Wilmar International

[Choon]

The company's path forward, at least for for the China market, is to leverage on existing and build new plant capacity to expand into more product categories e.g. central kitchen, soya sauce, vinegar.

A clear plan for growth. Hopefully that will raise asset utilisation and margins significantly.

https://m.21jingji.com/article/20211231/...9e085.html

Vested.

[Choon]

Wilmar's ROE is low, fluctuating between 8-10% in 2017-2021.

Does this represent that Wilmar is not an attractive business with strong earnings power despite its vertically-integrated business model (from farm to factory to consumer)?

Or is ROE not an adequate theory/framework to evaluate the business performance/quality of Wilmar?

Thoughts and insights please. Thank you.

Vested

[money]

Actually wilmar has been in my watchlist for some time. i like the idea of the vertical integrated business model and its expansion into china, yet like what you say, the ROE isnt high, so i dont exactly know whether i should conclude if it has strong earning power.

Probably you see that it has fallen about 10% lately but the general market sentiments have also been quite weak. It should be fine in the long term

[Choon]

A thought that come to mind is that perhaps KKH does not think in terms of ROE? 

Perhaps given the nature of commodity business, he has not been influenced/captured by modern finance theory to think of business in the dimension of ROE?

Perhaps what are more important to him are scale, resilience and as long as the business turns in a positive profit? 

Because if a management sets a target in terms of ROE/EVA and reward themselves accordingly, surely over a long period of time, the high ROE/EVA would be achieved (sometimes / many times at the expense of long-term value).

[weii]

A thought that come to mind is that perhaps KKH does not think in terms of ROE? 

Perhaps given the nature of commodity business, he has not been influenced/captured by modern finance theory to think of business in the dimension of ROE?

Perhaps what are more important to him are scale, resilience and as long as the business turns in a positive profit? 

Because if a management sets a target in terms of ROE/EVA and reward themselves accordingly, surely over a long period of time, the high ROE/EVA would be achieved (sometimes / many times at the expense of long-term value).

Part of Wilmar business is cyclical so you need to adjust the ROE for that sector. For example, due to current high coal prices and shipping rates, the ROE for coal mining and shipping companies will appear high.

The branded consumer pack business will be good for tracking its ROE over time to reflect higher brand royalty and pricing power.

Some businesses are still at a stage where many small competitors have yet to exit the industry. Thus the market leaders will concentrate on building economics of scale and research spending to differentiate their products. It will take time for pricing power to emerge and thus ROE to increase. An example will be China Sunsine if you track it over a long period of time.

[weijian]

Wilmar's ROE is low, fluctuating between 8-10% in 2017-2021.

Does this represent that Wilmar is not an attractive business with strong earnings power despite its vertically-integrated business model (from farm to factory to consumer)?

Or is ROE not an adequate theory/framework to evaluate the business performance/quality of Wilmar?

Thoughts and insights please. Thank you.

Vested

Hi Choon,
From AR21, I see that Wilmar has ~26bil net debt (total debt minus the cash) with 22.6bil equity (including minority interests for simplicity sake).

With PATMI=2.07bil:
- ROE ~ 9.1%.
- But if we account for the debt, ROIC ~ 4.3% (2.07/(22.6+26))

Since we are talking about earnings power, which itself is a generic description used across industries. I believe ROIC would be a better gauge than ROE, since it accounts for the capital structure (ie. owner equity and debt)

So rather than referring to "high single digit to low double digit" returns, first we should actually use the figure of "mid single digit" as the basis for discussion/thoughts.

I believe this ballpark number may answer some of your questions.

My 2 cents:

(1) We can safely say that most family businesses are more concerned about extending their dynasties over generations, rather than optimizing for profits to get their annual bonuses. This effort can be through improving resilience of the business (positive for OPMI) OR simply trying to exerting more control by buying out depressed OPMIs at low prices (bad for OPMI).

(2) Many commodity players are at the mercy of prices and those who control the distribution (the brokers). The brokers themselves have huge liquidity risks (Noble as the easy one to raise as the poster child victim). And finally FMCG companies themselves are at the mercy of input costs increases (this threat has never been higher in the current immediate future). By been fully vertically integrated from farm to consumer, they give up the obscene profits of a boom to protect on the downside. And downside is the most important factor for dynastic rule, not obscene profits. So I see the Kuok Clan doing a lot of things to improve resilience of their business.

(3) Rather than looking at earnings power from a quantitative viewpoint, we should also look at the qualitative aspects. For example, I would love to see how sticky Wilmar is to its customers to determine whether it has a moat or not. Then connect the dots between quantitative (profit margins, ROE/ROIC) and qualitative (moats) and see if they are telling the same story. If they are not, then probably our work/thinking on at least 1 of the 2 aspects is wrong.

[brattzz]

Kuok's biz philosophy is solid sound, commodities has to be kept low price/cost to maintain/expand the market share and be in business forever+ever!

[BlueKelah]

Kuok's biz philosophy is solid sound, commodities has to be kept low price/cost to maintain/expand the market share and be in business forever+ever!

Problem is their debt, and gearing is too high, this could become an issue should commodity prices collapse and rates unexpectedly hit 10%

[Choon]

In my view, their debt gearing is not high and in fact very conservative (adjusted D/E of 30%).

I think one must take into consideration the nature of commodity business in assessing gearing. It would be too broad brush and wrong to apply the generic debt/equity formula across all companies.

Wilmar's annual report provides a very good explanation of an adjusted d/e ratio - in essence deducting the inventories and receivables amount from debt - to arrive at adjusted net debt (pg 93 of AR2021)

Why does Wilmar's adjustment make sense? My understanding/imagination is as follows:

1) Wilmar borrows $100M to buy sugar from farmers (thus taking on debt of $100M on Wilmar's book);

2) But at the same time, Wilmar enters into contract to sell those sugar at a $102M.

3) Importantly, the contracts in point (2) are delivered very quickly. Importantly, Wilmar also enter in various hedges (e.g. FX, sugar futures) to lock in the price of $102M. 

4) What happens is that through (2) and (3) the sugar inventory on its book becomes as reliable and as liquid as $102M of liquid cash.

Thus I think debt incurred for the the purchase of commodities and protected by the mechanisms above can rightfully be deducted from debt for the calculation of D/E. 

Which means the D that goes into calculation of D/E should only be debt incurred for CAPEX and M&A and investments and share buybacks.

[weijian]

Which means the D that goes into calculation of D/E should only be debt incurred for CAPEX and M&A and investments and share buybacks.

Hi Choon,
What you have described is just working capital requirement. Part of Wilmar's business is acting as a broker and brokers have high working capital needs. Since this is their business model, why should it be excluded? 

Why should debt that is used for part of their business model be excluded? If a serial acquirer uses debt for MA and MA is part of their business model, is it justified to exclude debt from the D/E calculations?

Of course, everyone has their "own" calculations. If not, the market will be terribly efficient!

How many legs does a dog have if you call his tail a leg? The answer: Four, because calling a tail a leg doesn’t make it a leg, even when auditors/ authorities/ journalists/ Mgt are willing to certify and vouch it is one.

That said. It is my personal opinion that their debt isn't a big problem. It is simply part of their business model. They need to have high debt to generate sufficient returns and this speaks about the merits of the business itself. But the Kuoks are old hands in this business - because they hold hard assets and vertically integrated, they have a better chance to survive than let's say a pure commodity broker in the downturn. Debt can't be ignored but it can be endured.