Research Visit: Chiang Mai Frozen Foods PCL (CM)

Research Visit:Chiang Mai Frozen Foods PCL (CM)

This article was earlier released to our subscribers on 1.Feb. 1999

The principal reasons to own shares in CM are for high dividend yield and promising future earnings growth. Also interesting are the non-correlating business prospects of CM as these have little to do with neither the overall Thai stock market performance nor a potential bust in the "bloated" US stocks. The principal risk would be 1999 Chinese currency devaluation in 1999 which would jeopardize the competitiveness of CM in the short run.

Conclusion is to continue recommend purchase:This company has its headquarters and two separate factories located in the outskirts of Chiang Mai. While CM has an export office in Bangkok and now Taiwan, senior management and all production facilities are in Chiang Mai. I visited CM with a subscriber who knows the firm well. We are both continuously impressed with this company and continue recommend purchase. (For purpose of some numbers please see separately the master table for this and CM’s profile and future posted news items).

Rather than using a rigid format I will here simply review some of the major and finer points of this perceived quality firm which Thaistocks.com still firmly rates as a "Long Term Buy Recommendation". This despite the stock price being up some 50% since my initial writing on September 15th "98. The subscribers issue from that date starts out by saying "Chiang Mai Frozen Foods, CM (27) is now my number one favored stock." Note that CM had a rights offering for new shares in November of "98. I stated that I viewed this as favorable and recommended fully subscribing. The value of the rights offering was 7 Baht per share. (You can see how this is calculated in our subscribers Write-up on December 1 1998 - see at the end of article).

The first thing needs to be clarified is the coming dividend reflecting the firms 1998 operations. It will not by as high as I previously indicated. The main reason being is that Thailand has a dysfunctional Banking system where even good clients (like CM) are far from assured Bank credit lines. CM feels it needs to keep a major part of its earnings within the company as the firm is steadily growing and does not want to depend on Banks. Above average long term growth needs capital. I now project a dividend of around 4 Baht, which nevertheless will yield well above 10% on the current stock price.

This is my own estimate based what Khun Prapas indicated. Obviously it will be up to the board of directors of his firm. Clearly the dividend payout would be higher if senior management was not concerned about the lack of lending capabilities by the local Banking system. In fact, this is now an ongoing concern for all listed smaller and middle-sized profitable firms in Thailand. Hence I should warn investors not to expect highest dividend payouts in the coming April/May period. Still double-digit level seems assured by many of my favorites including CM.

Our meeting:We met on a cooler morning with Mr. Prapas who spend the good part of his day with us. After a two hour intensive interview by us he invited us for lunch and we then toured one of the two adjacent factories.

CM will expand its cold storage facility.Cold storage is very important in their line of business. It allows CM to inventory certain products at far below freezing levels and to so manage its overall business to higher profitability levels. It became clear through our conversations that cold storage capacity is a mighty important necessity to future business growth. CM’s products must be frozen well below the freezing level (-18 degree Celsius) for it to have longest shelf life. Simply a few degrees below 0 does not do accomplish this. Hence this is an expensive and important part of their overall operations.

CM just completed a rights offering.CM earlier obtained 160 million Baht from issuing new shares to be used for business expansion. (Nov. "98). The company has increased its capital by allotting 8.5 million new shares at 10 Baht apiece to existing shareholders in the proportion of 68 new shares to every 100 old shares. The total new outstanding shares are now 21 million.

On Earnings Estimates:My earnings estimate for all of 1998 is 12.7 Baht per share. My earnings estimate for all of 1999 is 7.9 Baht per share. My earnings estimate for all of 2000 is 8.8 Baht per share. (All numbers here are strictly operating earnings).

On Valuation: On the current stock price of approximately 32 the p/e is 2.6 for trailing calendar 1998, 4.2 p/e for full calendar 1999, and 3.55 p/e for the full calendar year 2000. Earnings could be affected in year 2000 due to potential drought effect and I reflect this in my estimate. This valuation is about 2/3 lower than the SET averages whose average p/e is currently at 8.8 for trailing past 4 Quarters. Based on the current market price, the expected dividend yield for the next 3 years is well above 12% for each year and this yield has very little to do regardless which various global risk scenarios end up playing out. The book value is right around 30 Baht per share and expected to increase.

In deflationary times with collapsing local and international interest rates, you want cash flow more than anything else. CM has high prospects in delivering high dividends for years to come and this expected income stream have very little correlation to neither the SET nor the US market.

Clearly last year (1998) was an extraordinary good year and this will not be repeated any time soon. Pre-devaluation raw material were used up yet sales were booked in US $ at post devaluation top exchange rates. This translated into sort of "windfall profits" which where unusual. While most export-resurgent companies will feel this effect, it is particularly strong in CM’s case. Anyway you look at it, CM’s long term earnings trend give it one of these below p/e 5’s, not worth missing. (I.E. 5 times 7-8 Baht long-term stable EPS trend line gives a current stock price of 35-40 for CM. So 35-36 is my buy limit unless you can accept a 2-3-year time frame.

The long term growth and ever increasing dividend income potential remain intact with CM. This is so for the following reasons:

1. The cold storage facility will be increased in the near future from 10,000 tons to 15,000. This gives way to more inventory and so new future earnings growth besides fewer ups and downs.
2. The company is starting to export to USA baby-corn and mixed fruit to Europe (mostly Sweden). These are new markets with high growth potential. Baby corns exports to US were 200 tons in "98 and are expected to be over 400 tons this year. Could USA fall in love with Baby Corn? Consider all the new Thai restaurants established now in the USA over the past 10 years. This is not just a fad.
3. The company is always helping farmers increase yields on the land they own. Some 20,000 farmers (the landowners) are cultivating an average of 1-3 Rai of land with the help of CM" s Agro. These are Agro-experts who reside full time on location (yes, day and night). The company can so extract ever-higher productivity. Expected productivity growth here is 3-5% per year. CM does not extend loans to these farmers but advances them the raw materials needed, like top quality seeds (imported from the US).
4. The company is now expanding the frozen fruit business. However this comes from a very low base, as some 95% of CM’s products are vegetables for exports. An example of fruit is the durian which when frozen becomes like an ice cream delicatessen. The process is different, as fruits unlike vegetables do not get cooked before final consumption. CM is determined to introduce several new fruit products in the next 2-3 years.
5. The company has a joint venture in China to produces initially now some 1500 tons there. While it is a small Taiwan- CM venture to date, it assures a foothold in the mainland.
6. There is an entrenched global trend to consume more vegetables for health reasons. This is mainly so in the developed countries" who are CM’s principal business clients. (Japan being currently by far CM’s biggest customer). The company also plans to sell more in Thailand but demand for the export market is stronger and besides has higher margins.
7. While the company has some (minor) Agro risk, it is very far removed from the "manic" Dow Jones or the fragile recovering SET. CM has a historical Beta coefficient of only 0.13 as compared to the SET and so this is an investment, which will lower overall portfolio risk exposure. This can be documented in modern portfolio theory.
8. The company has 3 main stockholder groups, which while it limits the "float", does give particular business advantages. Japanese, Taiwanese and Thai Management own some 2/3 of all outstanding shares. The lack of trading volume is a shortcoming but to a long-term "high yield-accumulator" a higher than current market price could be justified. The future income stream of CM through annual dividends is well above average.
9. The company has major tax advantages, as its 2 plants are BOI approved.
10. This company is in a defensive business. Meaning not dependant on forever growing global economic activity. I.E.Japan has been in recession for a decade, yet Japan is CM’s biggest and still growing customer.

The company’s main products are:1) Green Been, annual output here is 9000 Tons.2) Soya Beans annual output here is 6000 Tons.Total production of all products for export is 21,000 Tons per year.

The company is the dominant producer of these products. Their largest competitor has capacity of less than 3000 Tons per year.

A research paper from Tisco and published on December 20 1998, writes the following about Industrial output in Thailand.

" ….Industrial output is down again. Industrial output declined by 3.1% year-on-year in November compared with a revised contraction of 3.4% in October. The seasonally adjusted MPI also dropped by 2.3% month-on-month to 94.8 from 97 in October. This sharp decrease was partly attributable to plant shutdowns for annual maintenance after some factories accelerated production in October. Thus while output of processed foods and beverages continued to rise, production of vehicles and parts, refined petroleum products, and construction materials declined m-o-m. On a y-o-y basis, however, production of vehicle and parts rose by a notable 105.3% though this was from a small base. Automakers have shifted attention to export markets, especially for pick-up trucks, due to the slump in domestic auto sales. "

CM’s industry, despite the current drought concerns, has above average good long-term prospects. CM takes advantage of Thailand’s very strength. And while some might be concerned about "Agro cyclically" we think in CM’s case these are less. Recall the company has a very short growing season and gets all its raw material through these independent farmers. CM does not itself grow anything.

About the drought in Thailand.It was reported lately that more than four million people in 34 provinces nationwide have been affected by the growing water shortage this according to the Civil Defense Office. The shortage has already hit nine northern provinces, 13 northeastern provinces, eight in the Central Region, two in the eastern provinces, one western province and one in the South, affecting 4.57 million people.

But… CM is teaching and helping it’s farmers to dig many new water wells and Chiang Mai is well north of the major Water Dam so often reported to be at these lowest levels. The plains in the central region of Thailand are the worst effected not the north. We are monitoring this.

CM has a 4 million US Dollar loan. All of the FX loss has been already expensed and so I expect a slight extraordinary gain for 4Q."98.

Imports needed by CM:Machines for production are imported from the US, Denmark and Canada. Biggest costs are electric, labor, and raw material. Labor costs have been favorable due to the general economic crisis. CM imports Fertilizer & Chemicals (from Norway), seeds come from USA through annual contracted prices. The company does not grow DNA altered seeds. The packaging is acquired in Thailand and not a big expense.

CM does not have any subsidiaries or any litigation proceedings pending.-End of CM research report-.

Data on Import and Export for Thailand in 1998.

The top 10 imported products in 1998 were electric machines worth Bt251.49 billion, machinery worth Bt170.7 billion, chemicals worth Bt161 billion, integrated circuits and parts worth Bt143.43 billion, crude oil worth Bt119.95 billion, metal worth Bt89.93 billion, computers and equipment’s worth Bt82.94 billion, electric appliances worth Bt74.83 billion, steel worth Bt74.9 billion, and textiles worth Bt63.35 billion.

The top 10 export products in 1998 are computers and equipment worth Bt316.14 billion, electric appliances worth Bt169.33 billion, apparel worth Bt126.66 billion, integrated circuits and parts worth Bt93.72 billion, rubber and rubber products worth Bt91.43 billion, rice worth Bt86.78 billion, gems and jewelry worth 76.55 billion, canned seafood worth Bt73.29 billion, plastics and plastic products worth Bt70.42 billion and frozen shrimp worth Bt58.65 billion.According to the Nation Newspaper of January 27, 1999

An Update on Safari (25) and a comment on the Insurance Sector.

We have been asked about Insurance stocks. I don"t really like this sector as for one; the accounting is always difficult to understand.

I know these firms often own allot of big bad "bear" cap. shares in their reserve portfolios. I would be very careful owning any insurance stocks here that you don"t" end-up instead getting a "quasi" SET index fund. Also insurance’s in Thailand are a sort of a luxury. It is one of those things you go mostly without when the economy turns sour as it has. (I don"t" mean car insurance). People in Thailand, unlike in USA or Europe, view most insurance’s as something they can live without. I think this industry is cyclical and so a "play on the SET". It’s an investment on the slow domestic economic recovery, which may need more time. One company, which I would mention, is "Ayud". AYUD (130) is top quality but as usual very little trading volume, information, and accounting understanding of its business.

As for an update on Safari,

The current admission price is for now set at 950 Baht per person. The grand opening has been delayed to next month. (No doubt, for Chinese New Year). 2 weeks ago all the local travel agents were invited for free and they reported "positive amazement". The admission price was to go up to 1400 Baht but this appears not happening for just now. The project is indeed 100% finished. We enjoyed their show twice and yes; it appeared flawless to all of us. Some people complained about the Dinner ("could be better", hmmm...), but I thought the food was good . The deserts are excellent but my fussy with food, Thai wife said, the food was "75% OK."

The company is a touch mysterious but probably in a sort of intelligent way. Their marketing ads for example do not indicate were you get the admission tickets nor exactly what it is. Just now Safari built two very large statues on 1/5 acre of land on two very good strategic locations. These are placed at busy intersections and one cannot miss them. People end up asking what is this? I guess that is the purpose of their ads. I feel the local English-language newspaper "Phuket Gazette" has not done a very good job in describing Safari nor giving many updates. Why not? It’s only the largest project ever build in Phuket.

Feedback:We have not heard anything or anyone speak negatively about Safari. All seem to like the show and all agree there is nothing like it, anywhere. The stage and premises are very well managed with security-ladies and management everywhere walking around with beefed-up mobile phones. We see their many mini-buses with their attractive logo bussing all their customers around the island. Labor costs in general have come down in the Kingdom due to many English speaking Thais seeking employment away from recession Bangkok. (I predict general inflation rates in Thailand will approach 1-3 % in 1999).

The big question is the "cheap Charlie" factor. A number of local contacts have said that while tourism is up, the kind of tourist coming here is "very cheap". True enough I believe. Coming back from Bangkok, one English fellow complained paying for a guesthouse room 500 Baht a night (14 US$)...he just felt this was "outrageous".

No question, Thailand has weathered the tourism economic turbulence well and emerged with strong double-digit growth in visitor arrivals on an already large base. January through November of 1998 saw a growth rate of 7.7% to 6.95 million people. This is in contrast to many double-digit declines in the region. Like Singapore took a 14% decline and Hong Kong, minus 12% in tourism arrivals, during the same period.

The big question then: Are tourists coming here all on this big bargain hunt? Earlier many of the local businesses made the mistake of upping prices dearly or quoting prices only in US$. This has rightfully upset many visitors. The key question then is: will Safari be able to differentiate itself enough so to keep it’s admission prices high (even higher than currently) so to meet those "rosy" projections. My guess is probably not. But that said I feel Safari management is smart and flexible enough to keep changing it’s non-rigid pricing policies and so should in time, be a big success.

Extremely Capital Hungry: Safari has also unsettled investors by issuing more stock through 2 private placements in the past 2-3 months, at 21 Baht per share. No doubt to complete this very capital-intensive project. Total capital costs are expected at 100 Mill. US$, for the whole Phuket project. The company has just this moment announced a rights offering -and I view this a negative.

The stock has been a market performer at best and so no doubt will keep rising and falling with the SET index in the near future. While the first few months of 1999 look like correction time for the general SET index, I feel the SET and Safari will close higher in market price this end of year than last.

But my main "bread and butter" and hence primary focus are as often stated: the value shares of Thailand, who’s time has now come. They should outperform along with an overall lower risk incurred then the SET index.

Best Personal Regards to all investors!

Paul A. Renaud

www.thaistocks.com

paularen@gmail.com