I want to start this article by saying I was wrong. In my last article as linked below, I gave a recommendation for Canone, with a TP of RM5.72 on the basis that the milk business is growing in profitability and Canone’s stake in Kian Joo Can Factory Berhad (“KJ”) is a healthy and profitable one.

http://klse.i3investor.com/blogs/rarecharms/91402.jsp

However the 2015 Q4 results came out and it was below expectations. The stock price tanked from RM4.50 to as low as RM3.5. People lost money and so did I. I was surprisingly glad that despite my high TP, nobody blamed me (yet) for losing money based on my recommendation. Perhaps nobody trusted me enough to buy on my recommendation anyway. Haha… aww shucks :(

I personally had no idea why Canone’s milk division and KJ reported lower profitability. I was looking at foreign exposure, commodity prices, USD/RM strength and I couldn’t find out why. KJ had a forex loss of RM8m (what.. why?) and Canone had marginal forex gains when both the USD and VND were stable against the RM in Q4 2015.

I hypothesize that it could be due to customer pressure for lower prices (I do not have data to prove this), while raw materials although have decreased in price are still priced in USD, muting cost savings.

The other recent development is an article in the Star newspaper that most of you should be familiar with.

http://www.thestar.com.my/business/business-news/2016/03/12/canone-mulls-sale-of-condensed-milk-ops/

In this article, it says that sources (this is hella dodge) claim that KWAP is interested in buying up to 80% of Canone’s milk division and Canone is seeking a valuation of 20X PE. In any case, I decided that as a follow-up to my previous article, I needed to re-run the numbers to find out the new valuation. First of all, a revision of KJ’s offer price from Aspire and TTC. 

KJ’s NTA has increased significantly from 2013, but PAT disappointed, only increasing 2% since 2013.

Next, I revised the two base case and optimal case valuation based on the latest result. 

As you can tell, the TP for both has dropped notably. However, in light of recent events, I need to readjust some valuation multiples. I call this new valuation the revised case (how original). 

I need to explain a few things here. First of all, I understand people are arguably concerned about the RM542mil of debt on Canone’s books. Out of this, approximately RM200mil is used for currency trade loans, bills receivable financing and BA. These are mostly trade financing loans which aren’t like term loans. They are short term loans to finance raw material purchases. To understand more, please refer to the appendix of Icon8888’s interesting article on EG.

http://klse.i3investor.com/blogs/icon8888/90015.jsp

Besides that, another RM218mil was used to finance the KJ acquisition which is paying for its own financing cost. Therefore, I don’t think there’s too much to worry about for the remaining RM100mil term loans.

On top of that, in my valuation, I assigned the general cans business a PE of 8 and a value of RM64mil. This business has assets worth RM302m and I’m assigning a fifth of its asset value. I would say that’s prudent enough.

From the Star article, for the dairy division, it states that “The plan is for the asset to be listed a valuation higher than 20 times earnings, so this is the potential upside for the buyer now.” I am going to discount this to a PE of 15, following my optimal case. Finally, to take a more prudent stance, I will use the original Aspire offer price of RM3.30 instead of the revised ones. With all these revision, we arrive at Canone’s value of RM5.55 (dude, you can’t fudge numbers like these).

Conclusion

I understand that we all need some margin of safety. Discount it even further, personally on your own. If you want a margin of safety of 50%, then your TP is RM2.27, please pass on this. If you think you need 20% margin of safety, then your TP is RM4.44. I am only here to give you a reference model with a price.

For me personally, I’ll take the Rm5.55 bet which I’ve already embedded a whole bunch of discounts into it. Nevertheless, the choice is yours. I could be wrong (again) and if I am, please let me know gently :)

Happy trading/ investing ya’ll

Cephas