This week I am talking about Hup Seng Industries Berhad.

I think many can still remember eating Hup Seng's Cream Cracker biscuits because it's been in the market for so long. I think some might still be eating it to this day. For me, I remember eating cream crackers with 'Kopi-O' when I was still schooling. It really brings back childhood memories.

Some of Hup Seng's new and old products.

Fast forward to year 2016, Hup Seng is still selling the old cream cracker biscuit products together other varieties of new and old biscuit products. And they also have instant beverage products such as In-Comix Coffee, tea and cereal.

Hup Seng started out in 1958 by four brothers in the Kerk family in Batu Pahat. It is now one of the leading biscuit manufacturers in Malaysia. Cream crackers have always been the main product for Hup Seng. Based on estimates by the company's management, Hup Seng commands one third of cream cracker market share in Malaysia.

Revenue & Profit

For the past 5 years, revenue continue to grow for Hup Seng.

The growth in revenue represents a 5-year CAGR of just 4.5%. Cream cracker sales have always been growing steadily at about 2%-4% annually, in tandem with Malaysia's population growth rate of 1%-3%. Revenue can be identified by 3 segments that they are operating:

Based on 2015 Q4 report.

As we can see, biscuit manufacturing contributes 49% towards revenue and trading division 48%. The rest of 3% is contribution from the beverage manufacturing division. Biscuit manufacturing segment is the most profitable segment for Hup Seng as it brings in 23.6% profit margin. The other two segments only have profit margins of around 11%-12%.

Hup Seng have increasing Gross Profit and Gross Profit Margins for the past 5 years. Comodity prices like crude palm oil do impact cost of sales. As we can see, it was a good year for Hup Seng as prices of CPO was quite low. Right now price seems to picked up a bit but it is still much lower than it was in year 2011 (CPO price around 3800+- compared to now 2600+-). This has contributed to better profit margins for Hup Seng. 5-year CAGR for Gross Profit is at 11.8%.

In line with better gross margins, opearating profits have also increased. 5-year CAGR at 16.3%.

In tandem with lower commodity prices, net profit and owner's earnings have also increased. 5-year CAGR for Net Profit and Owner Earings are at 31% and 29% respectively.

Do note that Hup Seng also benefited from higher forex gains due to the stronger USD against the Ringgit in year 2015. Net profit margin stands at 19.4% in year 2015. If we exclude higher forex gains and lower commodity prices, and theoretically put margins back to 2013-2014 levels which is around 14.5%, we can still see profits of RM 41.59 million from revenue of RM 286.86 million. It is still higher than profit gains from past few years.

ROAE & ROIC

Hup Seng have high Return of Average Equity (ROAE) for the past few years and as a matter of fact, it is increasing.

ROIC or Return of Invested Capital however is something more impressive. Have a look:

It is almost 100% in year 2015, 96.4% to be exact. How many listed companies in Malaysia can actually be this efficient utilising its working capitals to deliver high profits?

Cash, Cash, Cash & Cash

Let's talk about cash for a second.

Cash is king. Some PM of a certain country apparently said that to a ex-PM of that said country. Well, actually we don't need others to tell us that. More cash is good right? Of course. If I have more cash each month, I can go on a holiday, feast & fine-dine, buy stuffs that I've always wanted to buy, donate to charity, help others or maybe even save it and invest for the future. Either way, it's great.

Likewise, in a business, if you don't generate sufficient amount of cash to operate your business, soon you might have to borrow some. However, If you have free cash sitting idle in your company, you can opt to expand your business or venture into new ones, or maybe even declare more dividends for shareholders.

Let's look at Hup Seng's Cash Return on Invested Capital (CROIC).

More than 70% which is very good. Even excluding year 2015, other years have more than 30% which is very good as well.

And take note: Cash Flow From Operations have always been higher than Net Profit.

Have a look at past 5 year free cash flow too:

Notice that FCF continue to increase, but Invested Capital is on a steady decline. Hup Seng does not require to invest so much each year to generate high amount of cash.

Oh I must mention this too, Hup Seng have 0 debts. So free cash flow calculated is indeed 'free'.

On the average, FCF vs Revenue is more than 10% each. Very good as well.

Now surely better cash flow can be explained right? Higher net profit does not necessarily guarantee better cash flow. Yes, that's right. To better understand how cash flow can be better, we look at Cash Conversion Cycle for the past 5 years.

Cash Conversion Cycle for Hup Seng is currently at -11.30. A negative cash conversion cycle is actually very desirable by most companies. A business can collect money from customers first before paying suppliers. Probably it might have good relations with suppliers that enable deferment of payments. This in turn makes cash flow more manageable and therefore we can see the better cash flow for Hup Seng.

Cash indeed is King.

Based on Q4 report, Hup Seng is currently sitting at RM 109.3 million in cash balances. That's RM 0.137 per share.

I think fundamentals for Hup Seng is strong. Now time to valuate it.

Valuation

If we look at EV/EBIT or EBIT/EV, this is an expensive stock at enterprise value of 12.5 times the earnings. However, if we look at Price to Free Cash Flow ratio, it is still considered attractive at 18.6. Inverse it and we get cash yield of 5.36%.

Hup Seng have a dividend payout policy of at least 60% of earnings. The exception would be for FY 2015 when it paid more than what it earned via special dividends. This is not sustainable going long term, so expect lower dividend yield than the current 5.86% yield.

Conclusion

I have no doubts that Hup Seng is a fundamentally strong company. Valuation wise is up to interpretation although I agree it is not cheap! As the F&B sector is a resilient sector even in the times of economic slowdown, I think Hup Seng will continue to do well in the future.

As of now, there is no growth catalyst for Hup Seng and therefore I do not expect price to shoot up fast. This can be one stock to hold for long term.

Note: This post serve as information sharing on how I can identify stocks with my selection criteria. It does not serve as a BUY/HOLD/SELL call. Please do your research beforehand as you are responsible for your own actions. Do not follow blindly as my selection criteria may not suit your taste. I do not currently own Hup Seng as of time of writing.

Thank you.

shinado