D&L Industries: A Great Company At A Wonderful Price
Summary
- The best mid-cap company in the Philippines run by excellent management with a strong track record of consistent growth for over 50 years.
- Asset-light business with a strong moat that enables it to consistently earn high returns on capital and create shareholder value.
- Macroeconomic factors and the pandemic have driven the share price to cheap levels during the last couple of years.
- Attractive growth outlook driven by the strong growth outlook of the Philippine economy, its robust export business, and increasing contribution of high margin products.
- Company Profile
D&L Industries Inc. (OTCPK:DLNDY) or (PH:DNL) as listed in the Philippine stock exchange is a Filipino, family-owned mid-cap company that manufactures specialized ingredients for food and chemicals used by leading consumer companies in the food, personal care, and automotive industry.
The company has been operating for 57 years and it went public in June 2012 at Php4.30 per share on the Philippine stock exchange.
As of the end of 2019, the company was 60% owned by Jadel Holdings Co., Inc. (JHI) (a holding company majority-owned by the Lao family), 11% by the Lao family, and 29% by the public.
Source: Company presentation
The stock has traded between a low of Php4.0 per share and an all-time high of Php13.50 per share (2017) since its IPO in 2012.
Currently, it's trading at Php7.58 per share with a market cap of Php54.14 billion or about US$1.11 billion. Average daily trading volume is Php2 million or US$40,000 value traded.
Background
Over the last decade, the company had shown excellent growth with earnings growing at a 9-year CAGR of 19%.
However, growth began to slow down since 2017. During 2017, earnings grew by 10.5% but this slow down was more due to a high-base the previous year due to the one-off boost in consumer spending as a result of the elections in 2016.
But in 2018 the company's earnings just grew roughly by 10% as the spike in Philippine inflation resulted in poor consumer sentiment.
In 2019, slowing global growth, compounded by the US-China trade war, led to a slowdown in the company's export business (which accounted for around 19% of revenue) while the delay of the approval of the national budget and the lingering effects of high inflation from the previous year, resulted in continuing negative consumer sentiment and a decline in government spending.
Then in 2020, the Covid-19 pandemic led to a severe drop in business activity affecting the company's domestic and international clients, resulting in a massive drop in sales volumes for the company.
It was especially worse for its domestic business as the Philippine government imposed one of the longest and most stringent lockdowns in the world for three months between March to May and as the Philippines had the second-worst case of coronavirus cases in the region, which led to continued quarantine restrictions affecting business activity.
As a result, since 2017, the company's stock price had declined from an all-time high of Php13.50 per share to just Php7.58, currently.
At the peak of the sell-off during pandemic, it fell to an all-time low of Php3.97 per share before recovering to a high of Php9.15 in January as the economy gradually reopened and as the news of a vaccine increased investor risk appetite. Since then, D&L's stock price has just been consolidating over the last two months.
Low Expectations Creating an Opportunity
Despite the huge rally (more than 70%) from last year's lows, I believe the company's shares still has significantly more room to run.
Currently, the company is trading at 21x FY EV/EBIT, which is at its 10-year EV/EBIT average. But it has already shown continued signs of improvement with earnings growing 8% yoy in the fourth quarter and with its non-food business -- which accounted for 75% of earnings -- already operating above pre-COVID levels.
Source: Company 4Q20 presentation
I believe that the company may be able to surpass its FY20 EBIT significantly and maybe even match or come close to its pre-pandemic EBIT (FY19 EBIT Php3.5B), which implies more upside than its current valuations indicate.
With a better visibility on the recovery given the start of the vaccine rollouts and as more parts of the economy are allowed to open, earnings growth should surprise to the upside during the next few quarters.
Products
The company mainly manufactures two types of products commodity and high-margin specialty products (HMSP) across four major segments: Food Ingredients, Oleochemicals and Other Specialty Chemicals, Specialty Plastics, and Aerosols.
Source: Company 4Q20 presentation
HMSP are highly specialized products that the company develops which are tailor-made for its customer's needs. HMSP accounted for 63% of the company's total consolidated revenues in 2020.
Source: Company 4Q20 presentation
Meanwhile, the commodity product segment includes commodity biodiesel and refined vegetable oils. This segment accounted for 37% of revenue in 2020.
Source: Company 4Q20 presentation
Commodity sales had a gross margin of 6.5% while high-margin specialty products had gross margins of 25.6%.
The company continues to invest in R&D as it aims to keep increasing the share of HMSP products to revenue to increase profitability.
Since 2010, HMSP has increased its share of total revenue from 54% to 63% currently.
Four Main Segments
Source: Company 4Q20 presentation
Food ingredients
D&L supplies specialty fats, liquid mixes, oils, culinary and other specialty food ingredients (flour mixes, seasoning mixes, ketchup) to the country's leading food manufacturers and restaurants such as Universal Robina Corporation (OTCPK:UVRBF), Jollibee (OTCPK:JBFCF), McDonald's, Krispy Kreme, Max's (PH: MAXS), among others.
It also manufactures customized food safety solutions such as cleaning and sanitation agents (dishwashing machine cleaners, degreasing materials) for various customers.
The company has developed over 1,000 varieties of food ingredients, most of which it customizes for its clients.
Source: Company 4Q20 presentation
Customized products account for about half of the food segment's revenue which have average gross margin of 70% compared to the commodity segment's gross margin of 24%.
As of 2020, the food segment accounted for 58% of consolidated revenue and 25% of net income.
Specialty Plastics: Colorants and Plastics Additives
The company supplies the local plastics industry with custom designed and formulated pigment blends, color and additive masterbatches, and engineered polymers for a wide range of applications through its subsidiary First in Colours (FIC), which focuses mainly on the domestic market, and D&L Polymers & Colours (DLPC), which focuses on the export market.
Source: Company 4Q20 presentation
- Plastic colour and additives: custom designed polymers for extruding, forming, or molding products; coloring and custom compounding. Also, it manufactures plastic colours and additives, dry colourants, and color masterbatches for a wide range of applications.
Source: Company website
- Colorants and plastic compounds: additive concentrates for film, moulding and extrusion to enhance the value and performance of the resins companies use.
Source: Company website
- Develops pigments and color masterbatches for plastic films and tapes, mouldings, wires, and cables and high-end fiber applications.
Source: Company website
- Engineered polymers: custom-designed colors, wide range of resins and compounds, additives, fillers, and colorants PVC compounds for automotive wiring, building wires, bottle cap liners, semi-conductor packaging, rigid bottles, and building applications.
Source: Company website
Oleochemicals, Resins, and Powder Coatings
Through its subsidiary Chemrez Technologies, the company manufactures an extensive line of oleochemicals -- chemicals derived from vegetable oils such as coco-biodiesel -- and specialty chemicals (resins and powder coatings) for both the domestic and export markets.
Oleochemcials accounted for 72% of Chemrez's consolidated revenue in 2020 and the rest by other specialty chemicals.
Source: Company 4Q20 presentation
Oleochemicals
Under the oleochemicals segment, the company manufactures commodity biodiesel and high-margin oleochemicals.
- Biodiesel: the company is the Philippines' largest Coconut Methyl Ester (CME) or biodiesel producer in terms of installed capacity (e.g., BioActiv - mainly used as diesel fuel additive) with the country's first continuous-process biodiesel plant and integrated oleochemical plant for specialties.
- Oleochemicals (other): high-margin oleochemical products: glycerin and other CME derivatives -- used as surfactants or foaming agents for soaps and detergents.
- Other: medium-chain triglyceride (MCT) oil derived from coconut oil.
Oleochemicals account for about half of the Oleochemical and Other Specialty Chemicals segment's revenue and the majority of the gross profits.
Source: Company website
Most of the products under the oleochemicals segment are principally sold in the export markets.
The company continues to develop new applications for CME that have high export potential to expand its product market base.
Other Specialty Chemicals
- Powder coatings: protective materials applied to metal and other surfaces to provide resistance against heat, weather and UV light, and certain chemicals; used in home appliances, metal furniture, fixtures and fittings, mechanical parts, tools and equipment and also the construction industry.
Source: Company website
Resins and additives: polymerized or chemically modified substances, which are manufactured in a variety of technical specifications to suit specific industry uses, end-user applications (paints and coatings, foam, textile, adhesives, construction, and fiber reinforced), and customer requirements.
Aerosols
Source: Company 4Q20 presentation
The only company in the Philippines that manufactures customized aerosol products focusing on maintenance chemicals, home care, and personal care products.
Source: Company website
Aerosol
- Three-piece aerosol cans and components which comprise the majority of aerosol product requirements in the Philippines and globally.
- Customized contract filling and formulation services
- Products for a wide range of applications: insect control, industrial maintenance chemicals, and home personal care products
Non-Aerosol
- Insecticides, liquid and gel disinfectants, cleaners, polishers, and liquid soaps
Source: Company website
Investment Thesis
Market Leader in a Niche Market with High-Switching Costs
D&L has carved out a specific niche in the consumer market as a supplier of customized products to consumer companies.
The company supplies leading quick-service restaurants, consumer, chemical companies with customized ingredients which no other company can provide.
Source: Company 4Q20 presentation
This ability has enabled the D&L to maintain and improve its margins over the years, earn high returns on capital, and take market share.
According to management, D&L's foreign clients have realized the advantages of sourcing its raw materials and ingredients locally, instead of manufacturing it internally or acquiring it from the open market, as they're able to lower input costs and generate savings through economies of scale.
More importantly, D&L is able to customize the companies' ingredients to fit local tastes.
For example, the D&L was able to supply Krispy Kreme with a local substitute for the toppings, glazings, coatings, and frying oil it uses for its donuts, gearing it towards Filipino preferences, and at the same time lowering the company's costs to make it affordable for the local market.
The products that D&L manufactures are often mission-critical components of its customers' production processes which result in higher margins and makes it difficult for customer to switch to competitors.
In most cases, the D&L is usually the sole supplier of these products given that these are highly customized for the customers' needs which has allowed D&L to generate a consistent base of sales volume for the company.
Furthermore, the market D&L operates in is too small for bigger foreign companies to enter, which results in lower competition and leading market share.
Longstanding Customer Relationships with Top Consumer Companies
D&L's ability to develop high quality and specialized products have allowed it to maintain strong and long relationships with its customers spanning 10 to 30 years.
The company's customers include top consumer companies in the Philippines such as Jollibee (the top quick-service restaurant/fast food in the country), Universal Robina Corporation (the top Philippine food manufacturer) McDonald's, KFC, Krispy Kreme, and Nestle Philippines.
Its longest tenured client -- 30 years -- Boysen, is the leading paint manufacturer in the Philippines. It also has been a long-time supplier to Sumitomo Electric (manufacturer of electric wire and optical fiber cables for the automotive and communications sector) and Yazaki (automotive parts supplier).
Source: Company presentation
Its long-term relationship with its clients has allowed it to better understand its customers needs and respond quickly to customer requirements and offer better products.
Attractive Growth Outlook
D&L's growth has slowed down during the last few years but I believe the company should return to previous years' level of growth given its export business has more room to run, margin expansion as it continues to invest in R&D and increase the contribution of HMSP, and as the Philippine and global economy start to recover from the pandemic.
Philippine Economy: Excellent Prospects
D&L is well-positioned to take advantage of the country's robust growth prospects given that it's indirectly exposed to the consumer sector with about 70% of its revenue coming from consumer companies.
The Philippine economy has grown at a CAGR of 6.2% annually from 2009 to 2019, according to CEIC Data, driven mainly by strong domestic consumption, which accounts for more than 70% of the country's GDP.
The Philippines' sustained robust domestic consumption is driven by the significant amount of money remitted by overseas Filipino workers annually which reached $33.2B in 2020, despite the pandemic, which represents 9.2% of the country's GDP in 2020, and growing BPO industry, which contributed $26.3B or 7.0% of GDP in 2019.
In addition, the country has a young working population which is expected to account for 64.15% of the total population by 2021.
Coming out of the pandemic, the Philippines is expected to grow between 6.9% and 8.0% in 2021 and 2022, according to Fitch Ratings.
The company estimates that, on average, it accounts for about 10% of the input costs of its customers' cost of goods sold or COGS.
Over the long-term, D&L's continued innovation and investments in R&D along with the Philippines' growing economy will drive margin expansion.
Increased Competition is Good For the Company
As competition increases in the consumer industry, D&L only benefits as demand for its products and services grows.
In fact, it's more than likely that competitors in the same industry are also D&L's customers. Therefore, while one company gains and another loses market share, it won't have a significant effect on D&L.
Focused on Innovation Driving Growth
D&L is more than just a consumer company but also technology company. Around 12% of its staff are in R&D. And 25% of non-raw material expenses are in R&D.
The company prides itself with its focus on research and innovation, developing solutions that have currently produced over 600 varieties of food ingredients, including specialty fats, dry and liquid mixes, and specialty condiments.
This focus has allowed its products to maintain market leading positions in their respective industries -- it has become the go-to supplier for many consumer companies as it's the only company that could provide their needs.
D&L Market Share in its Product Categories
*Market share 2012 - Could not find current market share data on segments
Source: COL Financial
Increasing Profitability: High Margin Products Increasing as a Percentage of Revenue
D&L's focus on continued innovation has allowed it to generate high margins -- the higher level of a products' customization, the higher the margins.
D&L aims to continue increasing the contribution of HMSP products to total consolidated revenue which should result in increasing margins and profitability over the long-term.
Source: Company 4Q20 presentation
HMSP products has steadily increased as a portion of total sales over the years from 54% in 2010 to 68% currently.
Source: Company 4Q20 presentation
Expanding Into New Markets
Moreover, the company aims to capture more markets for other ingredients which consumer companies haven't outsourced yet such as the production of gravy, for example.
It's also hoping to reach more food and beverage companies and grab more market share by focusing on 'in-house development'' and ''substitute imports' market for ingredients.
Exports Have Significant Potential
The company targets to grow its export business to 50% of consolidated revenue by 2025.
As of 2020, its exports accounted for 29% of total revenue compared to just 15% in 2014.
Source: Company 4Q20 presentation
Export sales have grown at a CAGR of 12.5% during the last five years as it has inked supply agreements with international food suppliers such as Bunge Limited (BG) in 2017 and Ventura Foods in 2014.
Ventura Foods is a US-based specialized food ingredients supplier that produces dressing, sauces, mayonnaises, oils and other flavorings which generates annual revenues of $3B. It services food companies, restaurants, and retailers worldwide and has been expanding in the Asia Pacific (APAC) region.
D&L provides development and production for Ventura's products which it sells in the APAC region.
The partnership with Ventura has huge potential as it introduces more products and given that the agreement covers the entire APAC region, which also includes New Zealand and Australia, and only four countries (China, Hong Kong, Japan, and Indonesia) are currently being serviced to date.
Bunge Limited is a leading global agribusiness and food company which sells its products in over 40 countries.
The company is one of the top commodity traders in the world, commonly known as ABCD which stands for Archer Daniels Midland, Bunge, Cargill, and (Louis) Dreyfus.
According to the D&L, its partnership with Bunge includes:
"OFI will become Bunge's exclusive commercial partner to import, market, sell and distribute packaged soft seed oils into Philippines. This would include soft seed oils such as soy, sunflower seed, rape seed, and canola which are not locally sourced in the Philippines.
Bunge will become OFI's exclusive commercial partner to export, market, sell and distribute coconut oil under its Farm Origin brand in to countries in the Asia-Pacific region."
Also, it gives a broader range of products to serve customers in the Philippines and strengthens its position as the number one supplier to the fast-growing industry.
The Bunge agreement also allows the company to supply soft oils such as canola, rapeseed, soybean, and sunflower that are not locally sourced in the Philippines. It also opens the opportunity for D&L to develop high margin specialty products that use these types of oil.
The company couldn't publicly disclose the sales mix of its export segment given its non-disclosure agreement with partner companies but management said that the export sales mix is better than its domestic business: it sells more high margin specialty products for its exports versus commodities.
Gross profit margins for its export products are higher than gross profit margins for the domestic business; the company exports more high margin specialty products for exports compared to its domestic business.
Expanding Capacity to Serve A Growing Export Market
In line with the company's export target, it's in the process of putting up a new food ingredients facility, which started construction in 2018, in order to sufficiently serve its growing domestic and export business.
The new facility is located in First Industrial Township (FIT), a Special Economic Zone in Batangas and will house two new plants -- one for food ingredients under D&L Premium Foods Corp. and an integrated facility to manufacture oleochemicals and downstream packaging under Natura Aeropack Corp.
The Special Economic Zone gives the company a number of special incentives such tax benefits and exemptions from certain duties and fees.
This facility will mainly cater to the company's export business in oleochemicals, food, and ODM (original design manufacturing) for consumer products segments.
The company believes this plant will be instrumental to its future growth as it plans to develop more high value-added coconut-based products, which have been gaining traction lately due to its perceived health benefits, and penetrate new international markets.
In fact, according to the company, the pandemic has already enabled it to make in-roads in supplying raw materials and finished products in several relevant FMCG categories.
Also, the new plant will add the capability to manufacture downstream packaging allowing the company to capture a bigger part of the product chain.
Current utilization for the food ingredients plant now stands at 65%; the FIT project will increase current capacity -- food and non-food -- by more than 100%.
For context, its existing 6 facilities combined occupy a gross land area of 11 hectares versus the new plant which will built on 26 hectares of gross land area.
According to management, this expansion will be enough to support the company's growth over the next 10 years.
The FIT plant was originally expected to be completed by mid-2021 but due to the delays associated with the Covid-19 lockdowns, construction completion was pushed back to the end of 2021.
Source: Company 4Q20 presentation
Value Compounder
Strong Record of Consistent Growth
The company has an excellent record of growth over the last decade with net income increasing at a CAGR of 19% since 2011 despite growth slowing down since 2016.
Source: Company financials
According to management, in over 50 years of operations, D&L has been able to double its net income every five years. And it believes it's able to maintain a sustainable level of growth of 10 percent in the long-term.
Run By Excellent Managers with a Long-Term Focus
D&L has been in operations for 57 years. I believe the company is run by excellent managers with interests aligned with shareholders and an emphasis on the long-term, instead of maximizing profits in the short-term.
Its focus on the long-term and transparency with shareholders is evident in its company reports and presentations.
For instance, it has been releasing an end of the year FAQ presentation for a few years now in its effort to increase transparency to shareholders, aside from quarterly presentations.
In its 2020 FAQ report it explains why it's pushing through with expansion despite the uncertainty brought about by the pandemic:
High-Return Business
A mark of a truly great business run by excellent managers is a company that consistently generates high returns on investment capital (ROIC) and require little incremental investment to grow.
ROIC measures how efficiently a company employs its resources to generate profits.
*ROIC: using Joel Greenblatt formula (EBIT/(NWC+NFA))
D&L has reported an average ROIC of 25% since its IPO.
Over the past seven years, the company has generated incremental operating earnings of Php2.3B on Php8.8B of incremental capital invested for a return on incremental capital of 27%.
It has generated cumulative net earnings of Php17.71 billion and returned Php8.79 billion (about 50%) in dividends.
Currently, the company has a dividend policy of returning 50% of prior year's recurring income.
Asset-Light
While the company's source of competitive advantage is its technological expertise and its focus on innovation and research, R&D expenses have been minimal.
On average, R&D only accounts for 0.4% of its total revenues, as the bulk of the company's costs are from raw materials. Raw materials usually account for 80% of the company's total expenses.
Meanwhile, rent expense accounts for 1% of total costs and capital expenditures only accounts for an average of 8% of revenue. Total fixed costs have average around 15% of total costs and expenses.
Source: Company 4Q20 presentation
Valuation
Based on its current FY20 results, D&L is trading at an EV/EBIT of 20.3x which is around its 10-year EV/EBIT median of 21.1
Source: Bloomberg, Author
Moreover, D&L is trading at a 29-30% discount to its global peers in terms of EV/EBIT FY21 and FY22
Therefore, valuations look attractive given its positive growth outlook and earnings are already recovering for two straight quarters.
With the vaccine rollout starting already for the Philippines this month and vaccine rollouts already moving along for the rest of the world, there's upside risk to revenue and earnings towards the end of the year.
I believe once analysts start rolling over estimates by September-October to 2022, D&L's share price should rerate starting mid-year.
If the company is able to reach near its pre-pandemic level of EBIT, it will be trading around 16x EV/EBIT which is at the lower end of its historical EV/EBIT range.
I believe it will start to rerate to its mean EV/EBIT of 21x EV/EBIT, which translates to a share price of Php9.58 -- presenting a 26% upside from its current share price of Php7.57.
I believe this price target is conservative given that during its high growth years, D&L has trader upwards of 21x EV/EBIT due to the quality of its business and sustained strong growth prospects. I can see the company reach near its previous all-time highs of Php13.50 1-1.5 years from now.
Recent Updates
The company has been recovering nicely since the first half of 2020. After 1H20 profits bore the brunt of the pandemic which saw its net profits decline 43.3% yoy to Php801M, the company has earned Php1.2B during the second half of the year, which is 51% higher than its first half income and surpassing the company's guidance of Php1.0B for the period.
As I've discussed previously, net income during the fourth quarter grew 8% yoy -- after declining for three quarters -- and its non-food segment, which accounted for 75% of the company's earnings for the quarter, is already operating above pre-Covid levels, according to management.
Export sales remained resilient and continued its positive momentum as it jumped 29% yoy which brought full-year growth to 34% yoy. Exports accounted for 29% of revenue for FY20.
Exports were driven by coconut-based products as the company is seeing increased demand for coconut oil globally given its perceived antiviral, antibacterial, and anti-fungal properties, and are great substitutes for petroleum-based raw materials such as personal hygiene and home care cleaning products.
Also, the company said it has been able to grab market share during the pandemic as its competitors had been unable to continue operations given insufficient working capital due to high indebtedness or as they have been importing mostly in China.
Key Risks
- Customer concentration: the company's three largest customers -- mostly food ingredients customers -- accounted for 21% of consolidated revenues (2019).
- Volatility in input prices: 80% of the company's costs and expenses are raw materials such as coconut oil, palm oil, and other types of vegetable oils, including monomers, polymers, and other chemicals. Fluctuations in the prices of these raw ingredients may cause sharp contractions in the company's margins. The ability of the company to pass on these price fluctuations depends on its contractual agreements with customers.
*The selling price for most contracts are not fixed -- these are reset every 45 days on average, which allows the company to pass on relevant price changes in raw material costs.
Conclusion
D&L Industries is arguably the best mid-cap company in the Philippines given its market leading positions in the industries it operates in, led by excellent management, which have generated consistent high returns on capital and consistent strong growth for over 50 years.
It's a family-owned company that has a long-term orientation with interests that I believe are strongly aligned with shareholders interests as shown by continued high returns on capital and its transparency in its communications.
It's an asset-light business with a strong moat in a niche market -- which doesn't attract competition -- enabling it to maintain high returns on invested capital and create shareholder value over the long-term.
Macroeconomic factors and the pandemic have driven its share price to cheap levels during the last couple of years. However, despite its share price already recovering over 70% from its lows last year, it still has more room to run.
In 2020, the company still generated a net income of Php2B, down 32% yoy, compared to other Philippine companies, which saw worse declines and losses, despite the effect of the pandemic which led to the most stringent lockdown in the world.
Second half net income was higher by 51% compared to the first half of the year and fourth quarter income was already up a solid 8% yoy with its non-food segment, which accounted for 75% of net income in 2020, was operating above pre-covid levels already.
Given the attractive growth outlook of the Philippine economy coming out of the pandemic, its robust export business, and increasing contribution of high margin products, I expect the company's valuation to rerate to at least its mean 10-year EV/EBIT or the low-mid 20s by year end as the Philippine and global economy recovers and as analysts rollover estimates to next year.
This article was written by
Analyst’s Disclosure: I am/we are long DLNDY. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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