The curious case of Malayan Flour

It is no easy feat to have a name "Malayan" Flour and still flourish and survive until today. To be able to be in business for 40 years, with its ups and downs, doing very well at times is a good story. Malayan Flour (MFlour) is today the second largest flour milling operations in Malaysia with about 25% market share or more. If you read further, it is looking at the Vietnam market (as well as Indonesia) for expansion. Besides flour milling, it has other businesses as in live stocks poultry and feed milling - however the main bread and butter remains to be flour milling- wheat that is.

Now, the Malaysian wheat flour business has one large challenge - which also allows MFlour to survive and kills off competition - price control. (At the moment it is priced at RM1.35 for general flour)
When the price of wheat is low, all millers will survive - with of course quality of the flour and distribution taken into consideration. When the price of wheat is high, the weak ones which have weaker balance sheet, quality, sourcing strength etc. will be eliminated. Hence, it is no surprise that the performance of MFlour as well as the rest are very dependent on the price of wheat.

Prices of Wheat over 10 years

If based on the chart above, the flour millers were facing their hardship in 2008 and again today in 2012. These results are pretty much the same for MFlour and Federal Flour (own by PPB). And to top off, with price control, the years 2008 and 2012 are period before election. No government will be brave to allow increase in price for a staple (almost) - as flour is used for bread, noodle, roti canai etc. What the government would normally do is to provide subsidies. That kind of subsidies will of course be dependent on the sentiment of the government itself and the trend nowadays are to reduce subsidies for all kinds of stuffs. This scenario is like between the rock and a hard place for these millers.

5 year track record for Malayan Flour - not too bad but its 2012 performance is going to be challenging

If you noticed the performance of MFlour, it's profits is pretty much cushioned due to subsidies while over the last 5 years it has not failed to improve its revenue to the extent that it is currently running on almost full capacities on all its mills in Malaysia. This year 2012 is very tough though as revenue for 9 months increased to RM1.5 billion while Net profit reduces to only RM15 million, hence I am actually seeing the worst results for MFlour for the last 6 years despite record revenue. Why such when 2008 was a worse year in terms of prices for wheat?

Besides probably reduced subsidies, now comes my speculation. What is surprising is that there are certain trends which we see is not going according to what the trend should be. If you notice on the revenue for MFlour, its revenue growth does not follow industry average which is around 4% - 7%. Its revenue exceeded that by far (almost doubled in 5 years) probably due to price increases and its other segments of its business (feeds and poultry as well as overseas) but I doubt it is entirely from there. It shows that MFlour is gaining market share in wheat flour. With price control, by right the more you sell, the higher the profit margin as economies of scale kicks in. For MFlour, it is not really that. It is hence dealing in price competition.

The bad news. MFluor's biggest competitor in this business is Federal Flour, a subsidiary of PPB - ultimately Robert Kuok. As already all know, Robert Kuok is the largest by far in these area of business - flour, edible oil, sugar etc. FFM has a market share of more than 40% in Malaysia. Being the largest by far in edible commodities comes together with the power of negotiation and sourcing - as well as ability to throw prices. Why do I say that?

Prices of wheat flour is controlled but not for those used for industrial purposes - which means the ones sold to bakeries and noodles maker are not controlled. Hence prices of bread by right should have increased when wheat prices increases. (White bread which uses wheat flour as well is sometimes subsidised though). This has always been the saving grace for the flour millers as through non-price control in their sales to other industrial buyers, pricing is more inelastic. The higher the price of wheat, products that directly rely on wheat will increase price naturally. Another thing, with so few players and the top two (FFM and MFluor) in Malaysia already in control of almost 70% of the supplies, it could have led to a cartel situation - but it is not recently. Additionally, MFlour based on its quarterly report is claiming squeezed margin including lower selling price as the reason for lower profits. Why?

Poorer margins due to lower selling price is being used as the reason for lower profits in 3 quarters 2012 by MFlour. It cannot be lower selling price if it is price controlled item

Could be- Very recently, PPB has gone downstream i.e. into bread making - Massimo. Some say it is due to Gardenia not relying on its FFM flour anymore and has moved on to MFlour, hence PPB is doing this, or could be due to PPB started bread making and Gardenia moved on to another supplier, I am not sure. But never mess with one as big as Robert Kuok especially when comes to food commodities.

I am sure I do not know what actually happened, but prices of bread remains unexpectedly this time around. the Massimo bread I sometimes eat - its price definitely remains and I am sure Gardenia's price (which I eat as well) stays the same or probably it even lowered its pricing for some of its range to compete against Massimo, which is priced more attractively. If you notice as well this time around, Gardenia stopped lobbying for price increase as it is fighting a different war.

With the artificial lowering of retail bread prices, we probably see MFlour's pricing being the supplier being squeezed as well. Both FFM and MFlour suffer in terms of profits in the wheat flour business - that's for sure. But MFlour is a single entity when comes to the business of flour milling as its profits from poultry and feed are paltry. PPB, Wilmar are not. Its flour business in Malaysia is just one of the few places it supplies this product. Hence, FFM can afford to make less in Malaysia while not suffering as much elsewhere. MFlour has less of that luxury.

So, sometimes being second may not mean good enough especially when times are a bit more challenging.

I think this is going to be a temporary setback though as MFlour remains to be resilient and a well managed company. I am not able to speculate on the volatility prices of wheat though. Once prices of wheat returns to normalcy, MFlour will be attractive once more, and I think another reason why it diversifies to other regional countries is due to flour is not a price controlled item in these countries.

Another thing which I do not understand on MFlour is that, this year it raised RM200 million from rights issue while at the same time issued a massive taxable (25%) dividends totalling RM100 million. Both of them happened first half of this year. As a company, rights issue are normally used for business expansion or paying down debt. However, a huge sum of dividends paid about the same time I think is a little bit careless on the part of planning of the company. See below.