Turnaround Stock: Auric Pacific (SGX:A23)

This is a stock that I previously bought because I managed to focus on the cash flow of the business, apart from its earnings. It was delisted via privatisation.

Management and Business Model

Auric Pacific (“Auric”) was previously a listed company on the Mainboard of Singapore Exchange. Its reach is in Singapore, Malaysia and Hong Kong. In late 2016, I came across this company while I was eating at Food Junction, a food court in Singapore. It is a diversified Food & Beverage (F&B) investment that holds a portfolio of strong brands.

Their business segments are categorized as [1] wholesale and distribution [2] manufacturing [3] food retail and [4] food courts

Many Singaporeans and Malaysians are no strangers to Auric Pacific’s operations. Auric Pacific owns iconic house brands such as the “Sunshine” and “Top One” brand of bread, “SCS” and “Buttercup” brand of butter. Like DKSH, Auric carries out marketing and distribution services in Singapore and Malaysia. It distributes several household names such as Post, Kellogg’s, Pringles, McCormick, Heinz, Twinings, Want Want biscuits, Tabasco, among many other brands.

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On top of existing businesses, Auric acquired Food Junction and Délifrance in 2007 and 2013 respectively. However, these two businesses were loss-making thus they reduced the profits of the Group when the financial numbers were consolidated.

Auric is managed by executive director Dr Stephen Riady and group chief executive officer Dr Andy Adhiwana. Dr Adhiwana is the son-in-law of Dr Stephen Riady. Indonesian conglomerate Lippo Group, who is owned by the Riady family is the controlling shareholder of Auric. They purchased the controlling shares of Auric in 1997 from Endang Utari Mokodompit.

Dr Adhiwana joined the company as the business development manager in December 2013. He was tasked to oversee and understand the different segments of the business. Subsequently, he was promoted to executive director in November 2014.

Also, upon taking his role as executive director, Dr Stephen Riady transferred 21.88% of Auric shares to him. Then, at the age of 31, he was promoted to group chief executive director in May 2016.

Woah, I wondered whether these promotions come too soon. In fact, Andy was just 31. Does he have adequate experience to make the right decisions for the group?

I dug more on his background.

Graduating from the reputable Heidelberg university in Germany with multiple medical degrees, he was performing well as a doctor. After a while, he did not like it. With a determined heart to change his life, he earned himself a Master of Business Administration (MBA) at National University of Singapore then he entered Auric as business development manager.

He quickly went to strengthen the business from all aspects. This strategy was achieved through visiting Auric’s subsidiaries and understanding the challenges of each subsidiary.  With the assistance of his colleagues, he came up with a strategy to protect the profits and grow it further. It was done through a rationalization exercise of non-performing assets and focus on operational efficiencies. Dr Adhiwana played to the strengths of the group by focusing more of the group’s resources to grow its bread and butter business – the manufacturing segment.

As executive director, he promoted decentralization and provided autonomy with divisional level for the organization to be nimble. Dr Adhiwana also spent time to pen out corporate priorities to his business unit managers. He also issued directives to promote synergistic needs between business units.

Despite his young age, it impressed me a lot that Dr Adhiwana is hands-on and he does not shy away from difficult decisions. I also enjoyed reading his letter in Auric’s annual report. The initial anxiety of Dr Adhiwana being unprepared was put to rest. Previously, Auric was run by its then-CEO Saw Phaik Hwa. Now, the business is run by Andy who is a family member and he owns shares which aligned him strongly to minority shareholders.

Dr Adhiwana owned 27.44% of Auric before the Riady family decided to take the company private.

Numbers

For a start, I love to look at previous full year results before looking at the latest quarters.

For FY2015, while revenue and gross profit increased modestly, Auric reported a loss of S$40.9 million. I was bewildered! How can this happen? Does this mean that their costs have ballooned significantly? I went down to its profit and loss statement and saw a monstrous figure under the accounting line “exception item”. It exploded from S$3.3 million to $44.0 million. It was an increase of almost 13 times!

The notes further revealed an increase in “impairment loss on intangible assets”, “allowance for impairment on unquoted investment funds”. “property, plant and equipment written off”, “allowance for impairment of property, plant and equipment” and “stocks written down”.

The financial statements also state that, excluding exception items of S$44.0 million, Auric achieved profit before tax of S$4.5 million. Looking at cash flow statements, it generated S$25.1 million operating cash flow before working capital changes.

Taking my understanding of the company, I believed that these exception items could be one-off as the company was restructuring its food retail and food court segments.

The food retail was bleeding an operating loss of S$5.2 million and food court segment reported higher operating losses. So to speak, the other profitable segments absorbed all the losses. Despite this, the company was able to produce profit before tax of S$4.5 million. I was getting excited. What if Dr Adhiwana was able to close down all the unprofitable stores in one stroke? Without any revenue growth, the profits would double on the basis that food retail turned breakeven. Add S$4.5 million to $5.2 million. I am not sure about you, but I was super excited.

Based on 31 December 2015 full year results, I did not emphasize on its profit margins and return-to-equity as the profits were affected by restructuring costs. However, looking at its solvency, the company had a net-cash-to-equity ratio of 26%. Current ratio was healthy at 1.9x. Its balance sheet was strong and it added confidence for me to continue my analysis.

Since first quarter in FY2016, Auric swallowed the pill and closed down the non-performing assets. Gradually, the food retail and food court segments turned profitable. That was a significant turnaround from its loss-making days from a year ago.

Fast forward, for 9 months FY2016 results, Auric reported S$11.6 million profit before tax which was already higher than last year’s full year results. Earlier, I was predicting that if the food retail and food court segments were rationalised profitably, their profits would double. It materialised.

The cumulative 9 months FY2016 results also demonstrated that Auric had generated S$40.3 million of operating cash flows. Accounting for its S$3.7 million capital expenditure, it generated S$36.6 million free cash flow. Again, this was significantly higher than previous corresponding results. The cash balances ballooned. It had a net-cash-to-equity ratio of 47%.  The current ratio was 2.2x

That was just one piece of good news I saw. What truly reaffirmed me about Auric’s turnaround and intrinsic value was Dr Adhiwana’s direct purchase of Auric shares. After receiving his first block of shares from Dr Stephen Riady, he continued to purchase shares using his personal money. From 1 September 2015 to 9 November 2016, he purchased nearly 7 million shares and it costed him approximately S$5.9 million. Woah! Dr Adhiwana was literally putting his money where his mouth was, and putting skin in the game!

Typically, I viewed key executive purchases of shares more favourably than a company buy-back of its own shares.

Immediately, I put the numbers into perspective and did a quick valuation of Auric.

At 8 November 2016 price, Auric closed at S$1.17. Its outstanding shares were 125,667,324, meaning its market capitalization was S$145.8 million. After adding debt and removing the cash, its enterprise value was S$67.2 million.

Utilizing the valuation method of Enterprise Value to Free Cash Flow, the figure comes up to 1.83x (S$67.2 million enterprise value divided by S$36.6 million free cash flow). In comparison with their closest peer, QAF Limited (SGX:Q01), I believed that Auric was severely undervalued. While there are working capital adjustments needed, take note that I used 9 months of results, which excluded the last quarter to derive at this valuation. Even then, EV/FCF was really ridiculously cheap for a consumer staple company!

At that valuation, it was a no-brainer! From November 2016 to January 2017, I purchased shares of Auric aggressively despite its share price moving up.

Risks

From my perspective, competition may cause their business segment margins to erode.

To be safe, I went to multiple supermarkets at different timings. From my observations, I believed that their iconic “SCS butter” brand enjoyed high market share and shelf space as well. For their “Sunshine” bread, they were selling well. With regards to other segments, Food Junction and Délifrance may face greater competition because their brand was not strong. These are consumer staples and the demand does not fluctuate too much, even during recession.

Developments

On the morning of 7 February 2017, Silver Creek Capital Pte Ltd, an entity jointly owned by Dr Stephen Riady and Dr Andy Adhiwana launched a general offer to privatise Auric. The offer price was S$1.65 per share. Both of them jointly held 76.72% of the Company before the offer. This meant that the Offer to garner 13.28% to be delisted. Looking at the odds, I felt a sense of disappointment because my intrinsic value of the company was much higher. With a reluctant heart, I tendered my shares by selling them at the open market at S$1.65.

(price chart credit: https://sginvestors.io/sgx/stock/a23-auric-pacific/share-price-history)

Summary

1. Focus on the free cash flow of the business more than anything else. Cash flow is the lifeline of any businesses. Just like a human, when blood stops flowing, the organs stop functioning.
2. Ascertain whether the management is doing the right things to stop the bleeding for the business to heal.
3. For turnaround stocks, the chances of succeeding are higher when a segment is not doing well as compared to ALL segments are not doing well.