Sunday, May 26, 2013

Who is Mispriced?

DKSH AG (DiethelmKellerSiberHegner) is a Zurich headquartered group which functions as an outsourcing partner to businesses seeking to expand in new or existing markets. They specialize in organizing and management of the entire product value chain - from research, sales, logistics to distribution. Their business activities are organized into four broad areas of expertise; namely: consumer goods, healthcare, performance materials and technology.

Leveraging on its nearly 150 years of experience, the group has a phenomenal global reach in 35 countries; including 660 locations in Asia Pacific. Having generated c. 8.8 billion in sales in 2012, DKSH AG is ranked as one of the top 20 Swiss companies (by sales and employees). The group also generated free cash flow of CHF249 millions in 2012.

DKSH AG went public in March 2012 on the SIX Swiss Exchange at an IPO price of CHF48 a share (or 18x of its 2011 net profit). Investors took favorably to the stock, probably due to its exposure to Asia. As on 26 May 2013, DKSH AG traded at CHF74.50, at 1.5x of its IPO price. Due to its management quality and history of growing its EBIT, the market accorded DKSH AG a 23x price to earnings multiple.

Interestingly, DKSH AG has a Malaysian subsidiary which listed on Bursa Malaysia in 1994. This entity, DKSH Malaysia contributes c. 14% to DKSH AG's total revenue. In Malaysia, it represents over 130 clients and distributes their products to over 13,000 sundry shops, hypermarkets and hospitals. Backing up its extensive network, DKSH's operations is supported by 18 regional offices, four distribution centres and seven regional warehouses scattered throughout Peninsular and East Malaysia.

Our Malaysian readers who live in Petaling Jaya will be familiar with the brands DKSH manages due its occasional warehouse stock clearance at Jalan University. For the uninitiated, the suite of brands it represents in Malaysia are testimony to DKSH's capabilities. They include Abbott, Boh Tea, Darlie, Ferrero, Indocafe, Mars, Quaker, Roche, Sanofi-Aventis, Wyeth. Its food segment also operates the Famous Amos Chocolate Chip cookie.

As it is essentially a distributor, its net margins is not large (c. 2%). However, it relies on pushing increasing volume through its very wide ranging and entrenched network. It also leverages on its global relationships to bring new products into emerging markets like Malaysia. For example, in Jun 2012, DKSH and Hershey's inked an agreement to provide sales, distribution and logistics services for the latter's chocolates and Bubble Yum gum in Malaysia.

For such an exceptional and storied company, DKSH Malaysia is trading at c. 14x of normalized earnings (stripping out exceptionals at RM860 million market capitalization) despite a strong run up. Given the quality of earnings and the segment DKSH Malaysia is operating in, applying a multiple closer to Swiss parent is not unrealistic. Assuming DKSH Malaysia trades at 23x, it would be a RM1.4 billion market capitalization on historical earnings. This implies a share price of RM9 per share (66% upside from current price of RM5.44). We had not factored in any earnings growth, a distinct possibility given its track record. Given the consumer and healthcare goods its handles, the resilience and growth potential of its earnings cannot be underestimated either.

Accumulating a large stake could be challenging as the stock suffers from low free float.  DKSH AG (75%) and Lembaga Tabung Angkatan Tentera (LTAT) (Malaysia Army pension fund) owns c. 85% of the company. LTAT is also DKSH Malaysia's bumiputera partner since 1991. Applying a liquidity and size discount on 20x earnings, DKSH Malaysia's fair value could be around RM7.80. Even at DKSH AG's IPO multiple of 18x, we are looking at RM7.06 per share fair value or 30% upside for DKSH Malaysia.

The above calculations obviously assumes DKSH AG is correctly priced at 23x. The converse could well be true, as in the valuations of DKSH AG is too high, rather than DKSH Malaysia being too cheap! That's the challenging of justifying using relative multiples. Perhaps, the truth is - where we believe it lies - somewhere in between 14 - 23x? Only time will tell. 



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