Biostime

This is a peculiar company which came to my attention from my friend in HSBC. Biostime started out as a probiotic supplement vendor in 2000. In 2008, they introduced imported infant formula into their product range and sales growth practically exploded. Anyone with a decent network of Chinese friends would understand, food safety is a huge issue in China. This is especially important when it comes to infant food products. Due to the melamine contamination scandal in locally produced infant formulas, the Chinese have absolutely no confidence in local products. Unless restrained by budget, most parents would opt for imported infant formula. In fact, there is a cottage industry blooming just around importing foreign infant formula and reselling them on personal blog sites. Anyone doubting this just have to read this piece of news (http://www.news.com.au/national-news/chinese-threaten-supply-of-baby-formula-in-australia/story-fncynjr2-1226547242828)

Biostime's infant formula and baby cereal products are imported with original packaging form their product suppliers, Laiterie de Montaigu and Kerry Ingredients and Flavors. The association with foreign companies have given chinese consumer confidence on their product quality. A quick search on taobao.com for Biostime reveals that the cheaper Biostime infant formula costs around Rmb228-300 while the higher end ones costs Rmb380-476. Thus, Biostime belongs to the high-tier infant formula market (Rmb200-300) and the supreme tier infant formula market (>Rmb300). For a start, let's have a look at Biostime's income statement.

Income Statement (Rmb' 000s)	2007	2008	2009	2010	2011	2012
Probiotic supplements	172,163	253,859	265,886	303,749	331,962	379,203
Infant formulas	0	40,812	238,108	793,565	1,684,655	2,715,291
Dried baby food	16,134	30,869	54,975	97,779	97,126	134,765
Baby care products	0	0	0	38,467	47,845	105,989
Nutrition supplements	0	0	0	0	27,446	46,653
Total Revenue	188,297	325,540	558,969	1,233,560	2,189,034	3,381,901
COGs	(50,425)	(88,666)	(163,016)	(356,387)	(732,907)	(1,152,955)
Gross profit	137,872	236,874	395,953	877,173	1,456,127	2,228,946
Sales and marketing exenses	(95,026)	(168,844)	(248,299)	(449,453)	(708,604)	(1,077,721)
Admin and general expenses	(9,992)	(20,321)	(26,462)	(87,640)	(82,041)	(116,871)
Other expenses	(6,006)	(4,025)	(6,100)	(10,370)	(23,326)	(38,609)
EBIT	26,848	43,684	115,092	329,710	642,156	995,745
Other income, gains and losses	554	922	3,061	4,353	71,751	56,934
Financial expenses	0	0	0	0	0	(2,106)
Profit before Tax	27,402	44,606	118,153	334,063	713,907	1,050,573
Tax	(9,916)	(9,444)	(9,836)	(68,380)	(186,556)	(307,467)
Net Profit	17,486	35,162	108,317	265,683	527,351	743,106
No. of shares (diluted)	N.A.	N.A.	N.A.	457,417	610,544	610,544
EPS	0.04	0.08	0.24	0.58	0.88	1.24

DPS	N.A.	N.A.	N.A.	0.20	0.76	1.08
PE	808.94	404.47	134.82	55.79	36.77	26.09

Revenue growth rate	N.A.	72.9%	71.7%	120.7%	77.5%	54.5%
Net Profit growth rate	N.A.	71.8%	67.2%	121.5%	66.0%	53.1%

These are growth rates that would make even Warren Buffett envious. The majority of their revenue came from an explosive growth in infant formula starting from 2008 (which perhaps not so coincidentally, is the year the melamine scandal surfaced). Their original business segment, probiotic supplement, while having decent growth, it now only accounts for 11% of total revenue. The million dollar is ... how long can this growth last? As at the closing price of HKD39.80, Biostime trades at a trailing 26x PE. Not the usual place where a value investor should be doing his digging. But if the growth rates can persist at the 40-50% for even a couple of years, this could well turn out to be a bargain.

(Rmb M)	2007	2008	2009	E2010	E2011	E2012
infant Population ('ooo infants)	38,085	38,567	38,857	39,246	39,638	40,034
Infant Formula Market (Rmb m)	20,316	25,497	30,346	36,805	43,945	51,783
Retail Sales Vol of milk formula ('000s tonnes)	248	295	340	394	460	530
Supreme Tier	437	688	1,214	1,767	2,307	2,770
High Tier	7,527	9,765	11,501	14,060	16,941	20,014
Mid Tier	8,086	10,454	12,624	15,311	18,325	21,594
Low Tier	4,266	4,590	5,007	5,668	6,372	7,405
Biostime Market Share	0.0%	0.2%	0.8%	2.2%	3.8%	5.2%
Average Annual spending per Infant	533	661	781	938	1,109	1,293

This is where the data gets a little flaky. The data above is obtained from the IPO Prospectus quoting Euromonitor. I do not have access to Euromonitor, hence 2010-2012 are actually estimates made in 2009 by Euromonitor. Nonetheless, they should not vary too widely and are useful in highlighting certain observations.

(i) Infant population growth is very slow in China ~1% per annum.
(ii) Growth in the infant formula market is driven by increased spending per infant.
(iii) The infant formula market has outpaced growth of the sales volume of infant formula, meaning consumers have been trading up.
(iv) Supreme Tier infant milk powder grows much faster than the rest. Low Tier infant milk powder grows the slowest. In China, parents are willing to pay up for branding, safety and quality.
(v) Biostime has been growing by gaining market share.

In China, many families are not aware that breast milk is the best choice for infants, especially those with lower education levels. Infant formula companies themselves have been spending alot on advertising to build brand image of infant formulas. One of the important secular trend here is that working mothers are increasingly feeding their children infant formula. This is pretty much driven by the difficulty and bodily stress involved in breast feeding their children. A news article here (http://www.havingababyinchina.com/reference/breastfeeding-a-baby-in-china/) quotes that only 22% of mothers at Shanghai continue breast feeding at four months compared to 75% at Cheng De. Those numbers are rather outdated, but it shows that as 2nd and 3rd tier cities urbanise and more women take up white collar jobs, they tend to give up breast feeding in favor of infant formula.

What do I have to be convinced of to buy this stock?

1) The Chinese will continue to spend more and more on infant formula. An average price for a tin of mid-tier infant formula cost around Rmb150. At an average spending of Rmb1,293 per infant per year on infant formula, this is about 8.5 tins of mid-tier infant formula. Can Chinese parents continue to trade up in terms of infant formula choices? There are very little data on household income in China. A 2010 article by Forbes quotes average household income in 2010 to be US$10,220 or Rmb64,000. According to this number, the average family only spends 2% of their income on infant formula. The 12th Five-Year Plan released by the chinese government targets an 7% annual growth in per capital net income for the period 2011-2015. Raising income should ensure that more families switch to high or supreme-tier infant formulas when they can afford it.

2) Biostime can continue to gain market share. The table below from the prospectus list some of Biostime's competitors in the supreme and high-tier infant formula market. I believe there are more competitors that the study did not include, such as Dumex.

Supreme-tier infant formula Market Share	2009	Mid-tier infant formula Market Share	2009
Beingmate Scientific Industry Trade	18.6%	Mead Johnson	17.7%
Biostime	13.1%	Beingmate Scientific Industry Trade	12.0%
Ausnutria Dairy	12.7%	Abbott Nutrition International	11.5%
Wakodo	3.0%	Biostime	1.3%
Others	52.6%	Others	57.5%

Biostime's main competitors are the foreign giants as Biostime is perceived as a french infant formula with ingredients from France. Thus, the main competitors are Mead Johnson, Dumex and Abbott Nutrition, all huge companies in their own right.

US$m	2005	2006	2007	2008	2009
Domestic Brands	607	882	1,255	1,472	1,903
International Brands	903	1,118	1,364	1,859	2,241

Historically, consumption of domestic brands and international brands have largely paced each other (again pardon me for the outdated data).  I believe there is more room for international brands to growth, through cannibalizing market share of domestic players.

More foreign players are also eyeing this market keenly. Fonterra, the world's largest dairy exporter, has plans to sell its own branded infant milk formula by mid 2013, despite being rocked by the melamine tainting scandal in Chinese dairy company Sanlu, which it held a stake. Swiss giant, Hero Group, have announced their entry into China's infant formula market by selling its products through a Chinese partner.

I suspect there is more momentum to go for both the company's revenue and earnings, as well as the share price. But, with the stock rallying so aggressively in recent months, I am very uncomfortable buying at this stage. If there is a meaningful pull back of 10-15% I will definitely contemplate a position. Otherwise, I think I would look for better risk/return elsewhere.

DirecTV Group

I was getting my usual fix of financial news a few days ago when randomly, I decide to take a quick look at DirecTV (DTV). This name has popped up quite a few times among various hedge fund managers' holdings. Warren Buffett holds it as well, through Todd Combs and Ted Weschler. This is the first stock bought by Todd Combs and/or Ted Weschler that passes the US$1bn dollar size threshold, which Warren revealed it in his recent annual report. For this one, I definitely regret that I did not do more work on this stock earlier.

And what did I find? I don't claim to be an expert on the America media industry, but DTV definitely piques my interest.. In fact, DTV is a rather typical Buffett stock. Ladies and gentlemen, this is a "cannibal".  What does that mean? Basically it is a company which uses large proportion of their cashflow to buy back their stock. One of Charlie Munger's tips for investment success is to look for "cannibals".


DTV is a satellite TV provider in the USA and Latin America. It also owns a 42% interest in Game Show Network, a network dedicated to game related programming and internet interactive game playing. That is a small part of the business and not so significant. Pay TV in the US is very competitive and have multiple players including: Cable TV, Telcos and Internet TV. The cable infrastructure, telco fiber optic line and internet penetration are all well developed. Pay TV penetration is also very high, at ~90%. Whereas in many parts of Latin America, Pay TV penetration is still growing from a low base. Some stats on their US and LatAm business below.

	2007	2008	2009	2010	2011	2012
DTV US Subscribers ('000)	16,831	17,621	18,560	19,223	19,885	20,084
ARPU (US$)	79.1	83.9	85.5	89.7	93.3	97.0
DirecTV US Revenue	15,527	17,310	18,671	20,268	21,872	23,235
DirecTV US operating profit	2,402	2,330	2,410	3,290	3,702	4,153
DirecTV LatAm subscribers ('000s)	3,279	3,883	4,588	5,808	7,871	10,328
Latam ARPU (US$)	48.3	55.1	58.0	58.0	62.6	57.3
Latam Revenue	1,719	2,383	2,878	3,597	5,096	6,244
Latam operating profit	159	426	331	623	916	955

As expected, their US business is fairly mature. Number of subscribers have been growing at low single digits. The management has been focusing on increasing ARPU, which translated into higher revenue growth compared to subscriber growth. This is unlikely to persist for long. Their LatAm business is where the excitement is. Just a flavor of how the LatAm Pay TV market is like:

(i) Brazil Pay TV penetration - 36%
(ii) Argentina Pay TV penetration - 62%
(iii) Venezuela Pay TV Penetration - ~40%
(iv) Colombia Pay TV Penetration - 31%

However, LatAm is only 1/5 of their revenue as of end 2012 but is growing strongly.

Income Statement (US$m)

2007

2008

2009

2010

2011

2012

Revenue	17,246	19,693	21,565	24,102	27,226	29,740
Broadcast Programming and other	(7,346)	(8,298)	(9,064)	(10,074)	(11,655)	(13,028)
Subscriber service expenses	(1,240)	(1,290)	(1,525)	(1,681)	(1,911)	(2,137)
Broadcast operation expenses	(323)	(360)	(341)	(350)	(389)	(414)
Subscriber acquisition costs	(2,096)	(2,429)	(2,773)	(3,005)	(3,390)	(3,397)
Upgrade and retention costs	(976)	(1,058)	(1,092)	(1,169)	(1,327)	(1,427)
General and admin expenses	(1,095)	(1,243)	(1,457)	(1,445)	(1,576)	(1,815)
Depreciation and amortization expenses	(1,684)	(2,320)	(2,640)	(2,482)	(2,349)	(2,437)
EBIT	2,486	2,695	2,673	3,896	4,629	5,085
Other income, gains and losses	26	55	34	69	84	140
Liberty transaction and related gain	0	0	(491)	67	0	0
Financial income	111	81	41	39	34	59
Financial expenses	(235)	(360)	(423)	(557)	(763)	(842)
Profit before Tax	2,388	2,471	1,834	3,514	3,984	4,442
Tax	(943)	(864)	(827)	(1,202)	(1,348)	(1,465)
Net Profit	1,445	1,607	1,007	2,312	2,636	2,977

EBIT  Margin	14.4%	13.7%	12.4%	16.2%	17.0%	17.1%
Net Margin	8.4%	8.2%	4.7%	9.6%	9.7%	10.0%

Programming Cost/Revenue	42.6%	42.1%	42.0%	41.8%	42.8%	43.8%
Subscriber acquisition/Revenue	12.2%	12.3%	12.9%	12.5%	12.5%	11.4%
Upgrade and retention/Revenue	5.7%	5.4%	5.1%	4.9%	4.9%	4.8%

My main concern here is that margins are at a historical high. While the management has displayed great talent at milking their US business, competition in US Pay TV industry seems to be getting worse. Programming costs are expected to continue climbing and so will upgrade and retention costs as cable companies shifts to HD. 

(US$m)

2007

2008

2009

2010

2011

2012

Net CF :

3,645

3,910

4,660

5,206

5,185

5,634

Capex :	(2,692)	(2,229)	(2,071)	(2,416)	(3,170)	(3,349)
Acquisition:	(348)	(204)	(134)	(617)	(11)	(16)

FCF

605

1,477

2,455

2,173

2,004

2,269

Stock repurchase

(2,025)

(3,174)

(1,696)

(5,111)

(5,496)

(5,175)

Cashflow from debt issuance/repayment

(220)

2,437

972

3,655

2,990

3,690

No. of shares (diluted)

1,202

1,114

989

876

752

644

Recurring EPS

1.20

1.44

1.51

2.64

3.51

4.62

Their LatAm Pay TV business is definitely one of the attractive selling point of this company but that is not all. This is a massively cashflow generative business. Even after plowing cash back into the company for capex and acquisition, free cash flow is almost equal to net profits. This is a cash cow! What is even more interesting is what they have done with all that cash. Between 2007-2012, DTV produced about US$11bn in free cash flow, but they have done back US$22.7bn worth of stocks. The total number of shares have almost fallen by half in the same period of time. The result of this? EPS growth greatly outpacing revenue or net profit growth. 

(US$m)

2007

2008

2009

2010

2011

2012

Equity

6,302

4,631

2,911

(194)

(3,107)

(5,434)

Total Debt

3,395

5,833

8,010

10,510

13,464

17,528

Total Asset

15,063

16,539

18,260

18,423

18,423

20,555

Debt/ Asset

22.5%

35.3%

43.9%

57.0%

73.1%

85.3%

EBIT/Interest

10.6

7.5

6.3

7.0

6.1

6.0

Debt/EBITDA

0.8

1.2

1.5

1.6

1.9

2.3

This rapid shrinking of the shareholder base while great, should not be expected to continue at a similar pace in the future. Over the last six years, DTV has greatly levered up its balance sheet to fund its share purchase. The debt to asset ratio climbed from 22.5% to 85.3%. Equity has become negative. While this may seem somewhat scary, EBIT/Interest ratio and debt/EBITDA ratio are still within safe limits. The management targets a debt/EBITDA ratio of 2.5x. Doing something like this will be very dangerous for a business with volatile margins. Historically, DTV does experience some volatility in their margins and there is a possibility of margin compression given the competitive landscape. Overall, I believe their debt levels should be manageable. The management has just approved a US$4bn stock buyback scheme and is committed to fund stock buyback from their free cashflow.

Analysts are projecting ~10% top line growth over the next few years. As of the closing price of on friday, DTV trades at a trailing PE of 12x. FCF yield is estimated to be about 7%. Compared to 10-yr Treasuries at 2% this is definitely quite attractive even though the stock has climbed quite a fair bit. Let's see if there is a pullback to give me a better entry.

Beijing Jingkelong

Jingkelong has really taken a beating this year, when the management guided for FY2012 net profit to be below FY2011. The supermart/hypermart business is one which I have always been curious and interested about, and this popped up on my watchlist when I was scanning stocks that have fallen from 52week high. But, is this really cheap now at trailing 7.8x PE (1H 2012 Annualised EPS of RMB 18.8c)? Let’s take a deeper look.

Now, the supermarket/hypermarket sector in China has been consolidating for some time. Euromonitor shows that 2000-2010 revenue CAGR for small scale grocery formats only averages 0.7% a year. Whereas for supermarket/convenience stores it averages 22-23%. In this business, big is beautiful. Hypermarkets has an average CAGR of 37.9%. Generally, one would prefer large format grocery retailers over the smaller ones.

Income Statement (Rmb m)	2007	2008	2009	2010	2011
Revenue	5,641	6,684	6,691	7,439	8,633
COGs	(4,919)	(5,760)	(5,759)	(6,397)	(7,335)
Gross profit	722	924	932	1,041	1,297
Other income, gains and losses	346	346	424	495	576
Sales and marketing exenses	(680)	(670)	(745)	(880)	(1,140)
Admin and general expenses	(195)	(195)	(227)	(213)	(202)
Other expenses	(33)	(33)	(45)	(44)	(53)
EBIT	158	371	339	399	478
Financial expenses	(91)	(91)	(85)	(94)	(125)
Profit before Tax	67	280	254	305	353
Tax	(77)	(77)	(65)	(77)	(80)
Net Profit	(9)	204	189	229	273
Net Profit attributable to equitu holders	125	157	148	181	210

Revenue growth has decent for Jingkelong, averaging above 10%. Not spectacular, especially if you take into account how fast the rest of the industry is growing. 

	2007	2008	2009	2010	2011
JKL No. of Hypermarkets	11	10	9	8	8
JKL No. of Supermart	64	71	72	76	80
JKL No. of Convenience Store	137	159	163	150	161
Lianhua No. of Hypermarts	111	127	132	143	152
Lianhua No. of Supermarts	1,731	1,788	2,818	3,014	2,984
Lianhua No. of Convenience Stores	1,880	1,957	1,980	2,015	2,014
Sun Art No. of Hypermarts	103	124	156	183	230

The thing is, if you look at store expansions vs other listed peers such as Lianhua Supermarket or Sun Art Retail, JKL is severely lacking. Competitors have been aggressively building new stores while the JKL management has been caught asleep at the wheel. 

	2007	2008	2009	2010	2011
JKL Inventory Days	44	45	50	57	70
Lianhua Inventory Days	45	46	43	46	53
Sun Art Inventory Days	N.A.	58	51	60	69

Comparing Inventory days, a key performance metric for supermarts or hypermarts, JKL has seen a significant deterioration from 2007. A lengthening of inventory days can be a warning sign for supermarts. This means that groceries sit longer on their shelves and warehouse, and are no longer as fresh. Ask any regular housewife and she can always tell you where to find the freshest fruits/vegetables/meat. Any deterioration in quality and consumers will vote with their feet.

The final nail in the coffin for me were the capex and acquisitions which levered up the balance sheet, bringing debt/equity ratio from 1.1x in 2007 (including operating leases) to 2.41x in 2011. They resulted in subpar growth for the company. In this aspect, Lianhua/ Wumart/ Sun Art Retail were far better managers/operators.

Verdict? When its cheap, it is usually cheap for a reason. If you are looking for exposure for the chinese consumer, you should probably look elsewhere.