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Image: Dutch Lady
I previously shared an article on The Fifth Person titled “7 Reasons Why Nestlé is on My Dividend Watchlist”. If you are familiar with Malaysia’s stock exchange, you will know that Nestlé’s closest peers is Dutch Lady Malaysia. These two companies have always been compared apples-to-apples by investors.
I decided to dive in further and find out more about Dutch Lady Malaysia. In my research, I discovered eight interesting facts about Dutch Lady that made it a solid and stable investment. But before I move onto the eight points, let me share a little bit more about the business of Dutch Lady.
Dutch Lady is 50.96% owned by Royal FrieslandCampina which is a one of the largest milk companies in the world headquartered in the Netherlands. Dutch Lady incorporated in Malaysia in 1963 and listed on Malaysia’s stock exchange in 1968. They manufacture and sell a range of dairy products and fruit juices like infant formula, condensed milk, powdered milk, sterilised milk, yogurt, fruit juices, etc.
These products are mainly sold in Malaysia and Singapore under the brand names Dutch Lady, Frisolac, Friso, Completa, Omela and Joy. Dutch Lady manufactures their own products and retail them through independent distributors who distribute Dutch Lady’s products in supermarkets.
Let us now move on to the 8 reasons why I love Dutch Lady Malaysia as an investment:
Dutch lady is able to remain profitable even during periods of economic crisis. Most companies will see their net profit dip substantially but for Dutch Lady their profits were hardly affected at all. The reason is because people will still consume Dutch Lady’s food products regardless of a recession.
Dutch Lady is able to consistently increase its revenue due to their ability to increase prices by passing down rising costs to customers. They are able to do this because of their strong brand equity among consumers. Even if they are priced slightly higher, consumers still choose Dutch Lady.
Free Cash Flow (FCF) is the amount of cash a company is able to generate after spending the money to operate and expand its business. Smaller companies usually have negative FCF because they had to keep spending on capital expenditure in order to expand the business. Investing in small-cap companies can be risky because the growth stories may not always turn out as planned and flop. Larger companies like Dutch Lady have already established their position in the marketplace and are at a more mature stage of the business cycle where high capital expenditure is no longer need. This allows them to generate higher FCF.
With high positive FCF, a company is able to do the following activities to increase shareholder value:
In my previous article on return on equity (ROE), companies are able to artificially boost their ROE through debt. But when you examine Dutch Lady, they are able to consistently generate increasing ROE without any debt. In fact, Dutch Lady has ZERO debt on their balance sheet. This reflects how strong their business model must be in order to generate such a high and consistent return on equity.
Cash Conversion Cycle (CCC) measures the days a company takes to convert cash into inventory and back to cash. The lower the CCC, the more efficient a company is at converting their inventory into cash fast. We can see that Dutch Lady has a ten-year track record of falling CCC. In 2013-14, Dutch Lady’s CCC became negative which means they collect cash even faster than they can spend it on inventory. In other words, Dutch Lady’s working capital is financed by its suppliers.
Companies can record profit but have negative cash flow because they are unable to collect cash from their customers. Hence, quality of earnings is very important. An earnings quality ratio of 1 means that a company collects a dollar in actual cash for every dollar of sales. The objective is to look for companies with earnings quality ratio above 1. Dutch Lady has been able to do that for seven out of the past ten years.
For the past ten years, Dutch Lady Malaysia has been able to consistently increase their net profit margin from 5.9% (2005) to 11% (2014). They achieved this due to management initiatives to operate a much leaner cost structure with lower operating costs.
For the past ten years, Dutch Lady has paid consistent dividends due to the high FCF they generate. Except for a one-off drop in 2008, dividend per share has been on an increasing trend.
This isn’t by all means an exhaustive analysis of Dutch Lady. In fact, we usually go deeper when we analyze a stock by using the investment process we developed for The Investment Quadrant. In addition, we also use the Dividend Machines investment process when investing for dividends.
However, just by looking at these eight points alone, it’s easy to tell that Dutch Lady has a resilient business model that’s able to generate profits and cash even during a recession. While its growth may be slightly limited, it’s an extremely stable company which would investors who prefer less volatile and steady investments.
[**Telco Stocks are great for dividends due to the nature of their business model. Find out the 5 Key metrics you must know when analyzing telco stocks – 5 Key Metrics For Analyzing Telco Stocks**]