Power Root is a growing Malaysian beverage company with promising growth potential as it expands into offshore markets. While the present valuations appear to be fair, they don’t take into consideration the current value of the brand or earnings potential if the export strategy is executed appropriately.

Interestingly, it looks like Power Root is producing a tasty pre-packaged product with a similar angle to Coca-Cola before they took the cocaine out (read more below). Based on M&A valuations, my target price for Power Root is MYR3.32, which could be achieved without corporate activity as the Company increases its presence in offshore markets.

Lately, one of the major shareholders, Koperasi, has been selling down its shareholding, which may have been depressing the price (or at least preventing it from reaching its potential).

The Company

Power Root was founded in 1999, in Johor Bahru, just over the border from Singapore. It manufactures and distributes herbal energy drinks fortified with two main rainforest herbs; Eurycoma longfolia (Tongkat Ali) and Labisia Pumilia or “Kacip Fatimah”.

Tongkat Ali is a flowering plant found in Indonesia, Malaysia, Thailand, Vietnam and Laos. The plant has traditionally been used for “antimalarial, aphrodisiac, anti-diabetic, antimicrobial and antipyretic activities… ” There isn’t sufficient scientific evidence to prove that Tongkat Ali can give you the rhino’s horn but it’s well known among locals as a substitute for the little blue pill.

Kacip Fatimah is the female version of Tongkat Ali, is also native to Malaysia. While the references are lacking, Wiki claims that the leaves can be used to treat women who experience a lack of libido or need to hasten childbirth (offering a bit more bang than a can of Kickapoo).

In 2003 the Company started its own 18-acre manufacturing plant in Johor Bahru to meet the growing demand. Currently the production capacity at the Johor Bahru plant is 140k carton/month of Instant Products (IP) and 120k/cartons/month of Canned Beverages (CB).

Power Root – Brands (Instant)

Presently, 68% of the sales are distributed locally with a growing proportion being exported. The Company is considering setting up a production facility in the UAE to cater to the growing demand in the MENA region according to this article and affirmed by the Company.

Power Root – Brands (Tin)

Power Root – Structure

Conclusion

Recently, I’ve been thinking more about SKP Resources after walking past a shop in Chinatown that was selling their flagship products. The shop was filled with trinkets and numerous cheap items; the business is in the very low value-add end of town with a significant reliance on one key customer (Dyson). I’m going to use this opportunity to reduce my SKP Resources position in the portfolio add a 10% position in Power Root as I increase my coverage in Malaysia.

Power Root represents a play on the increasing consumer class in Malaysia and SEA as it expands its roots in the region. The market potential represents the kind of opportunity that larger bottlers will be looking for as growth opportunities in their home markets wane.

Thesis

Power Root is an established Malaysian brand that has the potential to capture above average sales growth as the brand grows internationally. Presently, Japanese bottlers are looking for ways to expand their market share in the international market and NARTDs (Non-Alcoholic Ready To Drink) represent an attractive avenue for growth.

While it’s difficult to put a value on the Power Root brand, the Company could be taken out for a similar multiple to other transactions. This means Power Root should be worth anything from MYR1.70-5.86 (see below). Failing a takeover, sales are currently growing at >20% p.a. with EBITDA margins doubling from 8.9% in FY2009 to 17.2% in FY2013.

Financial Performance

In 2013, they opened up distribution networks into Philippines, Algeria, Maldives, Somalia and Australia.

Power Root – Financial Highlights

Management & Shareholdings

Power Root – Shareholders

Say Swee How – Executive Director: One of the three founding members of Power Root, Dato How Say Swee had a background operating retail food outlets in Western Malaysia before becoming involved with Power Root.

Chee Yen Low – Managing Director: Another founding member of the group with over 13 years of experience in the F&B industry, Dato’ Low Chee Yen has been managing director of the group since 2007.

Fuei Boon Wong – Executive Director: Also a founding member of the group, Dato’ Wong Fuei Boon had owned and operated several mini-markets in Johor Bahru before becoming involved with Power Root.

Koperasi Permodalan Felda (KPF) – Major shareholder: A cooperative that’s owned by 230k settlers and Felda (Federal Land Development Authority) group employees. Recently been selling down shares,

Recently top management have been adding to their positions.

Risks & Mitigating Factors

The key risks to the group are:

• Rising raw materials prices
  • NARTDs have traditionally been able to raise prices to combat inflation but quick spikes in the raw commodity prices resulting from increased natural disasters could cause one-off impacts to earnings.
• FX risk
  • As an increasing proportion of the sales come from offshore, Power Root’s earnings will be more exposed to FX volatility. The impact shouldn’t be material compared to the potential upside from the export market.

Valuation

NARTDs have been topical in the past few years as global conglomerates look for new markets to expand into. Japanese bottlers have been expanding into new markets through acquisitions of the existing players. The Charlie’s acquisition by Asahi highlights the potential from M&A valuations.

Charlie’s – Recent Takeovers

The Independent Valuation report on Charlie’s yielded the following potential valuations:

Charlie’s – Valuation

These are similar to the current CompCo valuations for the more established bottlers. Assuming that a discount for size and premium for control net each other out then there’s some potential for Power Root.

Applied to the current earnings estimates, which don’t take into consideration the potential for a new bottling operation in UAE yields the following valuations:

Power Root – M&A Valuation

At the bottom end of the scale (assuming limited growth) Power Root looks to be fully valued. However, if the Company is able to succeed with the offshore bottling operations it’s not difficult to make an argument for further upside potential.

Reading between the lines in a couple of Edge articles (here and here), Power Root should be able to increase the offshore sales from MYR90m to MYR130m (export revenue is 32% of total revenue MYR279.35m for FY2013). Assuming that there was no growth in the domestic market and Power Root was able to achieve the level of offshore revenue growth Kenanga Research is proposing Power Root looks to be fair value.

Power Root – Valuation only considering offshore growth

Therefore, based on the current earnings there isn’t a reasonable margin of safety at the current levels. I’d argue that the brand, which holds a 20% market share in coffee and 30% market share in energy drinks in Malaysia, represents an intangible margin of safety that isn’t taken into consideration in the above earnings based valuations.

I’m basing my target price on the potential M&A takeover valuation of MYR3.32, representing 76% upside from the current value.

Disclosure: This is not meant to be interpreted as investment advice. If you’re considering investing do your own due diligence. I do not presently have a position in Power Root but may initiate one within the next 30 days.