My Bull Case For Neo Group (5UJ)

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Introduction

I chanced upon Neo Group  while reading an article in Straits Times. The article detailed the success stories of a few of our local enterprises. What caught my attention was the founder’s humble background and entrepreneurial spirit and the company’s explosive growth. The article on Neo Group not only inspired me but also left a positive impression. However, I didn’t follow-up by digging deeper into the company.

A few months later, I was involved in the planning of a school activity with my course committee and lecturers. We decided to engage a halal caterer called Deli Hub based on the suggestion of my lecturer. When the food arrived, we were quite concerned as the portion was much smaller than expected, compared to the previous caterers we engaged.

Fortunately, everyone had enough to eat and the buffet spread was picked clean. I decided to ask around if the food was satisfactory since it was the first time I saw a buffet spread with little to no leftovers. To my delight, most of my the attendees liked the food and preferred that we engaged this caterer for future events.

I went back to report to my lecturer about the positive feedback and what he told me next got me excited. He mentioned that Deli Hub was actually the suggestion of other course lecturers and that Deli Hub was becoming quite popular among the school due to the quality of the food and ability to cater to last-minute orders. I immediately went to take the name card of Deli Hub which was placed near the drink dispensers and guess what I found? Deli Hub was a subsidiary of Neo Group!

After the event, I went home to connect the dots and started researching on the company. I loved what I had found and made my first investment in Neo Group @ $0.97 in June 2014. As it turned out, I didn’t get the timing right and the share price has tumbled by 37% since my purchase. However, I am still vested and bullish on the long-term prospects of Neo Group. Here is my bull case.

 

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The Business

Neo Group is involved in 3 complementary businesses: Food Catering (53% of revenue), Food Retail (17.1% of revenue), and Food and Catering Supplies (28.9% of revenue).

Under its Food Catering Business, the Group operates four brands namely, Neo GardenOrange CloveDeli Hub and Best Catering. All four brands supply buffets spanning a wide variety of styles and prices, to suit a diverse range of occasions, from private to corporate to community functions. In 2012, the Group was ranked by Euromonitor as the number one events caterer in Singapore for 2011. It is estimated that its current market share of the catering business is 10% .

Under its Food Retail Business, the Group operates umisushiissue izakaya and NANAMI UDON. Recently, the Group opened LJJ Café and acquired two other brands – Choz and Fu Yuan.  The Group also operates a flowers and gifts business, I DO Flowers & Gifts, which supports buffet settings and provides flowers and gifts through an online platform for a variety of occasions, catering to a wide range in budget.

Under its Food and Catering Supplies, the Group operates NKK, H-Cube F&B, and the recently acquired 55% of Thong Siek Holdings, parent company of “DoDo” fish balls, the largest fish ball manufacturer in Singapore. The group also recently acquired 90% of CT Vegetables & Fruits.

The nature of Neo Group’s core business in Food Catering is rather defensive. In 2 separate articles in THE EDGE (December 29, 2014 and October 15, 2015), the Neo Group’s founder, Neo Kah Kiat, mentioned that the crisis of 2007 and 2008 did not really affect the catering business. In fact, there seemed to be more meetings going on during that period. Neo Group became more aggressive in its marketing which enabled the company to capture a greater slice of the corporate market.

Neo Group also benefits from the rising secular trend of engaging caterers for events rather than getting friends and family to cook/contribute food.

Lastly, the food catering industry is extremely fragmented with many small players due to the low barrier to entry. Since Neo Group is the largest catering business with only 10% market share of the $360m industry, there is definitely further room for growth and expansion.

 

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The Management

Neo Group is currently led by its Founder, Chairman, and CEO Neo Kah Kiat. He owns 69.74% of Neo Group. Executive Director Liew Oi Peng, wife of Neo Kah Kiat, owns 5.56%. Executive Director (Business Development) Lee Kwang Boon owns 4.97%. Executive Director (Food Retail) Liew Choh Khing, brother of Liew Oi Peng, owns 1.17%. In aggregate, the key management owns a total of 81.44% of Neo Group. High levels of economic ownership by key management ensures interests between themselves and the shareholders are aligned. However, such high levels of ownership has resulted in the stock to be illiquid and infrequently traded; but that shouldn’t be a concern to long-term investors.

Neo Group’s capable management has enabled to bag multiple awards consistently over the years. While not a fool-proof indicator, I find that such awards and accolades is evidence of the management’s competency.

Neo Group’s Neo Kah Kiat is an ambitious man. At an annual appreciation dinner in July 2015, he shared that the company was aiming to grow revenues to $1bn by 2025. Given that the 14M15 revenue was at $77.4m, Neo Group has to grow its top line at a rate of 29% every year for the next 10 years. Neo also aims to achieve 30%-40% market share of the catering business.

Neo has backed these ambitious goals with a series of acquisitions as mentioned above. Furthermore, Neo Group’s facility at 30B Quality Road is expected to open in 2019. It will be 5 times larger than the current facility at 1 Enterprise Road.

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The Financials

Neo Group’s financials isn’t in good shape and should be closely monitored for any improvements or deterioration. Neo Group has the typical growth company financials: high revenue growth, low bottomline growth, rising/high debt levels, and negative free cashflow. While Neo Group’s ROE has been very high, it should be noted that the main source of the high ROE is from the high level of gearing, which is not desirable. The pursuit of high growth via frequent acquisitions and aggressive CAPEX has weakened Neo Group’s financials. This may prove to be detrimental to Neo Group’s intrinsic value should the growth plans go awry.

Having said that, I trust that the management knows what they are doing and will only consider raising my stake in the business when its financials strengthen.

 

The Valuation

I purchased Neo Group at a valuation of around 18x P/E. Now, it is valued at 11.9 P/E. This is probably due to the market discounting the fact that the food manufacturing business that was acquired recently has been losing money and will negatively affect the group’s overall earnings power. Hence, the 1-year forward P/E should more or less be about 18x P/E.

Based on the growth plans revealed by Neo, there are a few ways to value Neo Group, from most bullish to most conservative, with a net profit margin assumption of 10% and P/E assumption of 15x:

  1. Neo Group does achieve $1bn in revenues by 2025. Neo Group could be worth $1.5bn or $10.28 per share (CAGR=32.6%).
  2. Neo Group achieves $0.8bn in revenues by 2025. Neo Group could be worth $1.2bn or $8.22 per share (CAGR=29.7%) 
  3. Neo Group achieves $0.6b in revenues by 2025. Neo Group could be worth $0.9bn or $6.17 per share (CAGR=26%)
  4. Neo Group achieves $0.4bn in revenues by 2025. Neo Group could be worth $0.6bn or $4.11 per share (CAGR=21%)
  5. Neo Group achieves $0.2bn in revenues by 2025. Neo Group could be worth $03bn or $3.37 per share (CAGR=18.6%)

While I am unsure of whether Neo Group can achieve its billion dollar revenue goal, I am pretty sure that the company will need to raise a lot more funds via rights or share placements to get there, which will adversely affect the per share value of Neo Group.

I believe, without the sale of equity, Neo Group can achieve between $0.2bn and $0.4bn in revenues by 2025. Hence, the business could potentially be worth $3.37-$4.11 per share by 2025.

 

The Bottomline

  • Simple and understandable business
  • Defensive and recurring in nature
  • Phase 3 expansion to be completed in 2019
  • Ambitious growth plans – up till 2025
  • Founder-led business with significant stake in business
  • Beneficiary of rising secular trend of engaging caterers for events
  • Potentially worth between $3.37-$4.11 by 2025

The Risks

  • Something bad happens to the Founder
  • Financials continue to deteriorate
  • Growth plans do not materialise due to unforeseen circumstances
  • Poor execution of expansion plans
  • Dilution from fund-raising activities to fuel growth
  • Food scandal

Kenny Chia

Undergraduate, SMU

4 thoughts on “My Bull Case For Neo Group (5UJ)

  • May 25, 2016 at 1:12 PM
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    Hi
    I was wondering if you held on your shares you mentioned that you bought at 0.97 till now? Or have you sold?

    Reply
  • May 26, 2016 at 10:19 PM
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    Hi David

    I am still holding on to the company and have no intentions on selling it anytime soon 🙂

    Reply
  • February 8, 2017 at 12:21 PM
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    Hi Kenny, what are your views on Neo Group now. I notice revenue has doubled but Expense seem to exceed revenue growth. Their business model is exciting but they do not seem to be able to contain cost

    Reply
    • February 10, 2017 at 12:12 AM
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      Hi Joe,

      I am less bullish on the prospects of the company. You’re absolutely right, they have a great core business but management can’t seem to manage their costs and have been on an acquisition spree. I divested my stake after attending the 2016 AGM as I did not really like what I heard and saw. With the release of the 3Q results today, I’m glad I sold.

      The Motley Fool SG wrote an excellent article on the results today https://www.fool.sg/2017/02/09/has-neo-group-ltd-overstretched-itself/
      I am sure you will find it useful. Hope that helps! 🙂

      ps:I enjoyed reading your blog, keep up the good work! I’m a shareholder of Riverstone and Alibaba as well 🙂

      Reply

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