Delfi Ltd (DELFI SP) is a Singapore-listed chocolate producer with a major presence in Indonesia as well as other Southeast Asian countries such as the Philippines and Malaysia. Delfi’s market share in Indonesia is 45%, far ahead of competitor Mayorah Indah’s 25%. Its brand names SilverQueen, Ceres, Delfi, and Goya have been consumed by 4 generations of Indonesians over six decades, building up significant consumer mindshare in the process. Indonesians have grown accustomed to the typically less-sweet and less-milky type of chocolate that Delfi is offering. In addition, the company controls a distribution system with access to 400,000 points-of-sale across a country that does not have proper cold-storage logistics. A manager at Nestlé said the following about Delfi:
Hi Michael - i was trying to access your original deep dive presentation / thesis - the link no longer works (at least for me) - would you mind double checking it and fixing it if it is indeed broken? thanks very much (i am a subscriber!)
Hi Will! Weirdly enough the link works for me. But in any case, I've now uploaded the actual PDF file to the Delfi post itself. Hopefully that should solve the problem. If not, let me know!
Thanks for the write up. Just to chip in a bit of situation in Indonesia. I believe that there are a lot of fundamental shift in the distribution system in Indonesia. This has weakened a lot of FMCG's distribution. While existing brand works well when put side-by-side with weaker brand, there are places where there is not much option for brand. And a lot of the distribution network's owner will want to carry local brand that gives them higher margin. That is why, the return that they get will be lower in future.
Hi Chris! I agree with you, this shift could be a threat to existing FMCG brands. Brands matter for convenience stores and e-commerce platforms, but then again it opens up the market for smaller, more nimble competitors. I'm hoping that Delfi will be able to come up with more modern products such as SilverQueen. I do think that Delfi's margins are already on the low side, and a contributing factor could be smaller distributors to mom & pop shops taking a cut. There is potential in the company in my opinion, just a matter of whether that potential will be realised within our investment horizon.
Good write up and summary of the main thesis. Have you considered why the Brand value or the distribution strength doesn't show up in the Return on Capital metrics? How are you thinking about the erosion of market share over the last 5-6 years?
The erosion of market has has partly to do with Delfi's SKU rationalisation (hurting revenue somewhere along the lines of 8-10%) together with the success of Mayora's Choki-Choki (a product whose success I don't really understand). That said, Delfi's organic growth in 2018-19 was somewhere around 5-10%, which in my view is acceptable.
I think the question to consider is whether the SKU rationalization was due to a proactive decision by management or forced on them by their distribution (ie C-Store channel)? This has implications on their competitive advantage..
I agree, that's a key point. I think it might have been a mixture of both. A shift towards convenience stores / modern trade as well as e-commerce. I do think that it has weakened their competitive advantage somewhat (access to a wide range of points-of-sale). At the same time, their larger brand names such as SilverQueen and Ceres are among the most well-known in the region, so they should continue to hold shelf space in a modern era and get attention of shoppers on e-commerce sites.
But generally speaking, these are the potential reasons why ROIC / OPM have been underwhelming so far:
• Their brand names probably don't hold as much cachet as those of the major MNCs
• They operate in the mass-market / value segment where consumers tend to be more price-sensitive
• 1/3 of Delfi's revenues comes from distribution, which is a low-margin (though high ROIC) business
• The utilisation rate on their two factories in Indonesia / the Philippines was just 55% just prior to the pandemic. With higher utilisation comes higher margins and higher ROIC.
• The operations in Malaysia and the Philippines are not profitable yet. Philippines only became profitable in 2019 – right before the pandemic. It's an issue of scale. If you focus solely on their Indonesian operations, I believe the operating margin should be around 300-400bps above the headline number, suggesting that it is in fact a very profitable operation with a ~20% return on equity.
• The depreciation in the Indonesian Rupiah must have been a headwind given that many raw materials are traded in US Dollars. Though that doesn’t explain the weak margins prior to 2008 when the Rupiah traded flat against the US Dollar for many years.
• Delfi made US$110 million worth of investments in plant and distribution system improvements from 2014 to 2020. This must have reduced margins to some degree.
• They’ve also gone through a shift towards modern trade (supermarkets, convenience stores) and this shift has probably required higher-than-average promotional spending and R&D.
Agree with your comments, but as a rule of thumb if a business with 'moat' like characteristics doesn't translate into the financial numbers then most likely Management is destroying value somewhere relative to the Business's Earnings Potential. It does not seem anything in the Management has changed, if anything the quality of Senior Management has deteriorated over the last 1-2 years..
> It took them from 2012 (post divestment of the Cocoa Business) to 2019 to get back to $470m in Total Sales
> Taking a closer look at Segment and Geographic mix you can see that Agency brands for them have not done as well as their own brands. Even their JV's have not delivered on the promised sales
> Singapore used to contribute $23m in Sales which has since gone to 0 and actually Malaysia for them has done well. Im not sure why a chocolate company that generates $43m in Sales cannot make money, its been losing money for over a decade..
Yes, the execution has not been perfect. That's partly why the share price is low and why there is upside potential if those problems are solved.
I think you're being overly harsh. The Rupiah depreciated almost 40% against the USD during this time period and Delfi reports in USD. Their SKU rationalisation dropped overall sales by close to 10%. Or if you think the Rupiah will continue to depreciate against the USD, then measure Mayorah Indah's results in USD as well to get a proper perspective. But I have never heard investors in say Mayorah Indah complain about IDR exposure.
It's okay if you don't like all ideas here. At a pace of 20+ ideas per year, only a few will be true winners.
I agree that they have managed their GPM well during a tough IDR depreciation period. Speaking of Mayorah if you look at their performance they have just done better in my view during the same period.
In full disclosure I own the shares and added last summer and have been following the Company closely for more than 7 years. The thesis you discuss is well thought out and was even applicable back then. The current price does offer favorable risk reward but one has to consider the probability of future events unfolding not just the possibility.. In my view the key there would be Management change to truly unlock the value most investors are expecting.
IDK , I ran into them when I was looking for Malay company listed in SIN, since I do not have access to Malay Exchange. It seems cheap, but I dont know much about the industry.
Hi Michael, Delfi does look interesting as a buy-out target. I am just surprised why this opportunity would exist if this is quite well known and well written about? And looking historically the business has not been able to produce a lot of FCF, given the valuation, I would think it should be able to consistently produce ample free-cash yielding double digits. Margins also seem so low, is that just the fact of the big share of Agency brands, with cost pressure and inability to take price and being more mass market orientated?
Hi Nicolaas! Indeed, that is the trillion-dollar question.
Delfi is listed in Singapore and does report in US Dollars. I suspect that if it was listed in Jakarta, it would have enjoyed a higher valuation closer in line with Mayora Indah. Note that Delfi divested its cocoa ingredients business in 2012, so any financial prior to that are not particularly relevant to the consumer brand business that Delfi is today.
Margins are indeed lower. I've seen the following theories as why that's the case:
• Weak brand cachet compared to the international brands
• 1/3 of Delfi’s revenues comes from distribution, which is a low-margin business.
• The utilisation rate on their two factories in Indonesia / Philippines was just 55% in 2019
• Malaysia and the Philippines are not profitable yet (Philippines turning profitable now)
• Depreciation of the Indonesian Rupiah was a head-wind post 2013/14
• Delfi made US$110m investments in plant and distribution system improvements from 2014 to 2020
• A necessary shift towards modern trade (supermarkets, convenience stores) led to promotional spending and R&D as well as reducing the number of SKUs
So clearly Delfi has a great deal of potential and remains a key take-over target. Rumour has it that John thinks incoming take-over bids have been too low. Hopefully. he will be considering them at a higher price. Some of Delfi's brands are a bit stale (Ceres) but provide good cash flows, while others such as SilverQueen are doing very well. I think the company still has potential but it has yet to fully realise that potential.
Thanks Michael for the detailed response. Doesn't help that they are listed in Singapore, trade in USD and operate in local currency in Indonesia mainly.
What do you know about the $16.9m claim that seems to come from when they sold their cocoa busines. When will this be concluded?
Getting Philippines and Malaysia right will be key, but a small market share there and battling against global brands here that have a strong footholding, correct? Or who is there?
Hi Michael - i was trying to access your original deep dive presentation / thesis - the link no longer works (at least for me) - would you mind double checking it and fixing it if it is indeed broken? thanks very much (i am a subscriber!)
Hi Will! Weirdly enough the link works for me. But in any case, I've now uploaded the actual PDF file to the Delfi post itself. Hopefully that should solve the problem. If not, let me know!
Thanks for the write up. Just to chip in a bit of situation in Indonesia. I believe that there are a lot of fundamental shift in the distribution system in Indonesia. This has weakened a lot of FMCG's distribution. While existing brand works well when put side-by-side with weaker brand, there are places where there is not much option for brand. And a lot of the distribution network's owner will want to carry local brand that gives them higher margin. That is why, the return that they get will be lower in future.
Hi Chris! I agree with you, this shift could be a threat to existing FMCG brands. Brands matter for convenience stores and e-commerce platforms, but then again it opens up the market for smaller, more nimble competitors. I'm hoping that Delfi will be able to come up with more modern products such as SilverQueen. I do think that Delfi's margins are already on the low side, and a contributing factor could be smaller distributors to mom & pop shops taking a cut. There is potential in the company in my opinion, just a matter of whether that potential will be realised within our investment horizon.
Good write up and summary of the main thesis. Have you considered why the Brand value or the distribution strength doesn't show up in the Return on Capital metrics? How are you thinking about the erosion of market share over the last 5-6 years?
The erosion of market has has partly to do with Delfi's SKU rationalisation (hurting revenue somewhere along the lines of 8-10%) together with the success of Mayora's Choki-Choki (a product whose success I don't really understand). That said, Delfi's organic growth in 2018-19 was somewhere around 5-10%, which in my view is acceptable.
I think the question to consider is whether the SKU rationalization was due to a proactive decision by management or forced on them by their distribution (ie C-Store channel)? This has implications on their competitive advantage..
I agree, that's a key point. I think it might have been a mixture of both. A shift towards convenience stores / modern trade as well as e-commerce. I do think that it has weakened their competitive advantage somewhat (access to a wide range of points-of-sale). At the same time, their larger brand names such as SilverQueen and Ceres are among the most well-known in the region, so they should continue to hold shelf space in a modern era and get attention of shoppers on e-commerce sites.
Hi MAR!
This is the trillion-dollar question. Why are their margins lower than those of peers. I covered the margin question a little bit in the follow-up post here: https://www.asiancenturystocks.com/p/q-and-a-with-delfi-ltd
But generally speaking, these are the potential reasons why ROIC / OPM have been underwhelming so far:
• Their brand names probably don't hold as much cachet as those of the major MNCs
• They operate in the mass-market / value segment where consumers tend to be more price-sensitive
• 1/3 of Delfi's revenues comes from distribution, which is a low-margin (though high ROIC) business
• The utilisation rate on their two factories in Indonesia / the Philippines was just 55% just prior to the pandemic. With higher utilisation comes higher margins and higher ROIC.
• The operations in Malaysia and the Philippines are not profitable yet. Philippines only became profitable in 2019 – right before the pandemic. It's an issue of scale. If you focus solely on their Indonesian operations, I believe the operating margin should be around 300-400bps above the headline number, suggesting that it is in fact a very profitable operation with a ~20% return on equity.
• The depreciation in the Indonesian Rupiah must have been a headwind given that many raw materials are traded in US Dollars. Though that doesn’t explain the weak margins prior to 2008 when the Rupiah traded flat against the US Dollar for many years.
• Delfi made US$110 million worth of investments in plant and distribution system improvements from 2014 to 2020. This must have reduced margins to some degree.
• They’ve also gone through a shift towards modern trade (supermarkets, convenience stores) and this shift has probably required higher-than-average promotional spending and R&D.
Agree with your comments, but as a rule of thumb if a business with 'moat' like characteristics doesn't translate into the financial numbers then most likely Management is destroying value somewhere relative to the Business's Earnings Potential. It does not seem anything in the Management has changed, if anything the quality of Senior Management has deteriorated over the last 1-2 years..
> It took them from 2012 (post divestment of the Cocoa Business) to 2019 to get back to $470m in Total Sales
> Taking a closer look at Segment and Geographic mix you can see that Agency brands for them have not done as well as their own brands. Even their JV's have not delivered on the promised sales
> Singapore used to contribute $23m in Sales which has since gone to 0 and actually Malaysia for them has done well. Im not sure why a chocolate company that generates $43m in Sales cannot make money, its been losing money for over a decade..
Yes, the execution has not been perfect. That's partly why the share price is low and why there is upside potential if those problems are solved.
I think you're being overly harsh. The Rupiah depreciated almost 40% against the USD during this time period and Delfi reports in USD. Their SKU rationalisation dropped overall sales by close to 10%. Or if you think the Rupiah will continue to depreciate against the USD, then measure Mayorah Indah's results in USD as well to get a proper perspective. But I have never heard investors in say Mayorah Indah complain about IDR exposure.
It's okay if you don't like all ideas here. At a pace of 20+ ideas per year, only a few will be true winners.
I agree that they have managed their GPM well during a tough IDR depreciation period. Speaking of Mayorah if you look at their performance they have just done better in my view during the same period.
In full disclosure I own the shares and added last summer and have been following the Company closely for more than 7 years. The thesis you discuss is well thought out and was even applicable back then. The current price does offer favorable risk reward but one has to consider the probability of future events unfolding not just the possibility.. In my view the key there would be Management change to truly unlock the value most investors are expecting.
Looking forward to your future postings!
Sure, okay. Agree that Mayorah has done well. Thanks!
Hello Michael,
Great report, do you know JB FOOD? Malaysian but listed in SIN.
Hi Diego - I've heard the name but I don't know much about the company. How come they're listed in Singapore, is my first question.
IDK , I ran into them when I was looking for Malay company listed in SIN, since I do not have access to Malay Exchange. It seems cheap, but I dont know much about the industry.
Hi Michael, Delfi does look interesting as a buy-out target. I am just surprised why this opportunity would exist if this is quite well known and well written about? And looking historically the business has not been able to produce a lot of FCF, given the valuation, I would think it should be able to consistently produce ample free-cash yielding double digits. Margins also seem so low, is that just the fact of the big share of Agency brands, with cost pressure and inability to take price and being more mass market orientated?
Hi Nicolaas! Indeed, that is the trillion-dollar question.
Delfi is listed in Singapore and does report in US Dollars. I suspect that if it was listed in Jakarta, it would have enjoyed a higher valuation closer in line with Mayora Indah. Note that Delfi divested its cocoa ingredients business in 2012, so any financial prior to that are not particularly relevant to the consumer brand business that Delfi is today.
Margins are indeed lower. I've seen the following theories as why that's the case:
• Weak brand cachet compared to the international brands
• 1/3 of Delfi’s revenues comes from distribution, which is a low-margin business.
• The utilisation rate on their two factories in Indonesia / Philippines was just 55% in 2019
• Malaysia and the Philippines are not profitable yet (Philippines turning profitable now)
• Depreciation of the Indonesian Rupiah was a head-wind post 2013/14
• Delfi made US$110m investments in plant and distribution system improvements from 2014 to 2020
• A necessary shift towards modern trade (supermarkets, convenience stores) led to promotional spending and R&D as well as reducing the number of SKUs
So clearly Delfi has a great deal of potential and remains a key take-over target. Rumour has it that John thinks incoming take-over bids have been too low. Hopefully. he will be considering them at a higher price. Some of Delfi's brands are a bit stale (Ceres) but provide good cash flows, while others such as SilverQueen are doing very well. I think the company still has potential but it has yet to fully realise that potential.
Thanks Michael for the detailed response. Doesn't help that they are listed in Singapore, trade in USD and operate in local currency in Indonesia mainly.
What do you know about the $16.9m claim that seems to come from when they sold their cocoa busines. When will this be concluded?
Getting Philippines and Malaysia right will be key, but a small market share there and battling against global brands here that have a strong footholding, correct? Or who is there?