Stock Analysis: FMCG — Dairy

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Disclaimer: I am not a professional financial advisor. All financial opinions written in this article are from my personal research and experience, and it is not a recommendation to buy or sell the stocks. Please check out my post on another platform for a complete version, as external links are not permitted here (bottom of the post).

I’ve been learning a new framework to improve my business analysis skills for the past month. The framework aids you in determining which items to investigate first and what to look for in a business model. It could be applied to a variety of other business models as well.

The process begins with determining who the owner is, then moves on to the background, and actions are taken while still holding a position in the company. Following that, we must dissect the company’s business model, from understanding its supply chain to when it makes payments to suppliers, how it processes, and finally how it distributes to end customers.

Because management does not publish all data, the entire process involves some degree of assumption, but in a reasonable way. And to test this framework, I’m using FMCG — Dairy business as an example.

Ultrajaya Milk Industry (IDX: ULTJ)

ULTJ began by selling dairy products produced with primitive technology. The Company introduced Ultra High Temperature (UHT) processing combined with aseptic packaging in carton packs in the mid-1970s.

Later on, the company began to process and manufacture Ready to Drink (RTD) tea, condensed milk, and a variety of dairy products.

Owner Profile

When ULTJ was founded, it took off as a family business. As a result, the majority of management positions are filled by the owner’s family.

Sabana Prawirawidjaja .Source: Annual Report 2020

Meet Sabana Prawirawidjaja, one of the company’s founders and the current president director since 1971. He is also a member of the Boards of Directors of ULTJ’s subsidiaries.

According to Forbes, Pak Sabana Prawirawidjaja is also the 46th richest person in Indonesia. This reflects how well the family’s business has been running.

During the covid pandemic, Sabana owns around 5.73% of the company’s shares in 2018, but by mid-November 2020, it had risen to 18.1%, and by 21 February 2022, it had risen to 43.72%!

There’s no clear indication here of what the action actually entails. However, it’s encouraging to see the owner repurchase a large number of shares. It demonstrates his confidence in his company and increases the value of the stock.

Company Structure — Subsidiaries

Source: Company Presentation 2021

• PT Kraft Ultrajaya Indonesia is a cheese manufacturer. ULTJ signed licensing agreements with Kraft General Food Ltd. in the United States in 1981 to produce and market cheese products under the “Kraft” brand. This partnership was upgraded in 1994 with the formation of PT Kraft Ultrajaya Indonesia, a joint venture company. PT Kraft Ultrajaya Indonesia has also appointed the Company as its exclusive distributor for its products. However, since 2002, the Company has stopped marketing products made by PT Kraft Ultrajaya Indonesia in order to focus on marketing its own products. PT Kraft Ultrajaya Indonesia is currently owed money for the lease of office buildings and warehouses, as well as the use of utility plants.
• PT Nikos Distribution Indonesiahandles the ULTJ distribution network (more information will be provided later).
• PT Nikos Intertradeowns PT Toll Indonesia, which mainly operates in logistics.
• PT ITO EN Ultrajaya is engaged in the field of trading, marketing, and selling RTD tea products of the company.
• PT Ultra Sumatera Dairy Farm & PT Ultra Peternakan Bandung Selatanengaged in agriculture, animal husbandry, and trade. These 2 are some of the main dairy supplies for the company.
• PT Menara Ultra Indonesiaengaged in trading, service, and industry
• PT Tirta Talagaa Jaya engaged in water management.

In addition to the subsidiaries, ULTJ has a number of important agreements with other businesses:

• PT. Sanghiang PerkasaTo manufacture and pack baby powder milk products, ULTJ has had a Production Cooperation Agreement (toll manufacturing) with PT Sanghiang Perkasa (a food division from PT Kalbe Farma Tbk) since the year 2000. Morinaga Milk Industry Co. Ltd. ("Morinaga") grants Sanghiang Perkasa a license to manufacture and sell infant formula milk powder, as well as continue to produce a formula for milk powder from Morinaga. This Agreement is in effect until either party gives the other a 12-month written notice of termination, or until either party gives the other a 90-day written notice of termination in certain circumstances.
• PT. Bina San PrimaIn 2002 ULTJ entered into an agreement with PT Bina San Prima and assigned PT Bina San Prima to serve as an exclusive distributor of the Company’s products for the traditional market sector, kiosks, shops, and institutions all over Indonesia.
• PT Unilever IndonesiaULTJ has signed a manufacturing agreement with PT Unilever Indonesia Tbk. to produce and package UHT drinks bearing the Buavita and Go-Go trademarks. This agreement was last updated in 2017 and is set to expire in January 2023. The agreement can be terminated by either party with a 12-month written notice or in the event of certain events.

Products

ULTJ Products. Source: Company Presentation 2021

The products are separated into 3 categories:

• Dairy — 73.9% of total net sales
• Tea & Health Drink — 19.1% of total net sales
• Others — 7.1% of total net sales.
• Tolling agreement for the production of powdered milk and UHT drink for an affiliate of PT Sanghiang Perkasa.
• Tolling agreement for the production of UHT fruit juice under the Buavita brand for PT Unilever Indonesia Tbk
• Exports to several countries in Asia, the Middle East, Pacific Island, Nigeria, Australia, and America

Supply Chain — Purchase

ULTJ Supply Chain. Source: Research on Annual & Financial Report

Note: Please keep in mind that I could be completely wrong about the entire supply chain. This is just an example of what I learned from reading the annual report and financial report.

Farmers from the South Bandung Farmer Cooperatives (KPBS) in Pangalengan and other District Unit Cooperatives supply the fresh milk, while PT Perkebunan supplies the tea leaves (PTP). In addition to the above company, it is stated in the trade payables that ULTJ purchases other raw materials from other major suppliers such as PT Tetra Pak Indonesia, PT Latinusa Indonesia, PT Tristar Makmur Kartonindo, Koperasi Peternakan Bandung Selatan, PT Jawamanis Rafinasi, and PT Teteco.

Several types of raw materials are still imported, including aseptic packaging materials for UHT drinks. Foreign trade payables are generated by the purchase of packaging materials and concentrate for beverage products. These materials were provided by SIG Combibloc Ltd., Chia Meei Food Industrial, and ADM Cocoa PTE Ltd.

Among the purchases are two raw material purchases that account for nearly 10% of the company’s revenue each year. PT Tetra Pak Indonesia and PT Anta Tirta Kirana. It is not specified what kind of raw materials are bought, but based on the website, I believe it is for aseptic packaging materials and food ingredients.

Process

Process. Source: Company Presentation 2021

The beverage products are processed using UHT (Ultra High Temperature) technology and packaged in aseptic carton packaging. With this processing and packaging technology, beverage products are sterilized by heating to 140o C for 3–4 seconds, then packed in carton under aseptic conditions (aseptic packaging system), allowing for longer shelf lives without the use of preservatives.

This UHT technology at high temperatures can kill all bacteria while preserving the product’s nutritional value and vitamins.

Since its inception in 1975, the Company has used UHT technology, and it is the pioneer of UHT and aseptic packaging techniques in the Indonesian beverage industry.

The Company manufactures a variety of beverages with various flavors, including milk marketed under the brand names Ultra Milk and Ultra Mimi, tea products marketed under the trademark Teh Kotak, and traditional drinks and other health beverages marketed under the trademarks Sari Kacang Ijo and Sari Asem. These items come in 1000ml, 500ml, 250ml, 300ml, 200ml, and 125ml sizes.

The company also manufactures sweetened condensed milk under the brand names Ultra Milk and Cap Sapi, as well as powder milk products in collaboration with other parties for toll packing.

All UHT drink products, including milk, tea products, health products, and other beverages are processed by aseptic processing and packaging machines, equipment, and know-how acquired from Tetra Pak and SIG Combibloc, while the solid material based products consist of sweetened condensed milk and powder milk, are processed by processing and packaging machinery, equipment and know-how gained from GEA Niro.

The whole process is a vertically integrated production process across all products, a highly-automated production process with minimal human intervention. Utilizes state-of-the-art production equipment and aseptic packing to ensure high-quality standards. Efficient Automated Storage and Retrieval System (“ASRS”) implemented at a warehouse using Automated Guided Vehicles (“AGVs”)

Distribution Network

Distribution Network. Source: Company Presentation 2021

Sales are carried out through various channels:

• Modern Retailersprimarily consist of supermarkets, hypermarkets, mini-marts, and grocery stores.
• Traditional Retailersmainly consist of small independent retailers and wholesalers.

In Java, the Company sells its products directly to the modern retailer, while the sales to the traditional retailer and wholesaler in more than 73,100 points of sales, is done by utilizing the distribution network of PT Nikos Distribution Indonesia, a subsidiary of the Company which is 70% owned by the Company

Outside Java, the Company sells its products through approximately 50 distributors across Indonesia. In addition to the domestic sales, the Company also exports to several countries such as Australia, Cambodia, Nigeria, Saudi Arabia, South Korea, and the United States

Demand

Market Share 2021. Source: Company Presentation 2021.

Market Share 2020. Source: Company Presentation 2020.

According to the annual report for 2017, ULTJ still has a market share of more than 50% in Liquid Milk. Over the last five years, the portion has been reduced to 35%. While RTD tea maintains a market share of around 69–73 percent.

Management’s explanation for declining market share, as stated on Pubex 2021:

It is true that there has been a decline in market share, market dynamics are extraordinary, from the 70s we were the only player, single player and pioneer, then currently there are 100 large and small companies that do this type of dairy industry, this causes a dilution of market share, but here the most important thing is the dominance of the market share itself. In a market where the number of players is increasing, even though the number of markets is getting wider, the market share will definitely decrease, but ULTJ will always try to develop market share and maintain it with the methods and strategies that we are currently implementing. So it is natural that there will be a decline, but we must remain dominant

Liquid Milk Market Volume. Source: Company Presentation 2021

The strong growth of liquid milk in 2021 appears to be causing the dilution of market shares. However, this also suggests that ULTJ sales are not increasing significantly, which would be reflected in the high market share.

Now, let’s talk about the framework.

The Framework

Working Capital

It is typically made up of the company’s cash, receivables, and inventory. First, let’s talk about cash. Because it is the first most important item on the balance sheet.

ULTJ Cash & Cash Buffer. Source: Annual Report 2011–2021.

ULTJ has a significant cash portion, the average portion is around 20% of total assets, and the composition has remained consistent for the past 10 years.

Cash is valuable because it serves as a reserve for bad times. When income is low but expenses continue to rise, having a large cash reserve can be useful.

ULTJ also has a significant Cash Buffer, which is a calculation of how many months the company can operate if its cash flow is poor for an extended period of time.

ULTJ Cash & Cash Buffer. Source: Annual Report 2011–2021.

Receivables are primarily made up of retailers and distributors, accounting for nearly 85% of total receivables. Farmers (third parties), related parties (subsidiaries transactions), and allowance for impairment account for the remaining 15%. I have no concerns on this one. I believe the composition is still good.

ULTJ Inventory. Source: Annual Report 2011–2021.

In the common financial report, inventory typically consists of raw materials and finished goods. Other elements may differ depending on the business.

Inventory turnover is commonly used to describe how quickly a company sells its inventory. According to the framework, turnover of less than three months is usually a good one.

By combining the following three values: cash, receivables, and inventory. You would receive the company’s working capital. ULTJ’s working capital has remained constant at 45–60% until 2020 when it fell to 37% before rebounding to 40% in 2021. (these will be explained later why).

Fixed Assets

The high percentage of working capital means that the company didn’t have to rely much on Property, Plant, and Equipment (PPE) to generate a satisfying income.

In the early years, the percentage of Fixed Assets was around 50%, but it fell dramatically over the next ten years to 25–35%. If the current machine utilization is close to its maximum capacity, management should have increased its CAPEX, which will be reflected in the Fixed Assets portion.

Business Payables & Business Loan

Business Payable & Business Loan. Source: Annual Report 2011–2021.

Simple explanations from the framework would be like this:

• Business Payables are debt (without interest) to produce inventories/services.
• Business Loans are debt (with interest) to acquire Fixed Assets or provide Working Capital.

If we look at the ULTJ history, we can see that a higher percentage of Business Payables is always preferred over loans. There is a significant increase in Business Loans in 2020, particularly in the Current Maturities of Long Term Loans.

What exactly are Long Term Loans? And why are they so large?

Financial Report 2020. Source: Annual Report 2020

In 2020, the company took a corporate action in the form of issuing Medium Term Notes (MTN)(difference between obligation & MTN)amounting to IDR 3 (three) trillion, as follows:

• Series A of IDR 1.5 Trillion, with an interest rate of 7.5% p.a, is due on November 27, 2021
• Series B of IDR 0.9 Trillion, with an interest rate of 8.0% p.a, is due on November 17, 2022
• Series C of IDR 0.6 Trillion, with an interest rate of 8.5% p.a, is due on November 17, 2023

Management’s explanation for issuing these MTNs:

“With the issuance of MTN Ultrajaya benefits in the form of implementing a plan to expand the supply chain, logistics, and distribution of the Company’s products and increasing production capacity. Likewise, increasing the production/supply of fresh milk raw materials so that it can substitute for imports,”

The MTNs are to blame for the turbulence in ULTJ’s balance sheet, which has increased its liability to 70%! This also explains why the Working Capital composition is changing.

Equity

ULTJ Equity. Source: Annual Report 2011–2021.

If you look closely, equity growth is declining in 2020. This is also because of the company’s action in buying back shares using their abundance of cash. As stated in the Annual Report 2020:

“In 2020, the Company Treasury bought back 1,155,352,800 shares at a purchase price of Rp. 1,600 per share, so that the total amunt of Rp. 1,848.6 billion. Meawhile, the direct equisition cost of share buy back is Rp. 5.9 billion. The share buy back deducted to total amount of equity”

This was great news for me as an investor, this will also reduce the total outstanding shares in the market, making the stock more valuable… until I found out that the management has to choose between 2 decisions regarding the treasury shares:

• The shares are removed completely (reducing outstanding shares permanently, which is my preference most of the time) or
• Resold to the public within 3 years.

Unfortunately, the management has chosen to proceed with the second option. As stated in the Pubex 2021:

“We always comply with the provisions of the Stock Exchange (BEI), which is that in two years it will be released to the market, that is what we plan to do.”

Financials — Revenue

ULTJ Revenue (IDR Billion). Source: Annual Report 2011–2021.

What matters in FMCG, is revenue growth and gross profit margin growth (GPM).

The revenue of ULTJ is growing at a compound annual growth rate (CAGR) of 13.59%. The decline in 2020 was caused by COVID-19, which reduced demand and impacted product volume sold. I haven’t double-checked with any other dairy companies. If the revenue of the other company is increasing, it means that the reason for the revenue decline is completely invalid.

COGS — Raw Materials

Purchase Raw Materials Breakdown. Source: Annual Report 2021

As previously stated in the supply chain, ULTJ obtains fresh milk from farmers of their subsidiaries as well as union farmers. To gain a better understanding of the cost, we should look for the item that contributes the most.

As a result, to dig deeper, I examined the raw materials purchased in the COGS section and came to the conclusion shown in the image above.

Raw materials contribute 64% of the revenue:

• PT Tetra Pak provided 9–10% of the aseptic packaging material and tools.
• 4–7% comes from PT Anta Tirta Kirana. I haven’t found an explanation for this one, but based on the website, it appears to be food ingredients and packaging material.
• The remaining 40% is made up of fresh milk, condensed milk, tea, and so on… I couldn’t even find a percentage of each item. But, if I had to guess, 30% should be fresh milk, based on the percentage of dairy products in net sales, 5% should be raw materials for tea, and the rest should be the other raw materials such as (concentrate for condensed milk, sweetened condensed milk, etc).

Transactions with PT Anta Tirta Kirana must be approached with caution because they change frequently. PT Tetra Pak is easier to predict because the portion is always around 9–10%.

COGS — Process

Production Process. Source: Annual Report 2021

Production expenses consist of direct labor, repair and maintenance, electricity and energy, salary and wages, spare parts, factory supplies, and anything related to the factory.

The entire production process should be entirely internal (which means not using 3rd party services). I might be wrong with this one, but I haven’t found any additional information related to this.

Final Thoughts

I believe ULTJ has a great business, with Operating Income and Net Income increasing year after year. What bothers me are the company’s recent actions, which are the MTNs.

I’m curious why ULTJ’s management issued the MTNs when they have a large pool of cash on hand. They could use their current cash to expand their business if they needed to.

Looking around, it appears that the company has been playing a defensive game by owning government bonds since 2018. ULTJ also bought and sold bonds from 2018 to 2021.

I would prefer that they use their money to be more aggressive, dominate more market shares, and expand the business even further, which will result in more revenues! However, it is entirely up to the management to determine what is best for the company right now.

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