Malaysia's Next Big IPO - Farm Fresh Berhad

2 weeks ago, Farm Fresh IPO prospectus draft was published on Securities Commission's website. This can be a good opportunity for me to value the company unbiasedly because the actual listing price is not yet published. So, let's get started. 

Farm Fresh Background

Farm Fresh is a famous Malaysian brand that produce fresh milk in the dairy industry. The company is very young with less than 15 years history, founded by Mr Loi Tuan Ee. Today, the company is the 2nd largest player in the ready-to-drink (RTD) milk category, with 18% market share. The market leader position of Farm Fresh is in the chilled RTD milk subsegment with over 54% market share. Besides, Farm Fresh is also among the top 3 in terms of market share in the ambient RTD milk subsegment and yoghurt category.

Mr Loi started Farm Fresh when he noticed that 95% of the milk offered in Malaysia are actually reconstituted or powdered milk. This means that most milks claiming that they are "fresh" are actually made by adding water & some additives to milk powder, instead of "freshly squeezed" from the farm. Then, he started Farm Fresh with the mission to produce fresh and pure dairy just as nature intended. With this mission in mind, Farm Fresh promise to deliver their milk from farm to shelf in 48 hours. To achieve this, their milk must be produced, packaged and distributed locally. 

Competitive Advantage of Farm Fresh

1. Exclusive Australian Friesian Sahiwal (AFS) Dairy Cow Breed 

To achieve Farm Fresh's 48 hours farm to shelf promise is easier said than done, or else their competitors would have did it long ago. Malaysia is not the best place to raise dairy cow because of our warm temperature. The milk yield for dairy cows raised in Malaysia is much lower than those from Australia or New Zealand, which is why their competitors choose to import milk powder instead.

Farm Fresh bought over a genetic company in Australia that has exclusive ownership to the Australian Friesian Sahiwal (AFS) dairy cow breed. This AFS dairy cow breed can withstand Malaysia's temperature while maintaining better milk yield than local dairy cow. This way, Farm Fresh solved the supply problem and can get locally sourced milk with quality on par with imported Australian fresh milk. 

Currently, they still have a farm in Australia that act as a nursery. The cross breeding of the AFS cow will be done over there and the offspring will be exported to Malaysia for milking. One thing to note is that the Australian farm is also producing milk and have 2 times higher milk yield than their Malaysia's cow.  

2. Vertical Integrated Grass-to-Glass Business Model  

Having the suitable AFS cow breed in Malaysia is the first step for Farm Fresh to deliver their fresh milk in 48 hours. They also need to invest capital into integrating their dairy milk value chain, from the farming of milk to processing and logistic facilities. For example, all their delivery trucks and storage facilities must be capable of storing the milk in a specific temperature to keep the milk fresh. 

By having presence from upstream to downstream in the entire value chain of the dairy industry, Farm Fresh has ensured lower distribution turnaround time and better quality control over their dairy products. This vertically integrated model is unique because most of their competitors import milk powder instead of producing fresh milk locally. This has given Farm Fresh the niche market to differentiate themselves. 

3. Home Dealership Network

The biggest competitive advantage of Farm Fresh is their "Home Dealership" network. Unlike most of their competitors that sell dairy products through distributors and retailers, Farm Fresh is unique by having the Home Dealership programme as a means for their distribution channel. 

Essentially, their Home Dealership structure is very similar to what we commonly known as "Direct Selling". Currently, they have 832 home dealers with 1,302 agents under these home dealers. This network contributed significantly to Farm Fresh's rapid growth through word-of-mouth marketing without the company needing to spend too much on marketing cost. They just need to share part of their margin with the home dealers, while at the same time they save listing cost from selling their products in large format retailers such as Tesco & Aeon.

To ensure every home dealers earn a bit of the pie, they limit their sellers according to geographic regions. For example, home dealers from Kuala Lumpur cannot sell in Johor Bahru, so there is no over competition between home dealers. Looking at the flip side, this system allows home dealers to penetrate into rural or untapped areas to expand their customer base and in return, this has contributed significantly to Farm Fresh's growth in market share. 

Growth Prospect

1. New Product Line

Because Farm Fresh is the biggest vertically integrated dairy producer in Malaysia, they have proven better insights to consumer taste compared to their competitors. For example, their Kurma flavoured product line is a homerun for the company. Customers love it so much that it is very hard to find available stocks anywhere. Another recent booster for the company revenue was when they launched their UHT product line that can be stored longer than their chilled fresh milk. 

Thus, Farm Fresh still has legs for growth because they are only big in the chilled fresh milk and UHT segments. They have yet to enter other subsegments in the dairy industry such as Growing Up Milk, Adult Milk and Ice Cream subsegments which can fetch higher margin. 

P.S. I don't think Farm Fresh will ever enter the milk powder market because that would be a brand destroying move and it is also not economically viable to do that with Malaysia's milk yield. 

2. ASEAN Market

80.3% of the IPO proceed will be utilised for expansion purpose. According to the prospectus, Farm Fresh management team is planning to export their product to the Philippines, Indonesia and Singapore after they ramp up their production with the establishment of new manufacturing hub. 

The Philippines and Indonesia are 2 emerging countries that still have very low milk consumption per capita, hence there is still a long runway for their dairy industry to flourish when income per capita increase. Although it will not be easy to establish brand presence in another country, but if the expansion plan proof to be successful, it will be a very rewarding one for Farm Fresh. 

Risk

1. Going Digital Without Proper Planning

Going digital is a must for every company in today's world, but it is a double edge sword for Farm Fresh. This is because over 30% of their revenue is contributed by home dealers and if Farm Fresh plan to sell online, this might cannibalise their home dealers' sales. So, it is very important for Farm Fresh to go digital with proper planning, or else they would be destroying their home dealership network competitive advantage. 

2. Disruption to the Cow Herd (No Insurance)

Cows are animals, and animals get sick from time to time. From their prospectus, it is known that Farm Fresh did not buy any insurance for their biological assets. If there is any disease outbreak in their farms, it will be detrimental to the company's business. Currently, their only mitigation method is by vaccinating all their cows and by placing their cows in different farms to avoid catastrophic losses.  

3. Product Quality Issue or Bad Apple Among the Home Dealers

Product quality risk persists for all FMCG companies. Incidents such as product issues or ill managed home dealers will reduce customers credibility to Farm Fresh's brand. No matter how careful a company is, accidents will eventually happen and it remains to be seen how the company will manage this issue when it happen. 

4. Concern Over Leasehold Land Issue

3 pieces of properties and farm land that Farm Fresh are occupying are leasehold lands with expiration date from 2032 to 2041. This may pose a problem in the near future when the expiration nears because moving the facilities and farms will be disruptive to the company's supply chain.  

Valuation

Valuing Farm Fresh is not easy because it is hard to predict how the growth story for Farm Fresh will turn out. Anyway, let's look at the financials in the prospectus:

The FYE 2020 net profit after tax dropped because of one-off tax expense of RM25.7 million. Below shows the normalised revenue, profit before tax and profit after tax: 

Currently, we know that the Malaysia's annual production capacity for Farm Fresh is 137 million litres of finished products. After all the expansion plans, their annual production capacity will increase to 272 million litres in 2025. Assuming the company can achieve utilisation rate of 65% (historical average) of the enlarged annual production capacity, I derived the following valuation:

In my valuation, I have used the lower end margin to reflect the higher depreciation, financing and marketing cost that is expected to increase in the future. As of now, the company should be able to continue growing at double digit for another 3-5 years, depending on whether they can successfully expand to other regions. Thus, using expected production capacity in 2025, I think Farm Fresh's fair value should be around RM2.9 billion or RM1.53 per share.

The dairy industry is an extremely competitive industry to be in. I doubt the other competitors will do nothing when Farm Fresh eat into their market share, so a price war may be expected in the future. If that ever happen, I will need to revalue Farm Fresh again.

Concluding Remarks

Above is my valuation practice for Farm Fresh, can't wait to see how the market would price the company when it debut in the Main Market. 

Farm Fresh has earned Malaysians' trust and love for their product, which is very rare because Malaysians typically favour foreign brands. Let's hope for more Malaysian brand to thrive.

Let's end this piece with Charlie Munger's quote: