Lotte Samkang is probably the most spectacularly undervalued stock
in the world. The stock is priced at 22 dollars and it's earning 18 dollars.
For those of you without calculators, that's a P-E of 1.2 times. I've been
investing for 18 years, and I don't remember ever seeing a stock trading as
low as 1.2 times earnings. The mind reels.
Most important, these earnings aren't of the mirage-like rub-your-eyes
type, as is (unfortunately) the case with so many would-be value stocks.
Lotte Samkang is a branded food company, based in Korea. (Korea is a value
investor's paradise nowadays.) The company has an inherently stable earnings
stream. It's not a deceptively cheap-looking cyclical that sells at 5 times
this year's earnings and 30 times next year's earnings. Lotte Samkang has a
strong market position, it makes lots of money, and it throws off bucketfuls
The shares sell at a 43% discount to book value, after backing out
an asset revaluation debited in 1998. The discount to stated book is 68%.
Lotte Samkang is small, with the equivalent of $220 million in
revenue. (All figures are converted to dollars at 1130 Korean won to the
dollar.) The company makes ice cream (47% of sales), vegetable oils and
margarines (41%), processed foods (7%), and other, including beverages
(6%). The company is in a type of business that's easy to like: small-ticket
items that people tend to buy on a steady basis.
Actually, before 1998, Lotte Samkang had performed in a rather
desultory way. The company let two woebegone business lines - congregants
in what I call the Church of Our Lady of Perpetual Sorrow - run up
operating losses that ate up half of consolidated operating profits. On the
financial side, the company had borrowed so much money that interest
expense consumed all of whatever money came in.
In December 1997, a new manager was airdropped in from Lotte
Samkang's sister company, Lotte Confectionery. The wondrous improvement in
profits under the stewardship of this new chief reinforces my belief in the
Great Man Theory of history. The sales force was realigned, the moneylosing
businesses were curtailed, and operating expenses were cut. In 1998,
operating profits adjusted to a normal depreciation rate - an adjustment
necessary for all non-U.S. industrial companies, by the way - surged 40%,
to $31 million. Operating return on assets jumped to a world-class 30% rate.
In 1999, reported earnings before special and extraordinary items
leaped 39%. Adjusted to a normal depreciation rate and tax rate, earnings
rose 55% to $18 million, or $14.21 per share. Sales were up 1%.
In the first half of 2000, profits continued to hum. Reported
earnings were up 62% while adjusted earnings were up 49%, to $12.5 million,
or $9.90 per share. I'm a bit concerned that sales were down 6%, but it's
attributable to an industrywide slackening in ice cream demand that appears
to be an aberration.
The company's high rate of profitability along with very lean
inventory (an incredibly low 1 month's worth) and receivables (1.6 months'
worth) combine to open up spigots of cash. Their free cash flow is running
at more than twice their earnings. For every hundred dollars flowing out,
122 dollars flows in. Those are bountiful proportions.
The company rides a virtuous cycle. The procedure runs like this:
generate lots of cash, use the cash to pay down debt, use the lower debt to
reduce interest expense; use the reduced interest expense to increase net
earnings and free cash flow. Rinse; repeat. (It reminds me of McClatchy.)
Lotte Samkang has a strong market position -- a lot stronger than
it appears on the surface. The company operates and presumably competes in
many of the same business lines as its fellow affiliated group member,
Lotte Confectionery. LC owns 9.8% of LS and there are important personnel
ties between the two companies, notably LS's president. There is little
doubt in my mind that Lotte Samkang works collaboratively with Lotte
Confectionery. Therefore, Lotte Samkang's market position in ice cream is
much stronger than its 4th-place, 17% share position would indicate. Market
share is more like 55% after Lotte Confectionery's share is aggregated with
Lotte Samkang's. In oils and margarines, Lotte Samkang is Number 1 with a
35% market share.
I like the management. From what I've observed over the past three
years, the people behind the Lotte group of companies have treated their
fellow shareholders fairly and honorably. Indeed, Lotte is one of the most
well respected groups in Korea. And they are profit-oriented instead of
Concerns that disinterested observers might harbor include the
company's location in a strange, faraway place; the company's location in a
strange, faraway place; and the country's location in a strange, faraway
Apprehension about Korea is rooted in how different and unfamiliar
the country is. This might make people overlook Korea's strengths. South
Korea is a great country in certain important respects. I admire their
entrepreneurial drive. After the war ended in 1953, they took a hardscrabble,
rubble-strewn economy and over the past fifty years made it grow faster
than any other economy in the world. Right now, our GDP may be growing fast,
but it's growing only half as fast as Korea.
Recently, Korean stocks have been rendered cheap by the debt
problems of two large groups of companies, Daewoo and Hyundai. Daewoo is
very bankrupt; Hyundai might be headed that way. These groups binged on
debt and now can't pay it back. It looks like the government will have to
come up with tens of billions of dollars to plug the hole.
We as investors should have our eyes completely wide open to the
collateral effects of these problems. But we shouldn't overly weigh them.
After all, these are top-down, macro issues; I don't know of anybody who's
ever made any money as a top-down investor. Successful investors have
always been of the bottom-up type who focus on the economics of a
business and aren't scared off by the state of the economy. Just think of
Buffett buying like crazy in the big recession/bear market of '73-'74.
Investing overseas will never be as easy as investing in the U.S. I
eventually got comfortable enough to put my money there when I realized
that a business is a business is a business, no matter where it's located
or what language is spoken. As you can see from my adjusted numbers above,
when the figures don't jibe with US GAAP, then simply adjust them. I like
the buying opportunities in Korea because 1) the country has a vibrant
economy, despite Daewoo and Hyundai; 2) I've found good companies with
financial characteristics that appeal to me; 3) they're table-poundingly
cheap; and 4) I'm able to obtain enough facts to make an informed decision.
For example, I get more detail in Korean financial statements than I get
anywhere else in the world.
Above all, it's not difficult to live with the risks in this
stock given that the stock is cheap. Breathtakingly cheap. The chasm-sized
discount to fair value provides a big, plush cushion against the risks. An
appraisal that capitalizes Lotte Samkang's $34 million of adjusted operating
profits at 9 times, then deducts its $27 million of net debt, indicates an
appraised value of $280 million, or $220 per share, give or take ten per
cent. The current stock price: 22. The stock would have to go up ten-fold
before it reached a reasonable price. It's astonishing.
Likely takeover candidate; strong earnings growth that widens the discount
to fair value; potential share repurchases.