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6 things I learned from the 2019 DKSH Holdings EGM

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DKSH Holdings (Malaysia) Berhad (DKSH) has been a listed company of the Main Market of Bursa Malaysia Securities Berhad since 1994. It is the leading market expansion services provider with a capillary distribution network in Malaysia. It helps its business partners grow in new and existing markets through its 29 business locations and eight regional distribution centres in the country.

It
is involved in three operating segments, namely marketing and distribution,
logistics, and others. The last segment mainly comprises the company’s chocolate
chip cookies and chocolate-related businesses under the Famous Amos brand.
DKSH’s majority shareholder, DKSH Holdings Ltd. of Switzerland (74.31%
shareholding), is also publicly listed on the SIX Swiss Exchange.

In December 2018, DKSH entered an agreement to buy the entire equity interest of Auric Pacific (M) Sdn Bhd (APMSB) – a distribution business in Malaysia — from Auric Pacific Group Limited for S$157.7 million (equivalent to RM480.9 million).

I
was interested about the management’s view on the proposed acquisition and
decided to attend the extraordinary general
meeting. Here are six
things I learned from the 2019 DKSH EGM:

1. APMSB manufactures and distributes house-brand products such as Buttercup and SCS butter in Malaysia. It also distributes and trades international chilled and frozen food products and fast-moving consumer goods ranging from McCain frozen foods to Oreo cookies in the country.  By acquiring APMSB, DKSH would be able to enhance its clientele and attract new clients. Business integration is key and DKSH will maintain APMSB’s management after the acquisition.

2. DKSH considers the proposed acquisition a horizontal integration strategy. APMSB’s strong presence in the chilled and frozen products segment as well as food service channels such as restaurants, hotels, and cafes would complement DKSH’s existing business. APMSB’s 2016-2017 net profit margin ranged between 6.1% and 7.1%, which is a lot higher than DKSH’s average margin of 0.4% between 2002 and 2017. In addition, the proposed acquisition is foreseen to increase DKSH’s distribution network and expand its food manufacturing range. Overall operational cost efficiencies will be improved as well. On a separate note, Auric Pacific Group Limited will be subject to a non-compete tender legally for three years so that they cannot establish a similar business after they sell it.

3. DKSH intends to fully fund the purchase through bank borrowings. A number of shareholders were concerned about the marked increase of the gearing ratio from 0.05 (as at 31 December 2017) to 0.90 should the proposed acquisition be approved.The post-acquisition gearing ratio will be 18 times higher than it was before if bank borrowings are used entirely to finance the purchase. The independent adviser also noted that DKSH may have to incur higher interest expenses for future borrowings given the high gearing.  The board of directors reassured shareholders that ‘a gearing ratio below 1.0 is still relatively conservative’ and is confident that DKSH will be financially sound based on its operating cash flow. As at 31 December 2017, APMSB’s unsecured borrowings stood at over RM13 million and the borrowings were factored into the purchase consideration.

4. Shareholders were worried that DKSH’s financial performance would deteriorate after the proposed acquisition. Some shareholders viewed DKSH as a dividend stock and concerned about the impact of the acquisitiononits future dividend yield. As highlighted by a shareholder and as addressed by a representative from AmInvestment Bank, DKSH’s net assets per share will be diluted from RM3.60 (FY2017) to RM3.59 and its earnings per share reduced from RM0.33 (FY2017) to RM0.29 if the proposed acquisition is completed.

5. DKSH Holdings (S) Pte Ltd (DKSH SG), a related company of DKSH also entered into an agreement to purchase 100% of equity interest in Auric Pacific Marketing Pte Ltd and Centurion Marketing Pte Ltd from Auric Pacific Group Limited for about S$60.7 million. Both target companies are involved ‘in the wholesale distribution and manufacture of food and allied fast-moving consumer products’ including butter and margarine in Singapore. The acquisitions in Malaysia and Singapore are inter-conditional of each other as Auric Pacific Group Limited would like to dispose all businesses in one transaction. The board emphasised that the proposed acquisition of APMSB was made on an arm’s length basis.

Existing structure. Source: EGM presentation slides
Structure after acquisition. Source: EGM presentation slides

6. Auric Pacific Food Processing Sdn Bhd, which is wholly owned by APMSB, must obtain a manufacturing licence from the Ministry of International Trade and Industry under the Industrial Co-ordination Act 1975 before the proposed acquisition is completed. As pointed out by a shareholder, Buttercup is an old brand that manufactures butter in Malaysia and should have had a manufacturing license earlier. The board explained that Buttercup has been around long before a manufacturing license was needed and they didn’t apply for one afterwards. It was DKSH that insisted for a manufacturing license. License approval was obtained in January 2019.

At the end of the EGM, results showed that 99.9% of the votes cast were in favour of the proposed acquisition. The acquisition will be completed by the end of March 2019.

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