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.
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.
The industry that FORK operates in is separated into three categories - 1. Packaging 2. Serviceware, and 3. Napkins and other disposable items.
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.
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.
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.
(Authors DCF valuation model)
Cost Of Capital:
(Authors comparable analysis)
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.
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)
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.
(Authors ROIC calculation)
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.
This article was written by
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.