Spritzer Valuation

*The following analysis is based on a review of Spritzer’s annual and quarterly reports, press reports, and a visit to the company’s factory.  We have not previously analyzed this company and do not hold any investment or trading positions in its stock.  Readers should not make investment decisions based on this report and should understand our target price is a byproduct of our assumptions, which could be flawed.

Company:  Spritzer Bhd.

Industry:  Bottled water

Headquarters:  Malaysia

Exchange:  Kuala Lumpur Stock Exchange

Symbol:  7103

Price per share (Malaysian Ringgit, MYR):  2.33

Price per share (US Dollar, USD):  0.53 [1]

Shares outstanding:  169,000,000

Market capitalization:  MYR 393,770,000

Target price:  MYR 2.38

*As of 1 March 2017

OVERVIEW

Spritzer Bhd is Malaysia’s largest bottled water company.  It was founded in 1993 and is headquartered in Taiping, which is approximately 270 kilometers north of Kuala Lumpur.  The company has eight subsidiaries that specialize in manufacturing and distributing various bottled water products, fruit flavored drinks, and toothbrushes, and it has won numerous awards for its products, mostly in Asia-based competitions.  Currently, domestic sales of Spritzer’s bottled water account for over 90% of its revenues.  The company, however, is attempting to increase its exports and make inroads into new markets, particularly in China.

Spritzer’s water source covers 330 acres in Taiping and is located more than 400 feet below the ground.  It takes Spritzer less than 24 hours to extract water from the ground and have it filtered, bottled, packaged, and ready for shipment.  Spritzer’s water is silica-rich, a fact it actively advertises due to a preliminary study from 2012 that found that silica-rich water might help to counter the effects of Alzheimer’s disease.

BOARD OF DIRECTORS AND MANAGEMENT

Several members of Spritzer’s board of directors and executive management team have significant experience in the bottled water and drink industries, providing Spritzer a wide breadth of industry knowledge.  Several board members also have relevant technical backgrounds and are associated with outside boards that are connected to the bottled water industry.  Additionally, the longevity of many board members’ tenureship—seven of the nine board members have served more than 15 years—brings stability to the company.

However, these strengths also present risks.  For instance, the long tenureship of seven of the nine board members could reduce innovation, and it could lead to a board that is less independent of management.  The independence of the board and its members also could be a concern given the numerous familial and professional ties between board members and management.

Additionally, only three of the nine directors are identified as independent.  In comparison, a Wall Street Journal survey from early 2016 found that 496 of the 500 companies that comprise the S&P 500 had boards with a membership that was at least 50% independent.  An independent board is thought, in general, to foster greater corporate governance.

INDUSTRY AND COMPETITION

In 2015, the world consumed 87 billion gallons of bottled water, which reflected a 6.9% compound annual growth rate since 2010, according to bottledwater.org.  In 2015, the global market value for bottled water was USD 169.9 billion, and with a growing population and more health-conscious consumer bottled water sales are expected to grow to USD 307.2 billion by 2024, according to Transparency Market Research.  In Malaysia, in 2016, sales of bottled water reached Malaysian Ringgit (MYR) 543 million, or approximately USD 123 million, according to Euromonitor International.  Spritzer is the market leader in Malaysia’s bottled water industry, with 48% of sales, according to the same Euromonitor report.

Locally, Spritzer and Singapore-based Fraser and Neave, which also has a listing on the Kuala Lumpur Stock Exchange, are the leading bottled water companies, but there also are smaller companies, such as Moma, as well as various generic brands.  Additionally, various foreign bottled water companies, such as Danone’s Evian and Coca Cola’s Dasani, are readily available in Malaysia.  Coca Cola’s Dasani is Spritzer’s primary competitor.

 COMPETITIVE ADVANTAGE

Spritzer attempts to distinguish itself by stressing the pure source of the company’s water—beneath a rain forest a few hours north of Kuala Lumpur—and, since 2012, the possibility that its silicon-rich water could stave-off Alzheimer’s disease.  This latter marketing effort stems from Spritzer-funded research conducted by University of Keeley (United Kingdom) professor Christopher Exley, who in 2012 found that “one liter of Spritzer water removes aluminum from the bodies of people with Alzheimer’s disease and in some individuals offered clinically-significant protection against cognitive decline.”  Professor Exley has stated these findings only are preliminary and further research is needed, and the Executive Director of Spritzer’s board of directors also has expressed similar sentiments, according to Free Malaysia Today.  Several other brands also claim to be silica-rich, to include Fiji-based Fiji, France-based Volvic, and New Zealand’s I AM NZ.

Spritzer positions itself at the high-end of the bottled water market in Malaysia, with its price points usually higher than Fraser and Neave’s Ice Mountain, Coca Cola’s Dasani, and the available generic brands.  This almost certainly stems from Spritzer’s effort to position its water as a premium product because of its water source and potential health benefits.  The company’s prices, however, typically are lower than prices of Evian, which is a brand owned by France’s Danone.

A survey of various convenience and grocery stores in Malaysia’s capital, Kuala Lumpur, identified the following prices for various 600ml-sized bottled mineral water (except for Evian, which was packaged in a 500ml bottle).  We visited these locations and documented the prices in February 2017.  As indicated in the table, Spritzer is the only brand available at all locations and, aside from Evian, it is the most expensive.  Prices are in Malaysian Ringgit, which is approximately MYR 4.4 to USD 1.

 

KUALA     LUMPUR	News.com	7 Eleven	Jaya Grocer	Family Mart	AEON
Cactus*	1.80	–	–	–	0.60
Dasani	2.00	–	–	–	0.90
Evian (500 ml)	7.10	5.70	–	5.20	4.80
F&N Ice Mountain	–	–	0.74	1.00	0.74
Spritzer	2.30	2.25	1.17	1.80	1.30

*Cactus is owned by Spritzer.

 SHARE PERFORMANCE

Since February 2012, Spritzer’s share price has appreciated almost 200%, a gain that significantly outperforms its closest local competitor, Fraser and Neave, as well as the Kuala Lumpur Composite Index (KLCI).  The below chart also includes Malaysia’s Bio Osmo, which is involved in the manufacturing and distribution of bottled water, and Power Root, which is not specifically in the bottled water market but has various bottled drink brands.

[wpdatachart id=8]

 GROWTH CATALYSTS

Malaysia’s bottled water industry in 2016 generated USD 123 million, according to Euromonitor International, which at a population of 38 million represents USD 3.32 per person.  For comparison, in 2015, bottled water sales in the United States reached USD 14.2 billion, which at a population of 320 million people represents USD 44.38 per person.  This indicates US consumers spend 13.36 times the amount Malaysian consumers spend on bottled water. With US gross domestic product per capita at USD 56,115 and Malaysia’s GDP per capita at USD 9,768—a ratio of only 5.7:1—this suggests Malaysia’s consumption of bottled water can increase significantly.  Malaysia’s domestic bottled water demand also will increase as local consumers become more health conscious, and as tourism increases.

Spritzer’s revenue growth also will increase with its international expansion efforts, which currently represent less than 10% of the company’s revenues, according to its 2016 Annual Report.  The company’s international operations began in 2016 in Guangzhou, China, and now include 10 countries, according to The Star Online, a Malaysian daily.  Spritzer most recently expanded to the United Kingdom, where in February it announced an exclusive distributorship to send approximately 50,000 bottles per month of its water, which will be branded in the UK under the name “Acilis.”  The company hopes its new relationship in the UK will help it expand into Europe, according to The Star Online.

 RISKS

Spritzer faces numerous tactical and strategic risks in its business.  In the near term, it faces weak consumer sentiment and a retail sector that will be challenged by higher raw material prices, according to The Edge Markets, a leading financial publication in Malaysia, which probably will lead to slower sales growth and increased costs in 2017.  Local and regional competition also will increase, which will place continued pressure on Spritzer’s pricing premium.   Lastly, any operational miscues in Spritzer’s international expansion could increase costs and potentially hinder the company’s success in new markets.

Long term, the company faces a range of internal and external challenges that could have a lasting impact on not only the company’s profitability, but also the growth of the bottled water industry.  For instance, the international public almost certainly will continue to have environmental concerns with the packaging of bottled water.  This concern probably will require Spritzer and its competitors to fund continuous research and development efforts to develop packaging that reduces the amount of waste.  Additionally, environmental concerns could foster a negative perception of the industry, and thus reduce consumer demand.

At the same time, technology surrounding water filtration and purification will improve the quality of general drinking water.  Consumers eventually could view the quality of filtered or purified water as equivalent to that of bottled water, and thus reduce their demand for bottled water.  Lingering environmental concerns over the packaging waste from bottled water probably would amplify this shift.

Spritzer directly associates its bottled water with maintaining one’s health.  Were its water source ever contaminated, or were a consumer to become ill from drinking Spritzer’s water, the company’s business would face significant setbacks.

Similarly, Spritzer aggressively has promoted its water as silica-rich and has highlighted the potential health benefits of silica-rich water.  Were the company to lose access to silica-rich water, the company would have to rebrand itself and recast the benefits associated with its water.  Finally, were research to find that silica-rich does not have the health benefits previously hypothesized, such as countering Alzheimer’s disease, the consumer’s perception of the brand could decline.

VALUATION

Thesis

Spritzer’s bottled water will continue to be the market leader in Malaysia, increasing its market share from 48% in 2016, according to Euromonitor International, to 50% by 2021.  During this period, the size of Malaysia’s bottled water industry will increase from MYR 543 million, or USD 123 million, according to Euromonitor International, to MYR 875 million, or USD 199 million.  This reflects a 10% compound annual growth rate (CAGR) in the size of Malaysia’s bottled water market, which is greater than the 6.6% CAGR Transparency Market Research estimates for the global bottled water industry due to the country’s emerging market status.  Over the same time, Spritzer will expand overseas and enter new markets.  Over the next five years, we expect the company’s exports to reach 20% of total revenues, where it will then stabilize because of the intense international competition of the industry and the general commoditized nature of bottled water.

Environmental concerns will amplify over the next five years as consumers become increasingly concerned with the waste associated with this industry, especially as improved technology improves the quality of publically available drinking water.  These concerns will lead Spritzer and its competitors to spend increasing amounts on research and development to create more environmentally friendly packaging.  Bottled water companies will pursue these efforts rigorously, not only to reduce the amount of plastic waste but also to create a competitive advantage.

Finally, research efforts studying the effects of silica-rich water on Alzheimer’s disease will proceed for several years but not yield conclusive results.  The inconclusiveness of these studies will weaken Spritzer’s marketing efforts to differentiate its product as a salve to the disease, thereby removing a potential competitive advantage and growth catalyst.

 Forecast drivers

Revenue:  Spritzer’s revenues are comprised of three components:  manufacturing, trading, and other.  Manufacturing is the company’s primary revenue source and we forecast these earnings based on our expectations that bottled water sales in Malaysia will increase 10% annually over the next five years and that Spritzer’s market share will increase to 50%.  We also forecast exports to reach 20% of Spritzer’s manufacturing revenues by the year 2021.  For trading and “other” revenue, we take the geometric average over the past five years and grow that average at 1% per year through 2021.

Expenses:  Most expenses are taken as a percent of revenues, with marketing, research and development, and capital expenditures most central to our thesis.  Given the company’s international expansion efforts, and what we assess will be an effort to increase domestic market share, Spritzer will have to increase its marketing expenditures.  Our model applies a marketing expense to revenues of 5.50% for 2017, then growing 0.50% per year.

Given environmental concerns and the potential for Spritzer to create a competitive advantage through its bottling composition, we grow the company’s research and development costs by 0.05% per year, bringing research and development expense to revenues of 0.36%, which is more than three times the median spend from 2012-2016.

Finally, we expect the company will need to maintain capital expenditure expenses as domestic demand increases and as the company expands internationally, but not to the same level sustained from 2012-2016, where the median capital expenditure to revenue expense was 6.76%.  For 2017, we forecast capital expenditures at 6.76%, but then decrease it by 0.25% per year.

Cost of Capital and Target Price

Beta	1.16
Risk free rate	2.958%
Market premium	5.5%
Total debt	MYR 16,565,000
Total equity	MYR 395,460,000
Weighted average cost of capital	9.14%
Terminal growth	3%
Target price	MYR 2.38

 

Beta:  To calculate Spritzer’s beta, we run a regression on Spritzer’s monthly returns over the last five years against those same returns in the Kuala Lumpur Composite Index.  This returns a beta of 1.16.

Risk free rate:  To calculate the risk free rate, we take the 10 year US treasury rate as of 28 February, which is 2.368%, and add the average difference from 2006-2015 in consumer price inflation in the United States and Malaysia, which is 0.59%.  This brings our risk free rate to 2.958%.

Market premium:  For the market premium, we simply apply 5.5%, which is at the high-end of the market premium range recommended by McKinsey & Company in the fourth edition of their book titled, “Valuation.”

Total debt and equity:  To determine the company’s weight of debt, we used the sum of short term and long term borrowings identified on Spritzer’s quarterly statement, for the period ending November 30, 2016.  This is a sum of MYR 16,565,000.  For the company’s weight of equity, we multiplied the number of diluted shares outstanding as of the company’s last quarterly filing—169,000,000—by the company’s price per share as of the close on 28 February—2.33.  This produces a sum of MYR 395,460,000.

Weighted average cost of capital[2]:  Based on the above calculations, we determine the company’s weighted average cost of capital to be 9.14%.

Terminal growth:  We assume a terminal growth rate of 3%.

Target price:  Based on our revenue and expense assumptions, and our calculation for the cost of capital, we arrive at a target price of MYR 2.38, which is 2.1% more than the closing share price on 28 February of 2.33.

INCOME STATEMENT (RM’000)
Revenue	2012A	2013A	2014A	2015A	2016A	2017E	2018E	2019E	2020E	2021E
Manufacturing	165,177	186,968	224,405	240,314	272,975	312,221	357,503	410,700	473,188	546,567
Trading	13,031	14,967	14,345	13,353	14,890	15,498	16,227	17,152	18,302	19,712
Other	0	0	0	0	361	372	387	406	430	461
Total Revenue	178,208	201,935	238,750	253,667	288,226	328,090	374,117	428,258	491,920	566,739
Cost of sales	(94,306)	(99,680)	(118,169)	(119,831)	(131,782)	(161,953)	(184,673)	(211,399)	(242,824)	(279,756)
Gross Profit	83,903	102,255	120,582	133,836	156,444	166,137	189,444	216,860	249,096	286,983
Operating Expenses
Depreciation	(10,952)	(10,587)	(11,304)	(12,154)	(12,707)	(12,690)	(13,936)	(15,340)	(16,917)	(18,680)
Salaries, Wages and Directors’ Remuneration	(10,589)	(12,020)	(15,539)	(18,148)	(19,866)	(21,353)	(24,349)	(27,872)	(32,015)	(36,885)
Marketing	(8,910)	(10,097)	(11,938)	(12,683)	(14,411)	(18,045)	(22,447)	(27,837)	(34,434)	(42,505)
Research and Development	(196)	(215)	(275)	(345)	(153)	(525)	(786)	(1,113)	(1,525)	(2,040)
Other Expense	(35,246)	(43,662)	(50,785)	(56,119)	(70,231)	(70,939)	(80,891)	(92,598)	(106,363)	(122,540)
Operating profit (EBIT)	18,010	25,674	30,742	34,387	39,076	42,584	47,036	52,099	57,842	64,333
Non-operating Expenses
Interest Income	0	0	0	0	0	0	0	0	0	0
Interest expense	(4,684)	(4,079)	(3,503)	(2,734)	(2,080)	(1,543)	(1,543)	(1,543)	(1,543)	(1,543)
Gains and losses	925	1,193	1072	310	82	135	135	135	135	135
Pretax profit	14,251	22,788	28,311	31,963	37,078	41,176	45,627	50,691	56,434	62,924
Taxes	(3,665)	(3,555)	(6,745)	(9,156)	(8,621)	(9,810)	(10,871)	(12,077)	(13,445)	(14,992)
Net income	10,586	19,233	21,566	22,807	28,457	31,366	34,757	38,614	42,989	47,933
Basic shares outstanding	130,635	130,884	132,570	137,508	146,125	149,437	152,824	152,824	152,824	152,824
Impact of dilutive securities	0	8,617	14,756	13,841	12,099	14,968	18,004	18,004	18,004	18,004
Diluted shares outstanding	130,635	139,501	147,326	151,349	158,224	164,405	170,827	170,827	170,827	170,827
Basic EPS	0.081	0.147	0.163	0.166	0.195	0.210	0.227	0.253	0.281	0.314
Diluted EPS	0.081	0.138	0.146	0.151	0.180	0.191	0.203	0.226	0.252	0.281

 

INCOME STATEMENT RATIOS
	2012A	2013A	2014A	2015A	2016A	2017E	2018E	2019E	2020E	2021E
Gross profit margin	47.08%	50.64%	50.51%	52.76%	54.28%	50.64%	50.64%	50.64%	50.64%	50.64%
Net profit margin	5.94%	9.52%	9.03%	8.99%	9.87%	9.71%	9.60%	9.47%	9.35%	9.22%
Salaries, Wages, & DR as % of revenue	5.94%	5.95%	6.51%	7.15%	6.89%	6.51%	6.51%	6.51%	6.51%	6.51%
Marketing as % of revenue	5.00%	5.00%	5.00%	5.00%	5.00%	5.30%	5.60%	5.90%	6.20%	6.50%
R&D as % of revenue	0.11%	0.11%	0.12%	0.14%	0.05%	0.16%	0.21%	0.26%	0.31%	0.36%
CapEx as % of revenue	5.02%	4.37%	9.92%	6.76%	7.71%	6.76%	6.51%	6.26%	6.01%	5.76%
Other expense as % of revenue	19.78%	21.62%	21.27%	22.12%	24.37%	21.62%	21.62%	21.62%	21.62%	21.62%
Taxes as % of pre-tax profit	25.72%	15.60%	23.82%	28.65%	23.25%	23.82%	23.82%	23.82%	23.82%	23.82%

 

[1] This implies a conversion rate of MYR 4.4 to USD 1.  We apply this rate to all other MYR to USD conversions.

[2] We do not account for inflation in our weighted average cost of capital calculation, given the relatively modest inflation that Malaysia has experienced over the past decade.  Based on data provided by The World Bank, Malaysia’s average inflation from 2004-2015 was 2.50%.

Malaysia Inflation – Consumer Prices, 2004-2015

2015	2014	2013	2012	2011	2010	2009	2008	2007	2006	2005	2004
2.10%	3.14%	2.11%	1.66%	3.20%	1.71%	0.58%	5.44%	2.03%	3.61%	2.96%	1.52%

Source:  The World Bank