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I made an 80.7% return in seven months investing in Neo Group when I chanced upon the company when reading the newspaper. This is a classic example of being observant and being able to spot potential investment ideas as you go through the activities in your daily life.
Neo Group caught my eye because they posted a 293.6% gain in net profit for 1H2014. I have a habit of being curious when a company suddenly posts a huge gain in their quarterly report. I wanted to find out what caused the jump in profits and, more importantly, whether it was sustainable and could be repeated in the second half of the year.
Before I share my research and the business catalyst that spiked Neo Group’s profit, let’s have a brief understanding of Neo Group’s business model.
Neo Group is the largest catering company in Singapore in terms of market share. The company has three business segments mainly food catering, food retail and food supplies.
The food catering segment comprises three brands — Neo Garden, Deli Hub, and Orange Clove. In total, this segment commands 10% market share of the $360 million food catering industry in Singapore in 2015. The food retail segment owns a takeaway budget sushi store called Umisushi which has 25 outlets in Singapore. Their food supplies segment is their sourcing point where the company purchases their food ingredients to distribute to their food catering and food retail units.
The merit of investing in a food catering company is that it usually has better margins compared to a regular F&B business. Food caterers enjoy a 19% profit margin while the rest only command 5-6% margins. The depressed margins are mainly due to the high cost of rent for retail spaces.
At the time when I was researching Neo Group, insiders had recently purchased their company shares. To quote Peter Lynch:
“Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.”
So this was a plus point for me.
Referring to the chart above, you can see that Neo Group’s net profit for 1H2014 was already equal to FY2013’s full year results. Upon further research, I discovered there were two reasons why FY2013’s profit figures were so low.
The first reason was the cost of Neo Group’s IPO listing that year. This is a one-off expense.
The second reason is due to the fact that Neo Group’s financial year ends in January and Chinese New Year in FY2013 fell in February. This meant that earnings from Chinese New Year was not reflected in Neo Group’s FY2013 results but instead reflected in 1H2014 – which explained the huge jump in profits.
Neo Group’s business is also seasonal in nature; customers cater food and throw more parties during holidays. Looking at the calendar, I noticed that there were more holidays in the second half of the year in Singapore – which meant even higher potential earnings for Neo Group in 2H2014.
So in a nutshell, with profits for 1H2014 already equal to the whole of FY2013’s earnings and more holidays in line for 2H2014, I expected Neo Group’s profit to significantly grow year-on-year for FY2014.
At the time, Neo Group’s trailing PE was 14, which I thought was fair value. So with their market leadership, good margins, and large potential upside for 2H2014, I decided to purchase Neo Group at 49 cents and waited for the company to announce their year-end results. True enough, Neo Group announced full year earnings gains of 111.9%. Its share price shot up to 90 cents and I sold my position for a tidy 80.7% gain in seven months.
I wanted to share this case study to illustrate that investing can be as straightforward as spotting a temporary opportunity like this.
At that point in time, it was clear that Neo Group’s full-year profit figures had a high potential upside. If the company posted a huge gain, there was a good chance that its share price might jump in tandem (which it did). And even if my hypothesis was wrong, I was, in my opinion, already buying the stock at a fair price and my downside was reasonably protected. Barring unforeseen events, Neo Group’s stock price was unlikely to fall 10-20% when the company was performing so well. At worst, the stock might have stayed flat if investors felt the higher profits didn’t deserve a higher stock price.
So while there are no guarantees when it comes to investing, putting the two together — a high potential upside and a limited downside — it was a calculated risk I was willing to take and one that paid off pretty nicely for me!
(Photo credit: Neo Group)