Can Wilmar International Limited Be A Good Investment Now?

Over the past five years from 27 December 2010 to 27 December 2015, Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI), hasn’t had the best of times – it had lost 8.9% of its value.

But, a single-digit percentage loss looks like a drop in the ocean when compared to the 48% fall in price that shares of agriculture giant Wilmar International Limited (SGX: F34) have experienced over the same period.

After five years of pain, can Wilmar, which produces mainly palm oil, sugar, and their derivative products, be a good investment now for its investors? The answer to the question rests heavily on the long-term performance of Wilmar’s business and unfortunately, there are signs which show that the company may have a low quality business.

Judging quality

The octogenarian investor Warren Buffett is someone worth listening to when it comes to assessing the quality of a business.

Buffett has been the chairman of the U.S.-based Berkshire Hathaway Inc since 1965. Over the past 50 years from then to 2014, Buffett has grown Berkshire’s book value per share – a good proxy for the firm’s true economic worth – by an astonishing compound annual rate of 19.4%. And, he had done so through astute acquisitions of great businesses and smart investments in stocks.

In the 2014 Berkshire shareholder’s letter, Buffett had written about six criteria that a business needs to meet in order for him to consider it as a potential acquisition for Berkshire. The six qualities are:

“(1) Large purchases (at least [US]$75 million of pre-tax earnings unless the business will fit into one of our existing units.),

(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),

(3) Businesses earning good returns on equity while employing little or no debt,

(4) Management in place (we can’t supply it),

(5) Simple businesses (if there’s lots of technology, we won’t understand it),

(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).”

Buffett’s acquisition criteria can be useful for us stock market investors because what makes for a good business can help lead to a good investment. As Buffett once said, “if a business does well, the stock eventually follows.”

But, it must be noted that not all of the six criteria above are applicable for us. In fact, criteria (1), (4), (5), and (6) can be skipped by most stock market investors.

That’s because most individual investors are not limited by a company’s size (Buffett has to consider only big companies because they are the ones that can move the needle for the US$330 billion Berkshire). Meanwhile, most publicly-listed companies will have management teams that are already in place and stock prices that are refreshed every day. In addition, Buffett’s preference for “simple businesses” that do not contain much technology is a reflection of his own analytical circle of competence.

Keeping all these in mind, let’s have a look at how Wilmar fares against the two remaining criteria in Buffett’s test.

Agriculture can’t grow quality

The Wilmar we know today is a product of a reverse takeover (RTO) that happened in the second-half of 2006. As such, I’ve taken a look at Wilmar’s numbers going back to only 2007.

Chart 1 - Wilmar's revenue and profit
Source: S&P Capital IQ (click chart for larger image)

Chart 1 above illustrates how the agriculture outfit’s revenue and profit have changed over the years. It shows the company’s ability to churn out a profit consistently and that’s something to like. The unfortunate thing, however, is that consistent growth is missing from the equation – to that point, Wilmar’s profit of US$1.88 billion in 2008 had shrank to just US$1.16 billion in 2014.

Buffett’s third criterion involves a company’s returns on equity and that is where we will turn to for Wilmar next.

Chart 2 - Wilmar's returns on equity and net debt to equity ratio
Source: S&P Capital IQ (click chart for larger image)

What’s striking here are two things: (a) Wilmar’s returns on equity over the past three years (2012 to 2014), at less than 10%, have been very poor; and (b) Wilmar’s weak returns on equity had happened despite the company using high amounts of debt as alluded to by how the net-debt (total borrowings minus cash) to equity ratio had been more than 75%.

A Fool’s take

While Wilmar has managed to remain solidly profitable since its RTO, it has failed to display sustained earnings growth and has generated low single-digit returns on equity in recent years. Such characteristics would likely make the company look like a very unattractive business in the eyes of Buffett.

That being said, it is worth pointing out that all we’ve seen above are backward-looking. As such, it is possible that Wilmar could churn out much stronger business results in the future, if management can turn things around. But in the here and now, I think it is fair to label Wilmar as a low quality business and that’s a risk that prospective and current investors of the company may want to be aware of.

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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 Berkshire Hathaway.