EVA on IPO: DMND (Diamond Food Indonesia)

A long-time food and beverage distributor and producer has recently gone IPO. Diamond brand is well-known. Its stock price has fallen 30% from its IPO price at 1.350/share. Let's do something different this time. To an extent, when we buy a stock, we fill 2 roles: analyst and investment manager. Analysis and decision-making. Each one has overlapping concerns but may differ in setting priorities. This is a fiction discussion between these two persons that is playing in my head for DMND.

Analyst: Good news. A well-known Diamond company recently just went IPO. Its share price is now 30% less. I have known this company brand since I was a kid.

IM: Really? What is it selling?

Analyst: Majorly milk and its derivatives, including ice cream. Many of them are imported products which it resells with its brand. The management said...

IM: Stop right there. I don't want a biased view, especially future outlook right now. How is the condition recently?

Analyst: Diamond has been a consistent value creator for the past 4 years. But it is not great. It's EVA margin is in the range of 1-1,6%. That indicates it is operating under tight competition. Sadly, EVA has been declining since 2017.

IM: I trust you do the EVA math correctly and made necessary accounting adjustments. That declining EVA trend is worrying me. You remember Matahari Dept Store (LPPF) right? Tell me more about it. How likely do you think that trend will continue?

Analyst: One significant adjustment relates to land revaluation. Left unadjusted, invested capital could be greater by 30% because of some accounting judgments, not based on the real money that investors have invested. And I used cost of capital of 11%.

As you might have guessed from a low EVA margin company, sales growth almost does not move EVA needle for DMND although its revenue has been growing at double digits. That leaves us profitability (EVA margin) as the key source of DMND value, and that has been in decline.

A cursory look at the details, DMND EVA margin components barely move at all. NOPAT margin has been declining if you want to point out the source of its weakness and has to do with its declining gross margin.

The management attributed that to a rising cost of its imports. Lots of its COGS is imported. 62% of its COGS is imported goods. It is pretty clear from NOPAT trend that DMND could not pass on that rising price to its customers. It is operating in a tight competition as evidenced by persistently low EVA margin.

IM: And now we have this epidemic which causes trouble for imported goods...

Analyst: Yes. Difficulties in importing goods would most likely lead to rising costs. And that would hurt DMND EVA this year. But I would not over-emphasized that change as something permanent. A reasonable long-term prospect would see DMND EVA margin to remain low, but not to the point of becoming a wealth destroyer.

I did some number crunching for this year's EVA. I assume a 15% decline in sales and a slower decline in SG&A (approximated by the management report to IDX). Imports would be a wild card, so I assume NOPAT margin would contract by 40 bps. Here is EVA that I came up with.

DMND EVA would be barely positive. Its EVA margin is just 0.3%. ROIC is 11.6%. But it is unlikely that this trend would continue. When imports back to normal, EVA margin would be close to 1% even if sales stagnated.

IM: Okay. It sounds like a wealth-neutral to me. Not great, but not too shabby either. So, what does the market implying? Its share price has been in decline. How reasonable is that?

Analyst: Well, at its IPO price of IDR 1.350/share, 80% of its share price is based on the market's judgment of its future NPV, which is about 14 times than what it achieves if we assume Diamond EVA to remain constant. Its CVA (constant EVA assumption) in 2019 was IDR 650 Billion, while the market expects its NPV to be IDR 9.2 Trillion. There is no way DMND could find additional NPV opportunities worth IDR 8.5 Trillion. Its IPO price was simply far from reasonable.

Currently at IDR 940/share, investors are still pricing DMND to earn EVA momentum of almost 2% for the next five years to meet its expected NPV of IDR 5.6 Trillion. It is a sharp rebound expectation even in normal times. It requires a drastic change in margins, something that it has never done before.

IM: So, even if EVA remains stagnant, it does not offer margin of safety. And even more so if EVA were to decline which I agree as a strong possibility this year. Okay, let's move on to the next stock. But before that, where do you draw the line?

Analyst: Well, its invested capital net debt is worth around IDR 300/share. Given that DMND has been proving, and I expect it to remain that way, as a value creator (but not much), I think below IDR 400/share is a hard bargain.

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