Download Lasco Manufacturing Limited

September 13, 2011
BUY
Lasco Manufacturing Limited
Price at Sept 13, 2011
Price Target
52-Week Range
Strong revenue growth, improved margins & tax break
$9.00
$10.50
$2.50 – $9.55
Mario Ahjahorie
Financial Analyst
[email protected]
Company Overview
Lasco Manufacturing (LASM) is a company which was formed
over a year ago and is the product of two long standing
subsidiaries Lasco Food Proccessor’s Limited and Lasco Food’s
Limited which together produce Soy and Milk based products.
The amalgamation of the entities was in anticipation of their
initial public offering and their combined product lines
include:
1.
2.
3.
4.
5.
6.
Key Metrics
Lasco Whole Milk
Lasco Readi Milk
Lasco Food Drink
Lasco Lasoy Lactose Free
Lasco Oats Porridge
Lasco Milky Soy
Q1 2010
Q1 2011
Gross Margin
29%
31%
Operating Margin
19%
19%
Net Margin
12%
19%
Debt-to-Equity
0%
0%
Current Ratio
95%
62%
ROE
8%
18%
ROA
29%
31%
Book Value
$0.86
$2.54
EPS (Last 4Q)
$0.73
$1.22
Trailing PE
8.48X
7.37X
N/A
3.55X
PBV
Company’s Board and Management
The company’s board and management have both its strengths
and weaknesses. Amongst the good are the qualifications and
experience of the board and management in the sector they
operate.
The allegiance (marriage) between the Chairman (Lascelles
Chin) and Managing Director (Dr. Eileen Chin) are key
weaknesses of the board and management structure.
Potentially the board could make strategic decisions in favour
of management instead of all shareholders. Additionally, the
presence of 2 out of 5 non-independent directors is
unfavourable as it fails to include a mechanism which is
protective of the rights of minority shareholders.
Business Model and Strategy
The company attempts to deliver low cost products to suit the
needs primarily of the Jamaican market. The company imports
the raw materials, add flavours and packages them for
distribution at retail and wholesale chains. Margins are
moderately positioned as the company tries to keep product
costs low for its consumers.
Figure 1: Lasco Manufacturing Timeline
1988
Lasco
Group
founded
May 2010
Renamed to
Lasco Man.
Oct 2010
Listed on
the JSE
Sep 2010
Initial Public
Offering
1994
Incorporation of
Lasco Foods
Figure 2: Shareholder Breakdown
Shareholder
% Stake
80%
0.4%
8%
12%
Hon. Lascelles A. Chin, O.J.
Wayne Chin
Connected Parties*
Public Investors*
* - Based on Sep 2010 prospectus
Figure 3: Board of Directors
The Hon. Lascelles A. Chin,
O.J.
Chairman
Dr. Eileen
Chin
Anthony
Chang
Lester
Spaulding
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Prof. Rosalea
Hamilton
Business Environment
Lasco Manufacturing is a Distributor
Lasco Manufacturing interestingly is a misnomer for a
company which is primarily considered a distributor, according
to data collated from the Statistical Institute of Jamaica
(STATIN). The Retail & Wholesale Industry, which LASM is a
part of, is one of the largest contributors to the economy,
however, it contracted for all quarters in 2010 and in the first
quarter of 2011. Commendably, Lasco has been able to operate
counter to this trend growing revenues an impressive 15% for
2011.
Similar to all manufacturing companies in Jamaica, Lasco faces
the risks of fluctuations in raw material costs and the impact of
escalation in inflation and the exchange rate on operating
costs. Historically, the exchange rate has exhibited a significant
amount of volatility but has settled in recent times around the
$86 mark, assisted by the IMF standby agreement. Similarly,
the inflation rate has abated compared to previous periods and
is targeted at single digit in 2011. The relatively benign
inflation outlook coupled with a weak labor market should
enable the company to control its operating expenses for the
foreseeable future.
High Electricity Costs – Not a Problem
Unlike other manufacturing entities, an examination of Lasco’s
financial data shows that high electricity cost is not a major
problem for Lasco. This might be due to the fact that LASM is
not involved in extensive manufacturing as alluded to above.
The company’s production process results in utility costs
(including electricity) accounting for a mere 5% of operating
expenses.
Economy weak, Lasco strong
Producing for local consumption is challenging given the weak
economic background. The economy eked out a growth rate of
1.5% for Q1 March 2011, after 3 years of contraction. It means
consumers’ spending power is still lukewarm as the growth rate
was not enough to make a meaningful dent on the
unemployment rate.
Fortunately for Lasco, their products are positioned at the
lower end of the spectrum, which allowed them to benefit from
a shift in consumer spending habits. On the flip side, a recovery
in the economy could see consumers shifting away from Lasco
products. To combat this, the company will have to ensure
their products are not branded only as low cost alternatives but
also as high quality products when consumers regain their
Figure 4: GDP Economy vs GDP Distribution
Distribution GDP lagging
Overall GDP rebound
1.0%
0.0%
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
-1.0%
-2.0%
-3.0%
-4.0%
GDP - Economy
GDP - Distribution
Figure 5: Inflation - Reducing
30.0%
Inflation rate has abated and
stabilized, allowing companies
like Lasco to better control
operating costs
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
Figure 6: Exchange Rate - Stabilizing
100
95
Jamaican Dollar exhibiting stability since 2009. Lasco
therefore benefits from stable raw material costs.
90
85
80
75
70
65
01-Apr-08
01-Oct-08
01-Apr-09
01-Oct-09
01-Apr-10
2|Page
01-Oct-10
Mar-11
spending ability.
Industry Specific Factors or Trends
Figure 7: Foritified Drinks
SEP, GK,
Nestle &
Other
27%
1. Gracekennedy
2. Nestle
3. Seprod
LASM
85%
Figure 9: Infant Formula
LASM
29%
SEP, GK,
Nestle &
Other
71%
Figure 10: Industry Margins
30%
26%
19%
20%
14% 13% 12%
8% 7%
5% 5% 4%
10%
DG
-3%
CCC
GK
CPJ
JP
JBG
SEP
BPOW
LAS
-10%
-20%
1
2%
0%
JAMT
Industry Profit Margins – LASM ranks 3rd
Lasco currently has the third most attractive net profit margin
of all the manufacturing and distribution companies identified
on the JSE, which include those listed on the junior and main
market. Although the company primarily markets low priced
products, they are still able to generate strong margins
compared to its peers.
SEP,
GK,
Nestle
&…
SALF
Oligopolistic Industry
Two common measures of industry competitiveness are the
Herfindahl-Hirschman
Index
(HHI)
and
the
Four Firm Concentration Ratio. Based on data gathered, the
HHI exceeds 5,329 which is extremely high and indicates an
industry which is not very competitive. Similarly, the four firm
concentration ratio which measures the market share of the top
four firms exceeds 70%. This reading (above 60%) confirms an
oligopolistic industry, which is dominated by Lasco.
Lasco
Man.
73%
Figure 8: Whole Milk Powder
LASM
And while the company's products have a presence in 18
countries outside Jamaica, its international sales account for a
minor nine per cent of revenues.1 According to the company,
they have an estimated market share of 73% in fortified drinks
which comprise Lasco food drink and Lasoy. While for whole
milk powder, the company estimated an 85% market share and
29% of the infant formula market.
CAR
Major Competitors
Lasco Manufacturing’s main Competitors in the food drink and
powder milk industry are:
-20%
http://jamaica-gleaner.com/gleaner/20100804/business/business1.html
3|Page
Figure 11a: Porter’s Model – Five Industry Forces
Competitive Force
Risk
Rationale
Threat of New Entrants
High
Lasco has economies of scale, brand loyalty and a dominant market
position. However, with no major impediments to entering the
market, there is a high risk of potential entrants. Already there are
formidable competitors such as Seprod, GraceKennedy and Nestle.
Bargaining Power of
Suppliers
Low
The company sources its raw materials (powdered milk) outside of
Jamaica and their supplier(s) operate in a competitive market. The
Herfindahl–Hirschman Index (HHI) and Four Firm concentration
ratio would therefore be very low for the suppliers.
Bargaining Power of
Buyers
Low
Buyers are not concentrated as the target market is mostly retail.
Therefore, measures such as the four firm concentration and the
Herfindahl–Hirschman Index (HHI) would be low for customers.
Availability of Substitutes
Medium
Again, there a number of substitutes on the market but none which
are able to compete on pricing like Lasco. In fact, Lasco’s products act
as substitutes in the infant formula market, in addition to their 29%
market share of the infant formula market.
Rivalry Among
Competitors
Medium
Competitors such as GraceKennedy, Seprod & Nestle have not been
able to make a significant dent into lasco’s market share of powder
milk (73%) and fortified drinks (85%). However, Lasco as a recent
entrant in the infant formula market only has 29% market which is
still a strong position
Figure 11b: Porter’s Model
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PEST Analysis of Jamaica
Figure 12
Political
Economic
 Complex taxation regime
 Weak local conditions
 Legislation only enables one power company
 Tepid global growth
 Lack of unity across Caricom
 High electricity costs
 Slow implementation of government policies
 High cost of capital
 High crime rate
Social-Cultural
Technological
 Consumer brand preferences
 Dated production processes
 Inefficient workforce
 Archaic distribution arrangement
 Employee theft
SWOT Analysis of Lasco Manufacturing
Figure 13
STRENGTHS
WEAKNESSES
 Dominate the powdered milk market
 Products have a stigma of being low end
 Well recognized brand locally
 Concentration in one product type (powdered milk)
 Company is more distribution oriented, a positive
 Low regional diversification, revenues concentrated
considering high manufacturing costs in Jamaica
in Jamaica
 Alliance between Chairman and Managing Director
OPPORTUNITIES
THREATS
 Tax break from listing on the JSE for the next 10 years
 Though
 Stronger profit growth to fund retooling and business
expansion
Lasco
benefits
from
weak
demand,
continued weakness in the Jamaican economy could
impact them.
5|Page
Financial Statement Analysis – June 2011 (See Appendix 1)
Financial Performance – Very profitable Quarter
Lasco’s first quarter ended June saw the company increase
Revenues 24% to $784 million. This was achieved amidst a
weak economic environment which saw the company’s low
cost products reaping gains combined with greater
visibility from the JSE Listing.
The company’s Gross Profit surged 33% to $247 million
as the company expanded its Gross margin ratio from
29% to 31% combined with revenue growth.
Figure 14: Income Statement Highlights
Income Statement
June 2010
June 2011
% Change
Revenues
634,715
784,554
24%
Gross Profit
185,565
246,916
33%
Operating Expenses
70,958
102,295
44%
Net profit
78,802
150,987
92%
Figure 15:Balance Sheet Highlights
J$‘000
June 2010
June 2011
% Change
Operating Expenses climbed 44% in the quarter to
$102 million and was driven by plant expansion and the
restructuring of the company.
Total Assets
935,367
1,009,924
8%
Current Assets
935,367
829,492
-11%
Inventories
188,517
219,493
16%
Cash & Equivalents
272,427
150,274
-45%
The effective taxation rate was 0% as the company has
benefitted for the quarter from the tax break enjoyed from
listing on the JSE Junior Market.
Equity
330,964
981,233
196%
June 2011
% Change
Net profit rocketed 92% to $151 million for the quarter
due to the combined effect of: a 15% growth in Revenues,
3% expansion in gross margins and a tax break.
Balance Sheet Strength – Very Liquid
The company’s total assets stood at $1.01 billion based on
an equity base of $861 million. The equity base expanded
86% through raising ordinary share capital in addition to
the full year retained earnings. (See Figure 15)
Figure 16:Key Ratios
J$‘000
June 2010
Gross Margin
29%
31%
8%
Net Margin
12%
19%
55%
Current Ratio
2.0
5.6
180%
ROE
1.6
4.1
158%
The company’s long-term-debt to equity ratio stands
at 0% after paying off its debts but is likely to surge in
coming quarters as the company seeks to borrow J$1.12
billion for relocation, modernization and expansion.
The company also maintained very healthy Liquidity ratios
for the quarter. The current ratio stood at 5.6 times
versus 2.0 times a year earlier. Closer inspection to identify
if inventories were skewing the ratio, showed an equally
strong Acid Test Ratio of 4.1X which was well above the
prior year’s 1.6X.
6|Page
DuPont Analysis (ROE Decomposition)
With one year of comparative data, we are able to estimate
that Lasco’s improved ROE was driven by an improvement
in net profit margins - which follows from the improved
gross margins discussed earlier. Financial leverage
declined as the company cleared its loans and the
corresponding reduction in interest expenses assisted in
the improvement of Net Profit Margin.
Figure 17: ROE – Dupont Analysis
ROE – Dupont Analysis
YE 2010
YE 2011
2.29
2.87
6%
37%
2.22
1.61
14%
48%
Asset Turnover
xFinancial Leverage
xNet Profit Margin
=ROE
Figure 18: ROE Comparison
70%
60%
ROE (Current)
Industry ROE Comparison – Lasco is 2nd best
Compared to other manufacturing companies in Figure 18,
only one other company (CPJ) has a better ROE and
earnings growth rate than most companies over the last 5
years. A very high ROE and growth rate makes us
undoubtedly have to classify Lasco as growth company.
-40%
LASM
40%
30%
JAMT
20%
DG
GK
Cash Conversion Cycle
Although the company’s balance sheet suggests that the
company has very good liquidity, it is also important to
measure the amount of working capital tied up in
receivables, inventory and payables. Figure 19 shows that
Days of Inventory, receivables conversion and payables
conversion all increased over the period. This suggests the
company extended its credit terms to customers, expanded
its inventory base and lengthened the time it took to pay
trade creditors. As a result, the rate of conversion of
working capital to cash increased significantly from 16 days
to 111 days. This is actually an unfavourable trend as it
means the company is taking longer to convert its working
capital to cash. In addition the trend is unsustainable and
we expect a flat to reduced cycle next year.
CPJ
50%
-20%
BPOW
SEP
10%
JP
0%
-10% 0%
SALF
JBG
LAScelles
20%
40%
60%
5 Year Growth Rate *
Figure 19 :Cash Conversion Cycle
Cash Conversion Cycle
Days of Inventory
Days of Receivables
Days of Payables
Cash Conversion Cycle
YE 2010 YE 2011
45
31
60
16
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54
87
31
111
Projections & Valuations
Profit Projections
For the year ending March 2012 we expect Lasco
manufacturing to generate revenues of $3.56 billion with
gross margins at 31%. Additionally, the company will pay
zero taxation and net profit should amount to $552 million
(EPS:$1.43) or 37% above the prior year. Based on the
dividend policy highlighted above we expect a dividend per
share $0.21.
Intrinsic & Relative Valuation
Based on the company’s stated dividend policy and
adherence to date, it is appropriate to utilize a dividend
discount model (DDM) to value the company. In this case
we use a two stage model for an initial growth phase which
is expected to last 10 years and stabilize thereafter. Based
on the company’s expansion plans, we expect profit growth
of approximately 25% for the next 10 years which should
taper off to 10% thereafter. The intrinsic valuation
therefore emerges at $10.50 using the DDM.
Figure 20: One year profit projection
Mar
Mar
2010
2011
Revenue
2,587,621
2,969,611
Projection
2012
3,563,533
Gross Profit
688,335
934,501
1,121,401
Op Expenses
559,530
426,574
477,762
Op Profit
197,181
555,573
686,519
Finance Cost
Pretax Profit
Taxation
Net Profit
197,181
53,077
144,104
37,701
517,872
116,671
401,201
134,400
552,119
552,119
Figure 21: Dividend Discount Model
Dividend Discount Model
Cost of Equity (CAPM)
16.20%
First Phase Growth Rate
25.00%
First Phase Growth Period
10 Years
Final Phase growth rate
10.00%
Figure 22: Relative PE Valuations
16.0
OverValued
SALF
SEP
12.0
CAR
P/E
Dividend Policy
The company has been listed on the exchange for less than
a year and therefore has no record of dividend payments.
However, in LASM’s prospectus, management has
indicated a commitment to paying out no less than 15% of
earnings, subject to the company’s need for reinvestment.
For their first financial year ended March 2011, the
company paid dividends of $0.15 which equated to 14% of
earnings, marginally below the company’s target payout
rate. Based on the current price, this equates to a dividend
yield of 2.4%.
8.0
GK
UnderValued
JBG
LAScelles
LASM
4.0
CPJ
0.0
0%
10%
20%
30%
5 Yr Growth Rate (%)
Additionally, based on trailing earnings, the company’s PE
is much lower than most market participants as illustrated
in Figure 22. From the chart, the stock is below the PE line
which suggests the stock has been undervalued by the
stock market.
Source: proprietary research
8|Page
40%
50%
Market Activity & Technical Analysis
Figure 23: LASMPrice, Volume & SMA’s
10.00
7
9.00
6
8.00
5
7.00
4
6.00
3
5.00
4.00
2
3.00
1
2.00
Share Price - Soaring
Since listing the share price has appreciated 251% from an
IPO price of $2.50 to a recent closing price of $8.79. The
stock appreciation is correlated with strong earnings
throughout the period and a generally euphoric reception
to junior market listings to date.
Bid/Ask Analysis - Bullish
In Figure 22, share liquidity is confirmed by a tight bid/ask
spread of $8.60/$8.80. Currently, the stock is also heavily
demanded based on the structure of the bids and asks. The
most significant volumes are bid at $8.35 with a volume of
576 thousand units. On the other hand, the lowest
significant Ask is for 60 thousand units at $10.
Significantly stronger bid volumes suggest that the price
will appreciate as bidders increase their bids to acquire
LASM shares.
Simple Moving Averages (SMA) - Bullish
The simple moving averages (Figure 21) indicate a fairly
bullish trend on the stock. A strong bullish signal arose
when the 20 day SMA broke above the SMA 5o and SMA
100 in April 2011. Since then the market price has surged
from $6 to a peak of $9. Confidence in this trend is also
asserted by stable and consistent trading volumes.
0
Oct-2010
Jan-2011
ClosePrice
Apr-2011
SMA 20
Jul-2011
SMA 50
SMA 100
Figure 24: Bid-Ask Analysis (August 31, 2011)
Bid
Ask
Volume
11,600
Price
($)
8.60
Price
($)
8.80
Volume
1,503
15,666
8.40
9.00
2,250
576,054
8.35
10.00
60,281
30,000
8.30
12.00
4,850
700
8.12
Source:Bloomberg
Figure 25: Fibonnaci Retracement of LASM
10.00
100% ($9.50)
9.00
$8.790
8.00
76.4% ($7.94)
7.00
61.8% ($6.97)
6.00
50.0% ($6.19)
38.2% ($5.40)
5.00
23.6% ($4.43)
4.00
3.00
Fibonacci Retracements – Trading above support
Fibonacci retracements (Figure 23) are one of the most
widely used technical indicators and are used to identify
resistance and support levels of a security. Lasco has rallied
since inception to a high of $9.50 and has pulled back since
hitting its peak. The first support level is found at $7.94 or
at the 76.4% Fibonacci line which corresponds to a
previous peak. The next support level which is considered a
major support one is found at the 61.8% of the peak to
trough, which is at $6.97. Notable, the stock also found
support around $6.97 after a pullback from a $7.95 peak.
Volume
Volumes Traded – Strong Investor Interest
In Figure 21 to the right, the orange bars confirm
consistent level of trading activity and by extension
investor interest. Peak volumes were reached in November
2010, shortly after the stock became listed. The stock
traded 190 days out of a possible 218 days with an average
daily volume of 167 thousand units. The stock therefore has
strong liquidity and investor interest.
0.0% ($2.87)
2.00
Oct-2010
Jan-2011
Apr-2011
Jul-2011
9|Page
Conclusion & Recommendation
Economy Weak but Lasco Benefits
Lasco Manufacturing Limited is the largest producer of fortified drinks and powdered milk in
Jamaica. Even though the company exports to other regions, its revenue generation is concentrated
in Jamaica. Interestingly the Jamaican economy has been undergoing a severe contraction since
2007 and the implication is that consumers spending ability would have been hampered. However,
throughout the downturn, the company has managed to significantly increase revenues and we
attribute this to fact that the company’s low priced products are able to capitalize on a shift on
consumer spending habits.
Dominate the Sector
Lasco dominate the Sector with their fortified drinks and powdered milk which account 73% and
85% of the market respectively. Notably, these products act as substitutes for infant formula in
Jamaica but Lasco has its own brand of infant formula which claims 29% of that market. It
highlights the dominant position the company enjoys, and the key seems to be that the company
identifies that they are operating in a weak economy and therefore try to offer low cost products.
Operating Very Profitably
Although the company offers low priced products, they still enjoy reasonable margins. Gross
margins were 31% as at March 2011 while net margins were 14%. This actually puts Lasco
amongst the top three manufacturing and distribution companies in Jamaica based on these
profitability measures. The companies ROE and growth rate are also amongst the highest of all
the listed companies in Jamaica and highlights the company’s strong profitability.
Aggressive Expansion Plans
The company’s first expansion plan was to become listed on the JSE Junior market to expand its
visibility and to take advantage of a 10 year tax break from listing. In the next few quarters, the
company has disclosed an ambitious $1.12 billion plan to relocate, modernize and expand its
plant in White Marl, St. Catherine. The move is expected to increase production capacity,
operational efficiency and allow the company to broaden its product portfolio. The company’s
expected payback period is 4 years and we expect these activities to be key drivers of profitability
going forward.
Valuation and Technicals favourable
The expected dividend yield based on the current price and next year’s earnings is 2.4%. The
intrinsic valuation based on this growing stream of dividends is $10.50 or a potential capital
appreciation of 21%. An examination of technical indicators such as the Simple Moving
Averages, Volumes traded, Bid-Ask spreads and Fibonacci retracements all suggest a very bullish
trend which is strongly supported technically. With the expected capital appreciation of 21% and
a consistent dividend stream, Lasco Manufacturing is recommended as a BUY.
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Appendix 1
$'000
YE March 2010
YE March 2011
Q1 June 2010
Q1 June 2011
YE March 2012
Projection
Revenue
2,587,621
2,969,611
634,715
784,554
3,563,533
Cost of Sales
1,899,286
2,035,110
449,150
537,638
2,442,132
Gross Profit
688,335
934,501
185,565
246,916
1,121,401
Other Income
68,376
47,646
6,949
6,710
42,881
Operating Expenses
559,530
426,574
70,958
102,295
477,762
Profit from Operations
197,181
555,573
121,556
151,331
686,519
Finance Cost
Profit Before Taxation
Taxation
Net Profit
197,181
53,077
144,104
37,701
517,872
116,671
401,201
5,354
116,202
37,400
344
150,987
-
78,802
150,987
134,400
552,119
552,119
Property, Plant & Equipment
142,273
192,055
-
180,432
Current Assets
988,866
1,145,493
935,367
829,492
Income Statement
Balance Sheet
Total Assets
1,131,139
1,337,548
935,367
1,009,924
Current Liabilities
458144
463,939
471,440
149,244
Non-Current Liabilities
278,346
31,598
Long Term Debt
Equity
262,760
394,649
830,246
262,791
247,205
330,964
31,598
981,233
Gross Margin
27%
31%
29%
31%
31%
Operating Margin
8%
19%
19%
19%
19%
Net Margin
6%
14%
12%
19%
15%
Ratios
LTD-to-Equity
67%
0%
0%
0%
Financial Leverage
2.51
1.38
2.83
0.85
ROE
37%
48%
95%
62%
ROA
15%
35%
8%
18%
DPR
-
0.14
Current Ratio
2.2
3.0
2.0
5.6
Acid Test Ratio
1.8
1.9
1.6
4.1
Earnings Per Share
1.04
0.20
0.39
Book Value Per Share
2.15
0.86
2.54
Revenue Per Share
7.7
1.6
2.0
Dividends Per Share
0.15
Per Share Data
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