I had a quick discussion with Delfi, asking them some of the questions that I received from you readers via direct messages and e-mail.
Here are the key points from that discussion.
1. What is the long-term margin potential of the company?
The reason for the recent drop in margins is because of COVID-19. Certain shops in the general trade segments had to close down. But Delfi hopes that it will be able to get back to 2019 margins, at the very least.
Delfi Indonesia is already a very profitable operation. What’s dragging overall profitability down is that the Malaysia and Philippines segments are not yet at scale.
Another drag on margins is Delfi’s post-2015 strategy to reduce its number of SKUs by 30-40% across Indonesia and the Philippines. As demand has shifted from general trade to modern trade formats such as minimarts (~1500sqft supermarkets), the company has had to cut down the number of SKUs it was offering. Before, Delfi was offering a huge number of variants and flavours of each product. Now it focuses on just a few key products. Delfi lost revenues due to this SKU reduction and it also reduced the company’s overall scale. But in the long run, it will put the company in a better position.
2. How do you deal with competition from multi-national corporations (MNCs)?
There has always been competition from MNCs in Indonesia. Ferrero gained traction in the novelty segment a few years ago.
Delfi’s market share dropped a little bit over the past decade, but the market share has stabilised in the past few years. Competitor Mayorah Indah on the other hand, has actually gained market share against the MNCs.
Delfi operates at various different price points, from value to mass premium. But SilverQueen, for example, is priced lower than Cadbury’s equivalent offering.
SilverQueen’s market share is increasing slightly. So the market share trend is healthy, and it is something Delfi is monitoring closely, along with profitability.
Delfi purchased the rights to Van Houten in its target markets, and the company is working on growing the brand. Van Houten is priced at a premium level, similar to the prices of key MNC products.
The way Delfi is dealing with competition is to double down on its major brands such as SilverQueen.
Delfi also possesses a competitive advantage in its extensive distribution network, which MNCs find difficult to replicate.
3. Do you have plans for further joint ventures (JVs)?
Delfi’s existing JVs with Orion (Choco Pie) and Yuraku (Black Thunder) are moving along, but they remain relatively small in relation to the company’s total revenues.
The reason why Orion wanted to enter into a JV is because of Delfi’s distribution network, which Orion wasn’t able to replicate itself.
Delfi is open to pursuing agency brands and partnerships. Though discussions have been slow since the start of the pandemic due to travel restrictions.
4. Can you explain the elevated cash conversion cycle?
In 2020, the company’s accounts receivable days was high because of weak collections as many customers worked from home. But COVID-19 is really an anomaly.
Delfi is already seeing collection recovering back to normal levels.
Over the past few years, the cash conversion cycle has also shifted due to a change in the company’s business model. As a greater proportion of revenues has moved toward modern trade (minimarts, larger supermarkets, etc.), the company’s accounts receivable days has increased. Supermarket credit terms are typically 60 or 90 days, whereas distributors (who deal with mom & pop stores) tend to pay much quicker.
Today, Delfi sells more directly to customers rather than via third-party distributors. That enables the company to maintain better control and also better prices. At the same time, it has also caused the cash conversion cycle to deteriorate somewhat.
5. Can you comment on the yearly inventory write-offs?
In 2019, there was an inventory write-off of US$3 million. This write-off arose from finished goods, raw materials or returned goods (such as spoilages or expired products).
In the normal course of business, customers don’t have the right of return – at times only during new product launches. Chocolate has a best-before-date of about 12 months. Product integrity is important to Delfi in these tropical climates.
6. Can you comment on SFRS 15 (“Revenue from contracts with customers”)?
SFRS 15 was implemented in FY2020, causing a reclassification of revenues.
Whereas before, revenues were recognised gross of promotions it is now accounted net of any promotions.
It caused revenues to drop, despite zero change in EBITDA.
FY2020 revenues already adhere to SFRS 15, so this drop in revenues should not be extrapolated.
7. Can you comment on related party transactions?
The amount of related party transactions has been limited over the past few years at just US$15 million in related-party purchases of ingredients.
After the cocoa ingredient business was sold to Barry Callebaut, they still source ingredients from them.
Any related party transactions are done on an arms’ length basis and on normal commercial terms.
8. Does Delfi have any long-term succession plans?
Two of the management team’s children are working for the company.
However, the children are not in senior executive or board positions.
The CEO is very energetic and has no plans to retire at this point.
9. Would you consider buybacks or other ways to reward shareholders?
Delfi is exploring different uses of capital. The company typically pays out roughly 50% of earnings as dividends. FY2020 was actually above the 50% level, given the board's view that it should return excess cash to shareholders.
In 2020, cash flow generation was very strong, so that bodes well.
But ultimately, it will be up to the board to decide exactly how much should be paid out as dividends or potential buybacks, amongst other measures.
For those that want to review my original write-up of Delfi Ltd, you can find it here or by clicking the picture below.
The above article and PowerPoint presentation constitute the author’s personal views only and is for entertainment purposes only. It is not to be construed as financial advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. From time to time, the author may hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article. Disclosure – I do not hold a position in Delfi at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).
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