Neo Group Ltd (Time to buy?)

In today’ busy Singapore, cooking at home seems to be a luxury for families whereby both parents are working. However, with an abundance of food catering companies here, eating delicious, freshly cooked and healthy food is becoming easier. In a nation obsessed with good food (we all know that our national favourite hobby is food), the food catering business here seem to be flourishing.

Ordering of food via telephones and the internet has never been easier. Indeed, the use of digital ordering strategy is a global trend (read here), whereby companies like Domino’s Pizza, Neo Group Ltd and Sakae Holdings Ltd are already investing in the Online Order System here to drive sales.

One such food catering company is Neo Group Ltd. It is recently listed in the Singapore Market (July 2012).

Its business can be broken down into 2 portions:

1. Food Catering business (Neo Garden Catering, Orange Clove Catering, Deli Hub Catering and Best Catering)
2. Food Retail business ( A chain of 22 “umisushi” food retail outlets islandwide and 1 licensed outlet in Jakarta)

Strong growth in the food catering division bolstered full-year (2014) earnings at Neo Group. Net profit for the period to March 31 rose 15.7 per cent to $7.4 million, compared with the 12 months to Jan 31 last year. Revenue jumped 47.8 per cent to $77.4 million in spite of an approximately 51.8 per cent hike in expenses. (read here)

However the above mentioned figures may be misleading as it takes into account 14 months.

• 14 months for FY 2015: S$7,403,000
  after adjustment, 12 months for FY 2015: Approx. S$6,345,428
• 12 months for FY2014 S$6,398,000

If we ‘average’ down the net profit for 2015 and compare it to 2014’s figure, there might be a slight dip.

The company’s growth story has been continuing well so far (read here).

• Record-Breaking Number of Events Catered on 19 February 2015.
• Singapore’s No. 1 events caterer with a 10% market share.

On 14 May 2015, Neo Group announced that they will pay S$7.35 million in cash and new shares in exchange for a 55 per cent stake in Thong Siek Holdings (read here and here).

Despite its short history in the Singapore Market, the stock price of the company has been progressively moving up, but in recent times, prices have dropped. The share price of $0.815 on 7 July 2015 is just a hairline above the 52 weeks low of $0.80. Kind of remind me of another F&B company – Japan Foods Holding Ltd (read here). I am unable to find out exactly why the share prices of Neo Group dropped.

There are many plus points in this company:

• It is in the food catering business. Based on their last annual report ending Jan 2014, at least 65% of their revenue is from food catering. From the Services Survey Series on F&B services conducted by the Department of Singapore for the year 2013, under key performance ratios, food caterers consistently ranked the highest among the various categories of F&B services. Food caterers have average profitability ratio of 19.9% as compared to 4.8% restaurant.  In addition, the earnings-expenditure ratio is 24.3% for food caterers while that for restaurants is 4.9%. This not surprising since unlike restaurants, catering business does not have to worry as much in paying high rents for good locations.
• Half of the 374 food caterers in 2013 are sole proprietorships/partnerships. While this means that there is a low barriers to entry for this business, it also means that the market is fragmented enough for a relatively large business like Neo Group which has scability to increase their market share over the years to come.
• Neo Group’s market strategy is to obtain more corporate clients (whom are less price-sensitive than retail clients).  The percentage of sales from corporate clients for Neo Group has increased from 43% in the fiscal year ending Jan 2013 to 48% for the last fiscal year ending Jan 2014.
• Acknowledging that there is labour shortage issue in Singapore, Neo Group has been busy incorporating mechanisation and modern food preparation techniques for greater productivity and efficiency as well as consistency in food quality and hygiene. Its Enterprise Road facility became fully operational in November 2014. (read here)

Nevertheless there are risks which I feel warrant some concern:

• Catering is a business with low barriers to entry.
• It only have a short history as a publicly-listed firm. Hence there is a lack of historical data on its past performance. The short term good performance may not translate to long term stellar growth.
• It is looking at doubling its sales force from a current count of around 45 in the near future. Hiring comes with its risks. In the first half of FY2015, half of the monetary value of Neo Group’s revenue increase had gone toward an increase in employee benefits expenses. In other words, it certainly won’t be cheap for the company to double its sales staff.

Now let’s look at Neo Group financial performance. A stellar performance no doubt.

Its revenue, net profit, total assets and earning per share have been trending upwards year after year.

However, its free cash flow is worrisome. (FCF = Operating Cash Flow – Capital Expenditures). Neo Group’s FCF is lumpy and seems to be getting worse. It could be due to the recent expansion spree (eg. Enterprise Road facility).

A quick look at its financial statistics:

1. P/E = 19.9 (From Morningstar)
2. EPS = 4.44 cents
3. Return On Shareholders’ Equity (%), ROE= 31.2
4. Return On Total Assets (%) = 14.7
5. Price to Book = 5.06
6. Dividend Yield(%) = 3.01
7. Current ratio = 1.11
8. Cash & Equivalents = 7.6 mil
9. Total Debt = 21.10 mil
10. Total Debt / Equity = 87.43

My thoughts on the statistics are as follows:

1. P/E is relatively high. Not good. However, expected for a growth stock.
2. The ROE is good, but maybe too good and not sustainable. Typically I would expect around 20% for good companies.
3. Its ROA of 14.7% is good, which is higher than its key competitor Select Group Limited ROA (which is 8.94). Return on assets is a key profitability ratio which measures the amount of profit made by a company per dollar of its assets.
4. Its price to book value is too high (not good). (eg. more than 1). Not good in the eyes of deep value investors.
5. Its dividend yield is respectable. At 3.01% it is more than the 2.8% yield that’s offered by the SPDR STI ETF (SGX: ES3), an exchange-traded fund tracking the fundamentals of Singapore’s stock market barometer, the Straits Times Index.
6. Its current ratio is not good. Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses.
7. The debt to equity ratio is also high. The amount of Debt as compared to the Cash & Equivalents is high. Not a good sign.

With these, let’s do a quick study on Neo Group Ltd’s share price of SGD 0.8150 (as of 7 July 2015) – via Trailing PEG & Intrinsic Value.

1) Trailing PEG

• P/E: 19.9 (from Morningstar)
• Dividend Yield (%): 3.01 (from POEMS)
• EPS compound growth rate: 24.48% (see below)

The trailing PEG will be 19.9/(3.01+24.48) = 0.72. Which is good (< 1).

2) Intrinsic Value

It is not possible to get the 5 yrs CAGR of Neo Group’s EPS as it was only listed in 2012.

So I will be using the net profit CAGR of 30.6% (but with a 20% discount. eg. 24.48%)

If we calculate the intrinsic value using a growth rate of 24.48%.

F = P(1+R)^N

• F = the future EPS
• P = the starting (present) EPS (SGD 0.0444)
• R = compound growth rate, 24.48%
• N = number of years in the future (5)

Estimated future EPS: 0.13

I will be estimating the future PE of Neo Group Ltd to be 19.9 (See below, data from Morningstar)

Future Stock Price

P=EPSxPE

• P = future stock price
• EPS = future EPS
• PE = future PE

Hence future stock price of Neo Group Ltd is 0.13 x 19.9 = SGD 2.587

Intrinsic Value

P=F/(1+R)N

• P = present (intrinsic) value
• F = future stock price (2.587) 
• R = MARR (15% or 0.15)
• N = Number of years (5)

Hence intrinsic value of Neo Group Ltd is SGD 1.29.

The stock price of Neo Group Ltd on 7 July 2015 is SGD 0.8150, which is lower than the estimated intrinsic value by 37%!

In summary:

Neo Group Ltd has consistently performed well over the past few years. However as it is only recently listed in the Singapore Stock Market, not much historical data can be obtained. The recent strong performance may not translate into long term stellar performance.

Nevertheless, it is expanding fast and is quickly gaining market share. But on the flip side hiring new staffs is costly.

Its recent net profit result as compared to previous year’s result (12 months) is not outstanding.

Its free cash flow is lumpy and has a downward trend over the years. It has a high debt to equity ratio which is worrisome considering that interest rates will rise soon. P/E & Price to Book value are relatively high.

Even though the Trailing PEG and Intrinsic value calculations may indicate that the stock price on 7 July 2015 is undervalued, one would need a bigger margin of safety given the short historical data (growth rate) we have. I would need a bigger buffer between intrinsic value and stock price to consider it a bargain.

Therefore I would be hesitant in buying the shares of Neo Group Ltd.