Sector financial performance:

This company was grouped into breakfast cereals& snacks sector of bakery industry while it has diversified product categories that also provide significant revenues.

It seems that the recent sales volume of companies in this sector indicate that the demands for breakfast cereals had been weak (primarily from non-core products) and declining and the decline may be reaching its maximum and rebounding in 2018. Accompanying with the decline in volume, selling price of those products seems to have been rising. Our analysis indicates that this sector is very sensitive to price’s rising. Company will lose its market share if it significantly lags behind its peers in price reduction or promotion. However, our data also indicates that the competition did not come only from the competitors inside the category but came from alternative products of cereals because the lost market shares from one company did not directly go to another one. At the same time, demand from international market seems to keep strong and contribute most of increase for those companies in the past several years.

However, while it is very sensitive to rising price, as a mature market with stable but slowly growing demands it is not that sensitive to reduction of price. Therefore, since there is no better way to stimulate sales, companies have been focusing on productivity and management costs controlling to try to improve their margins and profits and it seems that companies have been doing well before 2017. However, increasing input costs seem to be causing upward pressure on price and hurting companies ‘profitability.  Companies have managed to improve their gross margins to average 34% (30-38%), operating margin to average 16% (14-17%), and cash flow margin to 8%.

Therefore, companies will firstly need to find the sensitivity of its products price to alternative products and competitors. As long as they find its sensitive point of price, companies’ performance may up to their brands loyalty and products’ innovation.

According our analysis, the sector’s ratios of enterprise price/adjusted EBI ranges 18-24, which present a decrease in multiples compared with 2016/17 caused by concern with consumption of cereal in future.

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Company performance:

It seems the demand for breakfast cereals of this company has been stable and fluctuated only in a small range in the past several years.

For fiscal 2018 compared with 2017(20180930)

Excluding impacts of acquisition, the net sales of its cereal products went up by 1% due to increase of 1% in sales volume.

Excluding impacts of acquisition, the net sales of its cereal products went down by 1% in 2017 (9 months), up by 2% in 2016, and down 3% in 2015. All the fluctuations in sales were due to the up and down in sales volume while the average selling keeps unchanged.

Margins, if we look at whole company including its RTE cereal, food, and nutrition segments, gained significant improvement in 2016 compared with 2015 ( gross margin went up from 25% to 30% and operating margin up from 9.5% to 14%). And this is mainly due to the improvement in gross margin in Michael food segment, which has been caused by the reduced costs and rising prices. While there are some unfavourable changes in Michael foods segment after entering 2017 such as rising costs and falling selling price, this company still provided a gross margin of 30% and operating of 13%. This is still attributable to the relative lower raw materials costs, higher selling prices of products, and shifting of sales to higher margin in Michael food segment compared with 2015 and 2014. Operating margin continued to be improved in 2018 primarily because of the reduced marketing spending (as percentage of sales, down to about 16%), the major benefits from synergies of acquisitions.

Generally, it seems that this company has been benefiting from the acquisition that it had in the past several years in many areas including enlarged sales scale, more diversified products, and as well improved margin by significant synergies saving.

Stock price

This stock currently has an enterprise price/EBI ratio of about 24. We think the improvement of its margins totally came from its higher gross margin in its basic food segment and from the largely reduced SG&A and thus may fluctuate as market environment changes. In addition, we are concerned on its high borrowing and its as high as 55% interest/EBI ratio. Therefore, considering increasing production costs we think it may be still a little overvalued while demand may be picking up as well.

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