Is This Share A Great Growth Stock For Tomorrow?

Neo Group Ltd (SGX: 5UJ), an events caterer and F&B (food and beverage) retail outfit with businesses predominantly in Singapore, has been a wonderful market-beater since its listing three years ago on July 2012.

From then till now, the company’s shares are up by 205% from S$0.30 to S$0.915. Singapore’s stock market has paled in comparison with the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the market benchmark the Straits Times Index (SGX: ^STI), growing by just 13.5% in the same period.

Neo Group’s stock market success has likely been a function of its business success seeing as how its revenue has nearly doubled from S$30 million in the fiscal year ended 31 January 2011 (FY2011) to S$57.3 million in the 12 months ended 31 July 2014 (H1 FY2015).

That annual top-line growth rate of 22.4% would put Neo Group squarely in the camp of being a growth stock. But, that was then and this is now. Can Neo Group continue being a great growth stock?

For some answers to the tough question, we can turn to the late Philip Fisher.

Fisher – a successful fund manager and the lesser-known mentor of the celebrated investor Warren Buffet – had a real knack for picking growth stocks; according to Forbes, he had held Motorola stock for 21 years and achieved a 20-fold (a 2,000% gain!) return, nearly tripling the U.S. stock market’s returns over the same period.

Fisher had detailed his stock-selection process in his classic best-selling investment book, Common Stocks and Uncommon Profits. In it, he laid out 15 characteristics (all posed as questions) that he thought great growth stocks should possess.

To fill in the blanks for the 15 questions, Fisher would dig deep into the details of a company and try and speak to its insiders, industry experts, customers, suppliers, and competitors.

Needless to say, most individual investors would not have the time nor connections needed to answer all 15 questions. But, there are still five of those 15 which individual investors can still go through with relative ease using a company’s publicly available information.

With these in mind, let’s run Neo Group through the gamut.

Characteristic No.1: Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years?

Research outfit Euromonitor had estimated that Singapore’s events-catering market was around S$307 million in size in 2011 (Euromonitor also forecasted back then that the market would grow by 12.9% annually for three years from 2012 to 2014).

If we compare the $307 million market size in 2011 with Neo Group’s sales of just $39 million for its events-catering segment (the events-catering segment makes up nearly three-quarters of the company’s total revenue) in FY2014, it’s clear that there’s still plenty of room left for growth for the company.

Characteristic No.2: Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

There are clues that showcase how Neo Group’s management is constantly thinking about how they can drive further growth.

A good example would be the expansion of the company’s central kitchen. Three years ago, Neo Group could serve roughly 12,000 people per day; today, the company’s kitchen capacity is up to 40,000 people daily.

In addition, as an example on how the events-catering side is finding avenues for growth, Neo Group’s management commented in the firm’s latest earnings conference last September that it’s setting up a specific weddings division within its high-end catering brand Orange Clove to handle wedding catering events. There are more than 24,000 weddings held each year in Singapore and that’s an opportunity the company can tap.

As for the F&B retail end, Neo Group has been busy expanding the store count of its affordable Japanese-cuisine concept, umisushi, from just one outlet in 2007 to 24 as of November 2014. In 2014, the company had also expanded its portfolio of F&B retail brands to include issho izakaya, NANAMI UDON, LJJ Café, Choz, and Fu Yuan.

Characteristic No.5: Does the company have a worthwhile profit margin?

Period Neo Group’s net income margin
FY2012 14.0%
FY2013 7.2%
FY2014 12.2%
12 months ended 31 July 2014 10.7%

Source: S&P Capital IQ

Although Neo Group’s net income margins have fluctuated over the past three years, those are still some healthy margin figures.

Characteristic No.11: Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

In Neo Group’s latest annual report, the company made the following statement:

“One of Neo Garden Catering’s [one of Neo Group’s four catering brands] unique offerings is our Buffet Express service. We are proud to be one of the first caterers who have the capability to provide last-minute buffet orders for up to 500 people, in just three hours from order confirmation.”

Having the ability to meet huge orders given tight timelines suggests that the company can take orders that other competitors will struggle with and is likely to possess the best infrastructure for its line of work (economies of scale in purchasing raw materials, a highly effective centralised kitchen, an efficient delivery network etc.).

Moreover, Neo Group was also the largest events-caterer in Singapore in 2011 with a 9% share of the market, according to Euromonitor.

These are all important clues which point to how Neo Group may be a cut above its competitors.

Characteristic No.13: In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

Fisher was wary of firms that needed to issue new shares to raise capital for growth. For investors, what’s important is the growth in a company’s per-share figures, such as the earnings per share or free cash flow per share. If new shares are constantly being issued, there might not be any meaningful per-share growth for investors.

Neo Group ended H1 FY2015 with S$9.2 million in cash and S$19.5 million in borrowings, giving the company a net-debt (total borrowings net of cash) to equity ratio of around 50%. That’s a reasonable level of leverage. But, it’s also not the strongest balance sheet you’d find around, so there’s some slight risk that the company may have to resort to dilutive means to raise additional capital for growth.

But that said, Neo Group does have growing operating cash flow (from S$4.6 million in FY2013 to S$9.6 million in the last 12 months) which can be the fuel for future growth.

A Fool’s take

So there it is, five points from Fisher which point to how Neo Group may be tomorrow’s great growth stock.

But crucially, investors shouldn’t stop here. That’s because there are still other risks to consider, chief amongst those being Neo Group’s valuation. After all, even the best companies can be expensive mistakes if bought at too high a price.

At Neo Group’s current price, it’s valued at 21 times its trailing earnings. That’s not exactly cheap given that the SPDR STI ETF has a price-to-earnings (PE) ratio of 14.

All told, investors would have to weigh the risks and rewards with Neo Group to come up with an intelligent investing decision on their own.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Neo Group.