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SI Research: Is Delfi Compelling Enough?

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When Warren Buffett acquired See’s Candies in 1972, he called the boxed candy business “the prototype of a dream business.”

You see, retail investors often get distracted by “the next big thing”, and miss out on opportunities of “boring” businesses. This inclination often makes retail investors susceptible to the “fear of missing out”. But from tulips to bitcoins, we have seen how asset bubbles form when the price actions become the main driving force, only to turn into costly investing mistakes when the bubble burst.

For the Oracle of Omaha, Buffett made his riches by focusing on businesses that he knew best instead of giving way to the herd mentality. He calls this strategy the “circle of competence”. Against insiders and deep pockets that often have an advantage in accessing and analysing information, it also seems like common sense that retail investors should keep within their “circle of competence” and employ the buy-and-hold strategy.

In this peak economic environment, with weakening global expansion, we believe the medium term outlook is going to be increasingly risk-off. In such a climate, investors often would put greater emphasis on fundamentals and quality. In this issue, we take a look at Delfi, a chocolate confectionery business similar to See’s Candies, and see if there are similar compelling reasons to buy a stake in the company.

Delfi – A Defensive Business

Originally known as PetraFoods, mainboard-listed Delfi is a manufacturer of chocolate confectionery. Operating in a relatively obsolete-immune industry, Delfi markets and distributes its own brand, as well as other agent brands, of chocolate confectionery in its core markets of Indonesia, Philippines, Singapore and Malaysia.

With a rich history spanning over 60 years, the group’s portfolio of chocolate confectionery brands, include 10 master brands such as SilverQueen, Ceres, Delfi and more than 20 key sub brands.

Delfi’s extensive sales and distribution network across South East Asia is supported by two chocolate manufacturing facilities in Indonesia and the Philippines. In addition, the company also markets chocolate confectionery products in other countries in Asia such as Thailand, Japan, Hong Kong, Australia and China through the use of sales agents and distributors.

In its key core market of Indonesia, Delfi commands a dominant 50 percent market share. In FY18, the Indonesian market accounted for 71.6 percent of Delfi’s revenue. As at 08 April 2019, the company has a market capitalisation of $855.6 million.

Poised For Recovery

Reviewing its financial performance, Delfi seems to be on the verge of recovery. In the past 5 financial years, FY13 to FY17, Delfi experienced a downtrend in revenue from US$509 million to US$381 million. In the face of ailing sales, the company embarked on a rationalisation exercise of underperforming brand products in FY16, which finally bore positive results two years later in the latest FY18. Revenue stabilised and grew 12 percent to US$427 million, kickstart by Delfi’s own brands which saw contributions grew 16 percent to US$281.3 million in Indonesia during the period.

Source: Company’s announcement

Profitability-wise, Delfi managed to maintain a rather healthy gross margin of over 34 percent, since improving from 29.8 percent in FY15. Earnings before interest, taxes, depreciation and amortisation (EBITDA), which exclude exceptional and one-off items also showed significant improvements. In FY18, Delfi’s EBITDA of US$51.3 million represented an increase of 15 percent from FY17 and an increase of 37 percent from FY15. In terms of net profit, Delfi generated US$20.9 million, a 6 percent gain, which represented a net margin of 4.9 percent and a double-digit return-on-equity (ROE) of 10 percent.


Source: Company’s announcement

Riding On Macroeconomic Tailwinds

While Delfi records input costs and reports earnings in the US currency, its revenue is derived mainly from the Indonesian followed by the Philippines markets. As such, weaknesses of the regional currencies of the Indonesian Rupiah and Philippines Peso would weigh on revenue when translated back into US Dollar terms.

In FY18, the Rupiah and the Peso depreciated six percent and 4.3 percent respectively against the US currency. However, despite that, Delfi still posted growth in the topline. This implied that the positive results and momentum in the company’s rationalisation efforts managed to offset the effects of currency headwinds. Going into FY19, the stabilisation of regional currencies should further bode well for Delfi.

Meanwhile, the Indonesian economy is expected to grow a solid 5.2 percent in this election year, further bolstering domestic demand. Delfi, given its lion share of chocolate confectionery, is therefore well-positioned to leverage on Indonesia’s rising purchasing power and middle class. Combining the two macro factors, we believe there is scope for Delfi to grow its revenue as well as boost its gross margin and hence further enhancing profitability.

Pristine Financial Health

As of FY18, the group held cash of US$54.7 million while total borrowings amounted to US$59 million. This translated to a small net debt of US$4.3 million.

Against its book value of US$206.1 million, Delfi’s total debt-to-equity ratio of 28.6 percent and net debt-to-equity of 2.1 percent showed that the company still maintains a pristine balance sheet. With a current ratio of 1.5 times, there are also little concerns towards Delfi’s short-term liquidity needs.

Alike another reason why Buffett likes See’s Candies, Delfi’s confectionery business is also cash generative. Net cash flow from operations was positive in the last six years in review, from FY13 to FY18. According to management, Delfi generated US$10.6 million from operations in FY18, “sufficiently funded the higher working capital and capital expenditure for the year as well as the dividends paid to shareholders.”

But… Expensive Valuation

Despite all the qualities we like about Delfi, the current valuation of the stock is rather unattractive. At the time of writing, stocks of Delfi are changing hands at $1.40 apiece, translating to a price-to-book value of three times and a price-to-earnings of 30.1 times.

Dividend-wise, the company declared a final dividend of 1.10 Singapore cents, to bring total dividends for FY18 to 2.57 Singapore cents in FY18. This would also translate to a not-so-attractive yield of just 1.8 percent. Whilst the total dividend of 2.57 Singapore cents in FY18 represented an increase from 2.42 Singapore cents in FY17, Delfi has also not been consistent with its dividend payouts as well.

In conclusion, since the right kind of investments are always buying into superior businesses at the right kind of price, we think Delfi – at its current valuation – does not give investors much potential upside for the risks they would need to undertake. Nonetheless, it is still a counter worthy to stay on the watchlist. Patient investors interested in Delfi may want to wait for more attractive valuation.

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