Fuling Global: High Growth Company With More Than 50% Potential For Price Appreciation

May 30, 2019 12:38 PM ETFuling Global Inc. (FORK)MCD, YUM, BERY, NWL6 Comments

Summary

  • Expected double-digit revenue growth.
  • Change in production strategy and innovating new products in-house.
  • DCF model shows the stock is undervalued by almost 75% with attractive P/E, EV/EBITDA, and EV/EBIT multiples compared to close competitors.
  • Even after using highly conservative EV/EBIT multiples and EBIT estimates, I believe the downside risk is very low and the upside potential is high.

Fuling Global (NASDAQ:FORK) has the potential to almost double its share price in 12 to 18 months. The stock has been slammed over the past year, down by more than 50% due to exaggerated fears around US/China tariffs impact on viability of the business model. FORK has hedged these geopolitical risks by moving production facilities to Mexico. Also, the company's eco-friendly products allow sticky contracts with all of its key customers. Furthermore, favourable US foodservice disposable industry trends should support the company's revenue and margins going forward. As investors begin to realise the benefits of new production facilities and the firm's new eco-friendly products, the stock could easily return to its 2018 range of $3.90-4.15, giving investors more than 50%+ price appreciation.

Company Overview

As stated in the 10-K, Fuling Global is a "specialised production and distribution company for environmentally-friendly plastic and paper serviceware with primary customers from the United States and European countries. We mainly conduct our operations in China and United States through our wholly owned subsidiary, Taizhou Fuling Plastics Co."

FORK operates under four revenue segments; cutlery (accounts for 50% of revenue), straws (17% of revenue), cups & plates (27% of revenue), and other plastic products (7-8% of revenue). The company's geographic reach is broad and diversified. As of 2018, percentage of revenue from regions include: US (85%), Europe (5%), Canada (2%), China (6), and others (2%). Percentage of revenue from customers include: Dealers (46%), Quick Service Restaurants (QSRs) (27%), Retailers (7%), and manufacturers (20%). Almost all the customer buy cutlery, straws, cups & plates, and other plastic products from Fuling Global. Thus, each segment has similar customers.

Favourable Industry Trends - Foodservice Disposable

The industry that FORK operates in is separated into three categories - 1. Packaging 2. Serviceware, and 3. Napkins and other disposable items.

foodservice industry

The company predominantly provides service ware products which include cutlery, straws, cups & plates. Serviceware accounts for 45% of foodservice disposable industry sales.

According to the Freedonia Group, demand for the US foodservice disposables is expected to rise 3.9% per year to $21.9 billion in 2019. The increase behind this is supported by boosted revenue growth from the US limited service restaurant segment, which accounts for 80% of all the food disposable sales. Fast casual restaurants, on the other hand, are expected to boost demand for disposable dinner ware, plates, and cups. However, the QSR (Quick Service Restaurant) segment demand is slightly expected to soften, brought by changes in customer preferences away from traditional fast food due to health concerns and moving towards more healthy alternatives. Although this isn't a positive sign for FORK, the company has already established contracts with its largest QSR customers, allowing consistent revenue.

Freedonia's latest research also forecasts that the retail outlets are expected to be the fastest growing end-user segment. It includes grocery stores, convenience stores, and warehouse clubs. This strong growth is driven by retail stores expanding into readymade/prepared foods to compete against QSRs and take out restaurants.

revenue seg %

As you can see above, revenue as a percentage of total sales from retail customers has increased from 1% in 2016 to 7% by 2018. With the expected increase in demand, retailers revenue as a % of overall sales should increase, offsetting any softening from the QSR customers.

Management

  • Insider ownership: High (positive). When management owns more stock, usually its interests align with that of shareholders.
  • Recent insider buys/sells (neutral). Not too high or low.
  • Large ownership by funds (Somewhat high). However, there's no sign of activist investors.
  • Glassdoor Reviews: Good. Shows employees are satisfied and management pays and treats them well.

Key Catalysts

1. Biodegradable and Eco-Friendly products should improve contracts with QSRs and Retailers.

FORK is one of the biggest Chinese exporters that produces biodegradable and environmental-friendly plastic products. On average, the firm is spending around 2.50% of revenue on R&D to develop and innovate their in-house environmental-friendly products through the collaboration with 'Technical Institute of Physics and Chemistry of the Chinese Academy of Sciences'. Although a lot of Chinese producers are capable of producing disposable serviceware to meet increasing QSR and retailer demand in the US, majority all of them lack in expertise to develop biodegradable plastic products, along with lack of the right production machines to support them. This ultimately differentiates FORK from other small Chinese manufacturers.

FORK's major customers such as McDonald's (MCD), Yum (YUM), Subway, Taco Bell, Burger King, etc. are planning to switch from traditional plastic products to more eco-friendly within 2 to 3 years. This will aid Fuling to continue to serve these major customers going forward, aiding the company to develop long-term sticky contracts with these companies. In fact, McDonald's has taken the step recently by going eco-friendly. Within the cups & plates segment, QSRs and retailers are looking for sustainable alternatives to replace traditional plastic styrofoam cups & plates. Currently, biodegradable products account for 2% of entire US foodservice ware revenue, with cups and containers accounting for approximately 75% of that demand. This changing trend puts Fuling in a better position to serve these customers in the future, improving revenue.

2. FORK's revenue will benefit from shifting some of its production from China to Mexico.

FORK is planning to shift its cups & plates and straw manufacturing facility from China to Mexico. Strategically, it makes sense considering that FORK generates almost 90% of its revenue in the US, which would allow the expected increase in orders from QSRs/ retailers, whilst saving on shipping costs.

The management says that manufacturing in China and exporting to the US is no longer cost effective as shipping/packaging straws are expensive because they are fragile. In addition to that, the ongoing trade dispute between US and China could further increase costs for the company. Lastly, manufacturing in Mexico would not only aid FORK to stay close to its US customers but also strengthen relationship with customers and provides a gateway opportunity to enter into Latin markets.

3. Leveraging existing customer base to improve revenue from Packaging segment (others).

Although the packaging segment constitutes a small percentage of the overall revenue, FORK recently launched a new product: "clamshell" in 2018. Packaging product is part of the 'others' category and it has the same customer base as serviceware products (cutlery, straws, cups & plates). Many of the packaging products made from polystyrene are expected to be banned due to political/socioeconomic reasons, difficulties in recycling, and they don't bio-degrade naturally. FORK's eco-friendly products should increase contract revenue from its existing customers, thus increasing 'others' segment sales as a percentage of overall revenue.

Packaging demand from full-service restaurants and QSRs is expected to rise due to increasing catering and take-out services. Companies that provide sustainable package solutions such as moulded pulp containers etc. are expected to benefit from this trend, Fuling is already developing this product in their R&D labs.

Pricing and Valuation

DCF

(Authors DCF valuation model)

Revenue Drivers:

  • I have used a very conservative assumption for revenue and margin growth rates. My assumptions are laid out in detail in the excel spreadsheet below. Please look at the revenue and margin drivers tabs for further info.
  • Revenue from the US is expected to grow in double digits based on increased foodservice disposable demand from retailers and QSRs demand for biodegradable serviceware.
  • In Europe, demand is expected to soften.
  • Revenue from the Chinese market is expected to grow in double digits for the two years, with rising fast food market and the consumer dining behaviour catching up with the US.
  • From other countries, which are mainly emerging markets, demand for foodservice disposables is expected to grow in double digits due to increasing middle class and changing demographics.

COGS:

  • Although plastic resin prices are volatile to oil prices, it looks like the correlation between plastic resin (PP, GPPS, HIPS, PET) is low based on the year over year price changes between both.
  • Part of it is due to price changes having a 3-month lag in recognising under COGS. Although oil prices are going to be volatile going forward, it's moderately correlated with the changes to plastic resin prices.
  • In 2019, gross margin could be slightly affected by oil price volatility. However, FORK receives subsidy income from the PRC government, it received $1.7 million in 2018, $1 million in 2017, and $1.6 million in 2016. Any sudden increase in raw material prices should partially offset with the subsidy income from the govt.

Operating Expenses:

  • Normalised as percentage of revenue going forward, based on historical changes. Please refer to the excel doc below for further analysis.

Cost Of Capital:

  • Historically, cost of capital has been around 9-12% for the majority of publicly-traded companies, on average. Since the company is sensitive to raw material price changes and geopolitics (US/China tariffs), competition, and customer economic sensitivity (QSR, Distributors, Retailers), I have used COC of 12.5%. Even after using a high discount rate, shares are still significantly undervalued, showing an intrinsic value of $4.09 (75% price appreciation).

Comparables Analysis

comps 2018

comps 2019

(Authors comparable analysis)

  • Compared to the previous year, FCF should slightly improve and it is expected to turn positive (as shown in the DCF model). On EV/EBITDA basis, the company still looks undervalued in contrast with closest publicly-traded competitors.
  • I have normalised WC as it is difficult to predict and it distorts FCF.
  • I have also normalised Capex to $15 million, which I believe is the Capex required to keep the company competitive. This won't include major or one-time capex items.

Downside case:

2019 EBIT - $9mm

3x Multiple (EV/EBIT)

TEV - $27mm

+ Cash - $8mm

Market Cap - $35mm

Shares Outstanding - 16million

Share Price - $2.18 (-7% from current price)

This draconian scenario assumes FORK's EBIT decreases by 25% from 2018 EBIT, this is well below the impact of increase in oil prices and plastic resin prices. 25% decline also considers a decline in orders from major QSR customers and reducing prices due to pressures from dealers, as a result of increase in competition. The EV/EBIT multiples I have used 80% below its current multiple. Even after all this excessive cutting, the company would almost trade close to its current price.

Base Case:

2019 EBIT: $11.47mm

4.9x Multiple (EV/EBIT)

TEV - $56.3mm

Market Cap - $63.8mm

Shares outstanding - 15.8 million

Share Price - $4.04 (72% Price appreciation)

Assumptions behind the 2019 EBIT is already explained above and in the DCF model. The EV/EBIT multiple is still highly conservative, considering it's almost 15% below its current EV/EBIT multiple (5.6x)

Bull Case:

2019 EBIT - $13.2mm

5.6x Multiple (EV/EBIT)

TEV - $73.92mm

+ Cash - $8mm

Market Value - $81.92mm

Shares outstanding - 15.8 million

Share Price -$5.2 (120% Price Appreciation)

I have used an EBIT margin of 8% from the estimated 2019 revenue. 8% has been FORK's 4-year historical EBIT average. If raw material prices don't suddenly increase and the firm continues increase contracts from QSRs and Retailers, this scenario can be highly probable. Also, I have used the current EV/EBIT multiple of 5.6x, which again I believe is very conservative.

ROIC

ROIC

(Authors ROIC calculation)

  • ROE and ROA can be manipulated by the management, thus I've decided to use ROIC instead.
  • I have adjusted WC by deducting cash from current assets and deducting short-term debt from current liabilities. This eliminates double counting.
  • I believe ROIC with goodwill and intangibles will range between 10% and 15% in 2019 and 2020 as NOPLAT experiences a doubt-digit growth and Capex declines, considering that they have already spent a lot on building new projects.

Conclusion

Overall, this Chinese small-cap stock is highly undervalued by the market. With already down by almost 50%, buying at the current price ($2.35) creates an excellent risk-reward scenario, considering that fears around the company's revenue and margin growth are extremely overblown. With favourable industry trends and management's strategy to shift production and creating in-house biodegradable products is a positive sign and the stock should trade back to its previous levels within 12-18 months.

Supporting Documents

FORK_val__key_metrics.xlsx

FORK_Business_Breakdown.xlsx

This article was written by

In an era of unprecedented QE, low-interest-rate environment (even negative) and expansionary fiscal policies, it's been a challenge to find deep value ideas. My Approach (Philosophy): I look at companies ignored by Wallstreet, trade at an attractive valuation relative to fundamentals and operate in an out of favour sector (a good house in a bad neighbourhood). Focus: Small and Micro-cap About me: Grad from the UK. Analyst living in NYC. CFA II (2021) candidate.

Disclosure: I am/we are long FORK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please refer to the supporting documents for more information regarding valuations, assumptions, and break down of the business.

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