Sector financial performance:

This company, a wholesale distributor of cigar, tobacco, food, confectionery, beverage, and grocery, has been grouped into wholesale cigarettes& food sector.

While it has been the truth that consumption of cigarette has been declining for years, our company’ sales volume data indicate that demand from existing stores for cigarettes did not decrease until 2016 as manufacturers continued to raise their products’ price (reduce the promotion of their price) and/or increasing exercise tax in some of regions. Demand for food distribution seems to have been strong and help offset the decline in cigar sales in the past several years.

While companies usually are able to pass on the increased price from supply side to customer side so that they can maintain the fixed profit per sales unit, the increase in cigarette’s price from manufacturer side has been giving huge pressure on cigar wholesalers’ gross margins, which have usually been very small due to the nature of intensive competition in this sector. And the decrease in sales volumes and downward pressure on gross margins inevitably resulted in significant shrinks in those companies’ profits (operating income decreased by 22% - 36% in fiscal 2017 compared with 2016 so far) and may push profits of some of wholesalers into negative range (operating margin 5% currently) if they were not able to pass the increased price to stores or save costs by other ways. The recently rising demands for food distribution, with higher margin, seem to be offsetting the lost profits of companies in this sector resulted from declining cigar sales/volume.

In this situation, lifting sales of cigarettes by grabbing more market shares from other competitors and pursuing growth from business with higher margin such as grocery food and fresh food distribution ( around 13% gross margin for food distribution compared with 5% for cigarette) have become the only ways for current wholesalers to keep growth of their profits.

A typical gross margin for companies in this sector is around 5-6% with around 5% SG&A spending as percentage of sales. Therefore, their operating margins usually have been very close to fall below zero.

According our analysis, there is a large span between companies’ enterprise price/adjusted EBI from 19-39 with interest/EBI ratio of 20-30%. 

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Company performance:

It seems the demand from retailers for cigarette, the core items (more than 75% total revenue) that this company distributes, finally decreased in fiscal 2017 (down by 3.7% as indicated by sales volume) as the cigar’s price continued to go up in the past several years. Cigarette’s price continued to rise in 2018 but the decline in cigar volume slowed down.

For fiscal 2018 compared with 2017(ended 20180930)

Organic sales of wholesale increased 3.3% attributable to increase of 2.6% in price (cigarette) and increase of 1.5% in volume(merchandise) offset by decrease of 0.7% in volume and mix (cigarette cartons).

For fiscal 2017 compared with 2016

Organic sales of wholesale of this company decreased 1.2% in the first nine months of fiscal 2017 compared with the same period of 2016, attributable to decrease of 3.7% in volume and mix (cigarette cartons) offsetting by increase of 2.2% in price (cigarette).

Organic wholesale sales increased 1.3% in fiscal 2016 compared with 2015, attributable mainly to increase of 2% in price (cigarette) offsetting by decrease of 1.3% in volume/mix ( cigar cartons)

Organic wholesale sales increased 4% in 2015 compared with 2014, reflecting an increase of 2% in price of cigarette and an increase of 1.5 in sales for other items.

This company’ gross margins as percentage of sales went down from 6% of 2014 to 5.5% of 2018. The decrease in gross margin is primarily due to the inflation in price (supply side), which has gone up by annual rate of 2% in the past three years. Because the profit for a carton of cigarette is usually fixed, the inflation in sales of a carton of cigarette resulted from increased price caused the margin as percentage of sales smaller. It is also possible that this company may have failed to pass all inflation in price/reduced promotion from manufacturers to the stores. As a result, its operating margin went down to 0.5% and cash flow as percentage of sales down to 0.3.  Its operating income decreased by 7% and 48% in fiscal 2016 and in the first nine months of fiscal 2017 as sales of volume decreased with a fixed profit per unit volume but increased about 50% in 2018 due to increasing volume in other item than cigar cartons.

Stock price

This stock currently has an enterprise price/EBI ratio of 19, which we think, is relatively undervalued compared with its peers considering its performance in food wholesale market.