Asian Idea Generator Weekly: An 80-Year Old Hong Kong Beverage Company, Screening For Predictability And An Unusual Aviation Proxy

by: The Value Pendulum

Vitasoy International, a Hong Kong-listed beverage company, is the largest position for Fundsmith Emerging Equities Trust, for which famed U.K. investor Terry Smith is Chief Investment Officer.

Investors prefer predictable names over their cyclical counterparts in the current volatile and uncertain market environment. I do a quantitative screen to try to identify such companies.

The number of air travelers globally is expected to almost double in the next two decades; the obvious proxies, airlines and airports, are not the only investment options.


Last week was the first issue of the Asian Idea Generator Weekly, which aims to filter the 30,000 stocks Asian investment universe for under-covered investment opportunities. This week, I continue with the search for Asia-listed ideas in the following three categories: 1) piggybacking the trades of institutional investors and insiders; 2) quantitative screens; and 3) proxies for secular investment themes.

Piggybacking: Fundsmith Emerging Equities Trust's Largest Asian Position

In the prior week, I wrote about Mark Mobius and the Mobius Emerging Markets Fund that he manages, and the Fund's Chinese movie play. This week, I look to Terry Smith, who runs U.K.'s largest mutual fund, Fundsmith Equity Fund, for inspiration. Between November 2010 (fund inception) and May 2019, Terry Smith's Fundsmith Equity Fund returned +341.2% compared with +153.2% for the MSCI World Index (£ Net) over the same period.

While Terry Smith has a stellar reputation, it is not as widely known that Terry Smith is also the Chief Investment Officer of Fundsmith Emerging Equities Trust. As per the Trust's website, Fundsmith Emerging Equities Trust is invested using the same strategies as the flagship Fundsmith Equity Fund with only one difference: "the companies invested in will have the majority of their operations in, or revenue derived from, Developing Economies and will provide direct exposure to the rise of the consumer classes in those countries." Fundsmith Emerging Equities Trust's largest position with an approximate 5% weighting as of May 2019 is Hong Kong-listed Vitasoy International (OTCPK:VTSYF) [345:HK].

Founded in 1940 and listed in 1994, Vitasoy International owns two key beverage brands: Vitasoy (products such as plant-based milk like ready-to-drink soy milk and tofu) and Vita (products like ready-to-drink lemon tea, distilled water and other dairy products); the Vitasoy brand of soy milk (launched in 1940) and the Vita brand of lemon tea (launched in 1979) are its key flagship products. In terms of geographical exposure, China, Hong Kong, Australia/New Zealand and Singapore contributed 67%, 26%, 6% and 1% of Vitasoy International's 1HFY2019 (YE March) revenue respectively.

At first glance, Vitasoy International seems expensive trading at 50 times consensus forward FY2020 P/E, based on its share price of HK$43.55 as of June 6, 2019. But Vitasoy International's historical financial track record has been nothing short of impressive. It achieved a ROE of at least 15% for every single year in the past decade with a historical 10-year average ROE of 20.8%. Vitasoy International's 10-year EPS CAGR of 11% is decent albeit unexciting, but Vitasoy International's earnings growth has accelerated in recent years boasting a trailing 12 months' EPS growth of 26% and a three-year EPS CAGR of 16%. In line with a faster pace of bottom-line growth, the company's P/E multiple has gradually expanded over time from the 20s in 2012 when China accounted for only 29% of its total sales, to 50x P/E now as China contributes two-thirds of its revenue and the company's growth is accelerating.

The importance of the China market as a growth driver for the company is also evident in the most recent 1HFY2019 period where China sales grew 33% YoY. In contrast, the other markets, Hong Kong, Australia/New Zealand and Singapore delivered more modest revenue growth rates of 4%, 5% and 9% respectively.

Let's evaluate the growth potential of the China soymilk market to have a better grasp of Vitasoy International's future growth trajectory. The per-capita per-annum consumption of soymilk in mainland China is approximately only one-tenth that of Hong Kong, according to research by Statista. The management of Vitasoy International also shared certain market share statistics with sell-side analysts in March 2019, which is helpful in further assessing Vitasoy International's growth opportunities in China. The company boasts a 70% share of the soymilk market in Hong Kong (validating the brand's status as a household name in the city-state, its home market).

In comparison, Vitasoy International boasts a relatively lower 40% market share of China's soymilk market, and there are opportunities for soymilk's share of the overall dairy market to grow by taking share from other dairy products. The most recent 2018 research report by Euromonitor states that soymilk sales in China grew 13% YoY in 2018 to RMB 11.4 billion versus a much lower 2% YoY growth reaching RMB 252.1 billion for the overall drinking milk products industry in the country, implying that Chinese consumers are switching from other dairy products to soymilk. Vitasoy International has a 12% share of Guangdong's overall dairy products market, putting it third behind Inner Mongolia Yili Industrial Group Co., Ltd. [600887:CH] and China Mengniu Dairy (OTCPK:CIADF) (OTCPK:CIADY) [2319:HK] with market shares of 28% and 17% respectively. Similarly, Vitasoy International is third in the Hubei dairy market with a 9% market share, with Inner Mongolia Yili and China Mengniu Dairy accounting for 32% and 27% of Hubei's dairy market share respectively.

Vitasoy International also shown its determination to excel in the Chinese market with its investments in both talent and manufacturing capacity. In February 2018, the company appointed Mr. Eric Zhong to head Vitasoy China operations as CEO; Eric has had prior experience working for multi-national food & beverage giants Danone (OTCQX:DANOY) and Mondelez (MDLZ) in China. Vitasoy International's current group CEO Mr. Roberto Guidetti managed Coca-Cola's (KO) China operations before joining the company in 2013. Vitasoy International also invested RMB 1 billion to construct a new (and to-be largest) factory in Dongguan, Guangdong province, which would be up and running by 2021, to meet growing demand for its products in China.

The high valuation premium that Vitasoy International enjoys is largely attributed to the non-discretionary demand (cutting back on soymilk consumption is unlikely to do much to help the household budget) for its beverage products, the brand equity of Vitasoy (an iconic 80-year old brand), and its growth potential in China as described above. Furthermore, Vitasoy International does not import any soybeans from the U.S.. In other words, its revenue and earnings should be relatively immune to the impact of U.S.-China trade tensions.

Vitasoy International's biggest challenge is fending off competition in China to sustain its growth momentum in the market. Importantly, Vitasoy is dominant in the Chinese soymilk market with 40% market share and no other competing soymilk brand has in excess of 10% share. Other new competing soymilk brands and products tend to be launched by dairy producers focused on milk and yoghurt that do not have prior experience in developing or marketing soymilk products. Furthermore, Vitasoy International is partially mitigating this threat by putting a stronger emphasis on the high-end segment of the soymilk by introducing high-calcium and high-fiber variants of its soymilk products.

Screens: Predictability Trumps Cyclicality

Investors are increasingly seeking comfort in companies offering predictability in terms of revenue and earnings growth, as trade tensions and slowing economic growth globally lower investors' risk appetite. The flip-side of this phenomenon is that such "predictable" stocks have been priced to perfection. These stocks command such a hefty valuation premium such that de-rating is a real possibility if global growth risks ease in future. In other words, the key is to find mispriced predictability, rather than predictability at any price.

The criteria I use in screening for predictable companies include the following:

  1. Positive revenue growth for every single year in the past decade
  2. Positive net income growth for every single year in the past decade
  3. Positive net income and positive operating cash flow for every single year in the past decade
  4. Net cash financial position as per most recent interim financials
  5. Three-month average daily trading liquidity above $1 million

The predictable companies ranked in descending order of current year forward consensus P/E are as follows:

Stock Industry Current Year Forward P/E Historical Trailing P/E Historical Trailing EV/EBITDA Return on Equity - trailing 12 months Return on Equity - 5-year average EPS growth rate 3-year CAGR EPS growth rate 5-year CAGR EPS growth rate 10-year CAGR
Ai Holdings Corporation [3076:JP] Other Computer Peripheral Equipment Manufacturing 12.4 12.4 7.9 14.2% 16.7% 3.2% 15.5% 27.8%
China Resources Gas (OTCPK:CGASY) (OTC:CRGGF) Group Ltd [1193:HK] Petroleum Bulk Stations and Terminals 16.2 18.1 9.5 19.3% 18.2% 16.1% 15.4% 11.8%
Seria Co., Ltd. (OTC:SAOGF)[2782:JP] All Other General Merchandise Stores 16.3 17.5 8.4 18.2% 20.9% 13.1% 13.2% 30.8%
Tsuruha Holdings Inc. (OTC:TSUSF) [3391:JP] Pharmacies and Drug Stores 16.7 17.3 8.1 12.7% 13.8% 12.6% 12.7% 14.5%
Monogatari Corp [3097:JP] Full-Service Restaurants 17.7 18.4 8.0 16.9% 14.9% 23.7% 12.8% 12.3%
Techtronic Industries Co. Ltd. (OTCPK:TTNDY) (OTCPK:TTNDF) [669:HK] Power-Driven Hand Tool Manufacturing 18.0 21.1 13.0 19.1% 17.9% 15.9% 17.1% 35.0%
Nitori Holdings Co Ltd (OTCPK:NCLTF)[9843:JP] Furniture Stores 19.8 21.4 12.1 14.5% 15.2% 12.9% 11.6% 14.2%
Otsuka Corporation (OTC:OSUKF) [4768:JP] Computer Systems Design Services 20.2 21.4 10.9 16.5% 15.0% 12.3% 10.6% 8.9%
Arcland Service Holdings Co Ltd [3085:JP] Full-Service Restaurants 22.2 23.1 9.8 14.8% 15.5% 11.6% 10.3% 18.2% Inc (OTCPK:KKKUF) (OTC:KKMMY) [2371:JP] On-Line Information Services 23.5 26.8 15.7 45.1% 44.4% 10.2% 14.6% 23.3%
Ariake Japan Co Ltd (OTC:AKEJF)[2815:JP] Spice and Extract Manufacturing 25.5 13.6 13.0 20.6% 13.3% 39.6% 30.6% 35.3%
Ace Hardware Indonesia Tbk PT (OTC:ACEHF)[ACES:IJ] Home Centers 26.5 29.9 21.3 24.3% 24.7% 18.1% 13.7% 22.1%
Workman Co., Ltd. [7564:JP] Men-s Clothing Stores 37.9 42.3 25.5 15.5% 14.3% 16.3% 11.9% 13.7%
Unilever Indonesia Tbk PT (OTCPK:UNLRF) (OTCPK:UNLRY)[UNVR:IJ] Soap and Other Detergent Manufacturing 44.9 37.6 26.0 112.2% 136.4% 15.9% 11.2% 14.2%
MonotaRO Co.,Ltd. (OTCPK:MONOY) (OTC:MONOF) [3064:JP] Electronic Shopping and Mail-Order Houses 47.7 55.8 35.9 36.4% 38.9% 28.9% 32.9% 26.2%

There are some caveats that one should be aware of, when it comes to investing in the list of predictable companies above. Firstly, past performance is not indicative of future results. Technological disruption and shift in consumer preferences are among some of the risk factors which could potentially change a company's future growth trajectory. Secondly, as mentioned earlier, some of these stocks might already have been priced for perfection. In other words, there is little or no margin of safety in terms of valuation.

Thematics: Asian Aviation Growth

Last week, I wrote about a video graphics card (VGCs) manufacturer, which will potentially benefit from bitcoin's price momentum in the near-term, and gaming growth in the long-term. This week, I return to something more basic: air travel.

The number of air travelers is expected to almost double from 3.8 billion in 2016 to 7.2 billion in 2035, according to research by The International Air Transport Association. Over half of this increase in passenger traffic over the next two decades will be driven by the Asia Pacific region; and China is forecasted to become the world's largest aviation market (defined by traffic to, from and within the country) by 2024.

Airlines are the easiest and most obvious way to play the aviation theme, but they might not be the most attractive proxies. Warren Buffett famously said in a 2002 interview with the London newspaper, The Telegraph, that "If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money." Although Buffett has since reversed course with Berkshire Hathaway (BRK.A) (BRK.B) becoming among the substantial shareholders in U.S. airlines as industry consolidation improved the dynamics of the industry benefiting the largest airlines, airlines still suffer from most of the issues Buffett highlighted in his 2002 interview. These negatives still plaguing airlines include huge fixed costs and commodity pricing.

Apart from airlines, airport operators are another proxy for long-term aviation growth. Charlie Munger has spoken about investing in Shanghai International Airport Co. Ltd. [600009:CH], which operates the Shanghai Pudong International Airport in Shanghai, a major aviation hub of China. At the 2017 Berkshire Hathaway AGM, Munger had this to say about Shanghai International Airport: "How can you lose owning the main airport in China?" However, the attractiveness of airport operators as investments are an open secret. Listed airport operators are usually not available for a bargain and Shanghai International Airport is no exception, trading at a fair but unexciting 25 times consensus FY2019 forward P/E.

China Aviation Oil (Singapore) Corporation (OTC:CAOLF) [CAO:SP] could potentially be a cheaper proxy for the long-term growth in aviation traffic for Shanghai Pudong International Airport. Listed on the Singapore Stock Exchange in December 2001, China Aviation Oil, or CAO's major shareholders are state-owned enterprise China National Aviation Fuel Group (51% stake) and BP (BP) Investments Asia Limited (20% stake). CAO is the Asia-Pacific's largest physical jet fuel trader and the sole supplier of imported jet fuel to China. CAO's earnings comprise both income from its joint ventures and associates (primarily contributed by its 33% stake in Shanghai Pudong International Airport Aviation Fuel Supply Company, or SPIA) and its jet fuel supply and trading business; SPIA contributed 65% of CAO's profit before tax in 2018.

CAO has a monopoly on the supply of imported jet fuel into China. Its 33%-owned associate, SPIA, supplies jet fuel to China's second-largest airport, Shanghai Pudong International Airport. SPIA owns and operates all refueling facilities at Shanghai's Pudong Airport, charging aircraft refueling at this airport an appropriate cost plus mark-up for its supply of jet fuel.

Outside of China, CAO also supplies jet fuel to more than 50 airports in 20 countries. CAO is the largest purchaser and trader of physical jet fuel in Asia Pacific, the second largest jet fuel supplier at Los Angeles International Airport and the third largest licensed refueller at Hong Kong International Airport.

CAO's valuation is undemanding. Net cash ($0.44 or S$0.60 per share) accounts for approximately 46% of CAO's market capitalization based on its share price of S$1.31. Shanghai Pudong International Airport Aviation Fuel Supply Company (SPIA), a 33% owned associate of CAO, contributed $65 million of associate income in FY2018. Assuming SPIA is valued at a 17 times P/E (representing a discount to its most comparable peer Thailand-listed Bangkok Aviation Fuel Services Pcl (OTC:BKARF) [BAFS TB] which is currently trading at 28 times trailing P/E), the value of SPIA alone is equal to CAO's current market capitalization, implying CAO's ex-SPIA jet fuel supply and trading businesses (which contributed the remaining 35% of CAO's FY2018 profit before tax) are free at current valuations without even allocating any value to the $379 million of cash on its books. CAO is not just cheap on a sum-of-the parts basis, it trades at 4.7 times consensus forward FY2019 ex-net cash P/E.

In a nutshell, CAO is primarily a play on the growth in China's outbound travel which in turn drives Shanghai Pudong International Airport's [SPIA] jet fuel demand. On the flip side, the key risk in the near-term for CAO is lower-than-expected jet fuel volume growth for SPIA, if the slowdown in China's economic growth adversely affects China's outbound travel.

Closing Thoughts

With rising trade tensions between countries and slowing global economic growth, it is natural for investors to seek refuge in companies offering predictable top-line and bottom-line growth. I hope that the profile of Vitasoy International and the screen for predictable stocks detailed above offer inspiration for investors.

At the same time, I would like to caution that many of the predictable companies have outperformed their respective benchmark indices and could suffer a de-rating if the market tide turns and favors a risk-on mode again. In other words, mispriced predictable companies and depressed cyclical stocks are the most attractive investment opportunities.

China Aviation Oil profiled in prior section fits the bill of both mispriced predictability and depressed cyclicality.

In the short term, jet fuel refueling volumes at SPIA would fluctuate based on month-to-month aviation traffic (the cyclicality component). In the mid-to-long term, the number of air travelers is certain to grow driven by rising incomes and the growing market share of budget airlines, and SPIA as a monopoly on jet fuel supply at the Shanghai Pudong airport will definitely grow in the long run (the predictability) component.

While the long-term aviation secular growth story is not challenged in any way, investors are overly concerned with a potential slowdown in aviation traffic and jet fuel refueling volumes in the short-term, offering a buying opportunity in CAO.

Disclosure: I am/we are long CHINA AVIATION OIL (CAO:SP). 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.