Mega First Q3 2021 Corporate Briefing - Revisiting My MFCB Valuation

I attended the Q3 2021 earnings briefing on 19 November 2021. After listening to the management and with them clarified some of my questions, I will need to update some of my DCF valuation assumptions of the company. 

Revised DCF Valuation Assumptions for Don Sahong Power Generation Business

When I valued MFCB's hydro business at RM3.76 billion, I made the assumption that the power purchase agreement with take-or-pay basis will apply to the 5th turbine too. Apparently MFCB decided to built the 5th turbine as a backup turbine when the others turbines are in maintenance. This is to reduce opportunity cost when turbines are in maintenance and cannot be used for power generation.  

Currently there is no power purchase agreement signed with the Laos government to extend the power purchase agreement to the 5th turbine, but MFCB is confident they can do it because the demand for power is high.

Secondly, I assumed the turbine utilisation (EAF) after the 5th turbine installation will increase energy generation to 2500GWh. However, because the 5th turbine can only run in the wet season and only serve as a backup generator, the expected additional capacity is 15% to 40% only. 

After correcting my valuation assumptions, my revised MFCB's power generation DCF valuation is as follows:

The intrinsic value for MFCB's power generation has reduced by around RM500 million to RM3.27 billion. (This is not inclusive of 5th turbine construction & other business contribution)

Good News from Earnings Briefing

1. Oleochemical Business Turnaround On Track

One major topic discussed in the earnings briefing is MFCB's venture into the oleochemical business. The management highlighted that MFCB actually did not actively venture into the oleochemical business, but rather an opportunistic investment.  

Sime Darby has been wanting to find the right person to turnaround the business for few years, and they finally found MFCB through recommendation from their advisor. According to the management, the opportunity presented is too cheap to let go. To put in figures, MFCB is paying RM73 million to buy a business that has:

1. Fixed assets with cost value of RM1.2 billion. (Book value: RM400+ million)

2. The liquidation value for the plants and machineries on 34 acres industrial land alone is already RM151 million.

Not only that, AK Yeow (ex-KLK Managing Director) has already assembled a strong team and is already on the ground turning around the business. The management is planning to turnaround the business within a year. 

One more thing, since the previous company (Sime Darby) ran the business so inefficiently, there is over RM200 million accumulated in tax losses. Thus, for the foreseeable future, MFCB does not need to pay any taxes after they turnaround the business. The management joke that after they successfully turnaround the business, they can easily get back the capital within 1 to 2 months of profitability. 😂

By the way, in the next quarter, MFCB will recognise a "substantial amount" of one-off gain because of negative goodwill from this acquisition. (I'm guessing more than RM50 million)

2. Good Progress on Solar Energy

The total installed solar capacity has increased 6.3 MW to 20.8 MW by the end of Q1 FY2022. MFCB will secure another 10-15 MW C&I rooftop project over the next 6 months. 

The company is investing heavily in this segment and hopefully we can see the efforts bearing fruits in the next few years.

3. Cukai Makmur has no impact on MFCB.

4. Resumption of Packaging Business Expansion Plan 

Management confirmed that MFCB is restarting their aggressive packaging business expansion plan. The recently acquired Stenta group has been consolidated to the group and we can see packaging revenue & profit doubling already. 

Moving forward, MFCB is constructing another factory for Hexachase and will also expand Stenta's production lines from 2 to 4 lines. The goal is to achieve RM1 billion revenue in few years time.

5. Resources Business will have Strong Recovery

The resources business was not performing because key customer shut down their factory for maintenance. Since the maintenance is completed, the export sales is expected to stage a strong recovery.

 

P.S. MFCB's resources business is the biggest quick lime manufacturer in Malaysia. I know MFCB is big, but I didnt know they are the biggest. Wow!

Not So Good News from Earnings Briefing

1. Budget 2022 Foreign Sourced Income Negatively Impact MFCB

According to Budget 2022, dividends repatriated from overseas subsidiaries on and after 1 January 2022 will be subject to 24% income tax. 

Because majority of MFCB's contribution comes from Don Sahong power generation business in Laos, the new Foreign Source Income Tax apply to MFCB when they remit the earnings back to Malaysia. 

The management is looking for other options to reduce the tax payment such as dividend relief and other options. (I forgot what other options..)

This will have big negative impact on the earnings because the tax rate difference is more than 20%. 

Concluding Remarks

In conclusion, I still think MFCB is undervalued or, at most fairly valued, even after taking into account of:

1. Lower hydropower business valuation after changing the assumptions, and

2. Higher tax expenses from Budget 2022.

As a shareholder of the company, I will just take a seat and watch the show. 

Ending this piece with my observation:

The story of how the oleochemical business was presented to the management team reminded me of Warren Buffett’s investing strategy in the later years. 

Most of the time, Warren Buffett don’t actively look for acquisition opportunity, but rather wait for distressed business go to them asking for help. (e.g. Long Term Capital Management, Bank of America, Goldman Sachs etc) In their own words, they “wait for the calls to ring”.

I see the similarities when the advisor of Sime Darby presented the acquisition opportunity to MFCB. Why would Sime Darby find MFCB when they know MFCB has absolutely no experience in the plantation and oleo business? I believe the deciding factors are because of MFCB’s financial warchest and the management’s reputation in the business world.