a
change in media economics and some valuation math”, which was written by
Buffett, as our guide.
Our guide
PPHB
Our previous analysis found two divides of development in
the paper packaging industry: (1) specialization in generic packaging products
and (2) transition into high-value packaging products.
For companies (e.g., MUDA and ORNA) in the first category to
do well, they have invested intensively in technology for expanding production
lines in order to achieve better economies of scale. As a result, the strength
of pricing power erodes as mass production proliferates.
PPHB is the only listed company that seeks differentiation
and falls under the second category. In addition to common paper
packaging products, customization services are offered for high value
industrial and consumer paper
packaging vis-à-vis paper-based promotional products. Through in-house
R&D,
it now also owns 2 design patents. Its Lean Manufacturing System &
Process helps
eliminate non-value added process. Consequently, it achieved
dual-reinforcement
leading increasing profit margins.
Revisiting our
valuation
In the Discounted Cash Flow model that demonstrated in our
previous publication (see here), PPHB is
estimated to worth RM1.78 apiece or 11.79x PE and 7.22x EV/EBIT on the basis of
10% growth in average Free Cash Flow per annum prior to 0% permanent growth
rate at 10% discount rate.
Given that we are conservative with the permanent growth
rate and discount rate, annual growth rate becomes the only variable requiring
further discussion.
“In the business world, unfortunately, the rear-view mirror is always
clearer than the windshield”
~Warren Buffett~
In addition to increasing demand for paper packaging
products, PPHB has been efficient in reinvesting retained earnings for steering
efficiency, productivity, and profitability – all in, organic growth.
PPHB passed the Buffett’s $1 test by returning additional RM2.07
Value on every RM1 Capital Expenditure, assuming 10% cost of capital.
Its FY16’s Capital Expenditure surged to RM12.633m,
surpassing its average estimate of RM4.573m.
While we can argue that fresh Capital Expenditure could be
used for PPE maintenance, its past Depreciation and Amortisation at top was
RM7m. That non-cash expense was significantly higher than RM4.573m average Capital
Expenditure albeit common understanding that Depreciation charges would roughly
match Capital Expenditure in zero growth case. Given the discrepancy, it is safe to conclude
that its maintenance requirement is minor
and even little reinvestment is effective
in boosting efficiency, productivity, and profitability.
Therefore, the recent RM12.633m Capital Expenditure is seen
to reinforce its organic growth in line with the increasing market demand.
Based on its track record of Buffett’s $1 test, we
hypothesize that PPHB would be able to increase its Earnings approximately by
RM2.615m (RM12.633m x 10% discount rate x RM2.07 value created) or 15.8% on the
FY16 base.
Although that 15.8% Earnings growth is higher than its 12.4%
CAGR, it is underpinned by 2.76x its average Capital Expenditure. Such growth rate
is in the bag of its track record, i.e. Earnings of FY16 grew by 16.76% with RM5.825m
(1.27x average Capital Expenditure) reinvestment.
Based on that potential, our assumption of 10% annual growth
rate and, hence, our valuation of RM1.78 apiece is deemed conservative.
Conclusions
In that masterpiece of Berkshire Hathaway Chairman’s Letter
1991, Buffett demonstrates a hypothetical business which earns $1m a year that
can grow at 6% per annum in perpetuity is worth $25m. This is in contrast to a
competitor earning the same $1m with no growth which is worth only $10. While a
multiple of 25 earnings is appropriate for the first company, the competitor
fetches 10 times earnings.
Currently, PPHB is selling for RM1.20 apiece, translating
into 7.95x PE and 4.5x EV/EBIT. Through sensitivity analysis in our previous Discounted
Cash Flow model, at the current trading price, Mr Market suggests
that PPHB’s earnings will deteriorate at 10% in perpetuity after experiencing
10% annual growth rate on 10% discount rate. The valuation of current stock
price is poorer than the valuation of 0% growth rate that guided by Buffett.
We conservatively suggest that PPHB is worth at least RM1.78
apiece. This valuation represents 11.79x PE and 7.22x EV/EBIT. It is still far
from Buffett’s 25 times earnings for a company growing at 6% yardstick.
“The market
may ignore business success for a while, but eventually will confirm it. As Ben said: “In the short run, the market is a
voting machine but in the long run it is a weighing machine.”
The speed at which a business’s success is recognized, furthermore, is not that
important as long as the company’s intrinsic value is increasing at a
satisfactory rate. In fact, delayed recognition can be an advantage: It may
give us the chance to buy more of a good thing at a bargain price.”
~Warren Buffett~
PPHB (8273) - Public Packages Holdings Berhad: Revisiting PPHB's Valuation
http://valueveins.blogspot.my/2017/03/revisiting-pphbs-valuation.html
http://valueveins.blogspot.my/2017/03/revisiting-pphbs-valuation.html
