Warren Buffett once said "I am 85% Benjamin Graham and 15% Phillip Fisher"
Quantitative rear-view mirror in Graham-approach determines if a value stock offers adequate margin of safety.
Qualitative rear-view mirror and windshield in Fisher-approach build our understanding of (1) businesses and products/services of a company and (2) key factors affecting the company's success.
Having these insights can provide a huge edge to investors.
Since we have focused on PPHB, it is the objective of this letter to review and synthesize important notes from Annual Report of its competitors - Boxpak, Kym, Master, Muda, and Orna.
In their Annual Report, wealth of information is available in the chapter on Management Discussion & Analysis (except Kym).
Scuttlebutt Approach
Global corrugated market: 90m tons worth RM140b in 2013.
Largest producing country: China but it relies on imports to meet local demand.
Expected growth rate: 4% per annum until 2019.
Projected distribution: By 2019, 47% of corrugated packaging will be used in the packaging of processed and fresh foods. Electrical goods will be the single largest non-food packaging application, followed by paper products and personal and household care items.
Local paper & corrugated packaging industry
Concentrated structure: Industry consolidation began when Oji Group acquired GS Paper & Packaging Sdn Bhd and other companies. Today, less than 100 manufacturers are listed in the M'sian Corrugated Cartons Manufacturer's Association. In comparison, there are some 1,200 manufacturers in Viet Nam.
Main raw materials: Paper rolls contribute more than 60% of the total production cost. Imported paper rolls are subject to 0%-10% import duty; local paper rolls are preferred. Prices of local paper rolls are influenced by the international prices of paper pulps, old corrugated cardboards, and waste paper as well as foreign currency exchange rate.
Increased production costs in 2016: Cost of various types of local paper rolls increased between 6% and 10%. Rebate of electricity tariff was reduced to 1.52 sen/kWh compared with 2.25 sen/kWH from July to December 2015. Natural gas tariff was upped by 5.95% from an average price of RM25.53/MMBtu to RM27.05/MMBtu. The minimum wage increased from RM900/month to RM1,000/month.
Waste management: Paper wastes are sold back to paper mills for recycling.
The product
Use of corrugated cartons: For primary and secondary packaging
A sustainable product: Paper and corrugated packaging is a sustainable product as it is required to (1) protect and transport goods and (2) provide marketing appeal and information.
Versatility: The process of corrugating can transform paper into all kinds of shapes and forms. Corrugated materials can also be made into other usable articles, such as stationery, paper plates, cups, and even furniture.
Environmentally friendly: Most corrugated content is approximately 73% recovered from recycling. Corrugated packaging and products are close substitute to plastic, foams, wooden crates and metal.
Patents: Master and PPHB own and produce some patented products.
The customers
Diversified local customer base: Paper and corrugated packaging companies serve food & beverage, solar energy, electronic and electrical, lubricants, footwear, furniture, converter, and ceramics industries. These industries are expected to register healthy growth.
Credit terms: 30-90 days
Nature of order: Customization with minimum production quantities are required. Excess production is a waste given that cartons have limited shelf life.
Anticipated risks
Gas Cost Pass-Through (GCPT) mechanism: Elimination of subsidy for natural gas will lead to higher energy cost. Bio-mass and coal are alternative sources of heat energy to soften (not eliminate) the impact of GCPT action. Thus far, only Muda has that facility.
Prices of paper rolls: Supply of raw materials (waste paper and pulp) is tight at the international level. Volume of recovered waste paper is limited in Malaysia. Both will translate into higher prices of paper rolls compounding by higher consumption of the local industry. Thus far, only PPHB has adopted Lean Manufacturing Systems & Process, which eliminates non-value added process, to eliminate wastes.
Drivers of growth
Demand: Industries that paper & corrugated packaging companies served are projected to grow. In particular, electrical & electronic and food industries have recorded double digit growth in the first quarter of 2017. Booming e-commerce and retail boost demand for corrugated products. Demand reinforcement also comes from public policies banning plastic bags.
Average selling price: Imports of raw materials and local paper rolls have become cheaper in line with Malaysian Ringgit appreciation in the first quarter of 2017. However, the net effect on average selling price and profit is unclear. In previous cases of increased raw material costs, only Muda, Orna, and PPHB have demonstrated success in passing increased cost to customers.
Production capacity: All players have acquired new machinery and expanded plant and production capacity. The most significant capital expenditure was made by PPHB in relative to the size of its Property, Plant and Equipment.
Efficiency and productivity: All players face the same issues of production cost and regard efficiency and productivity as keys to profitability. While its competitors cried foul of compressed profit margins, PPHB has reported increasing profit margins year after year.
The best guy in the industry
In this letter, we have learned the (1) businesses and products/services and (2) key factors affecting the performance of companies operating in the local paper and corrugated packaging industry.
Like any commodity business, selling volume at the lowest cost is key to success. Based on this single aspect of efficiency and productivity, PPHB is clearly the best guy in the industry albeit offering differentiated high-value total packaging solutions.
That conclusion is reinforced by its track record in meeting Buffett's tenets, which are summarized below:
