Don't Worry, Merry Christmas!

http://www.playingforchange.com/journey/introduction

Merry Christmas dear all!

Competitive advantage and PE contraction

I find the Porter's idea on generic strategies immensely useful to think about business. The generic strategies are Cost, Differentiation and Segmentation strategy.

Look at our Singapore local supermarket market, you'll find Cold Storage (Strategy: Differentiation) running ads on TV telling you they are the fresh people, whereas Giant (Strategy: Cost) competes on price. A niche player like Guardian (Strategy: Segmentation) runs circles around strong rivals like Watsons and Unity NTUC healthcare.

The awesome thing is, Cold Storage, Guardian, Giant, 7-11 & Shop and Save, all operates under the DairyFarm Group. This gives the company tremendous bargaining power in buying terms from their suppliers and bargaining for favorable lease terms or advertising rates.

Look at DairyFarm's cash conversion cycle,

Inventory days = 50 days

Receivables days = 7 days

Payables days = 233 days

CAN YOU BELIEVE IT! it has a Negative cash conversion cycle of 176 days!

We further confirm this by comparing its operating profit with operating cashflow

Op Profit = 423.7 mil

Op Cashflow = 481.3 mil

Lastly, we compare Net Profit to Free Cash Flow

Net Profit = 364 mil

Free Cash Flow = 198 mil

Is this worrying? I don't think so, cuz the company is expanding its operations all over Asia with similar strategy. With ROA of 28% in 2009 and 31% in 2008, I'm happy that the company is expanding and not limiting its growth.

I quite sure Dairy Farm Group is a good company...but is it a good investment?

With 2009 EPS of 27 cents grows to 31 cents in 2010. The stock at 8.40 will be trading at a PE of 27X and PB of about 20X. Should I own this stock?

Let's assume we have a perfect mirror ball...We gaze clearly into the future that EPS will continue to grow at 18% for the next 5 years, but then the PE declines to a not-unreasonable 15x. Will it be worth buying today?

From the simple table, we see that by paying a spectacular 27x PE for a wonderful company growing at 18% per annum. The actual return just might not be that spectacular.

Of course you might want to say, what if in 2015, DairyFarm still trades at a PE of 27x (or higher), then you'd miss out an opportunity to make 18% per annum! True...The company's growth might also fall to a respectable 8% and PE declines to 12x.

Thanks, but this is just not the type of game i'm willing to play.