Management Perspective: Visibility and confidence building up
“The recovery in the third quarter confirms that we’ve survived the worst of this pandemic. Our income for the third quarter doubled from the income recorded in the second quarter, and even managed to surpass our first quarter income which was not fully impacted by the pandemic yet”, remarked President and CEO Alvin Lao.
“As more and more of our customers resume operations, and as people learn to cope with the new normal, we gain more visibility and confidence as to the way forward. In fact, the imposition of the second Modified Enhanced Community Quarantine (MECQ) in August did not have a material impact on our business, and we continued to see an improvement each month.
We believe that the current awareness on health, safety, and sanitation which benefited certain business segments are here to stay beyond the pandemic. As such, we will continue to capitalize on these trends while at the same time reinvent and further build resilience in business segments where there are clear shifts in demand, in order to make these businesses more relevant.
As our optimism in the prospects of the business builds up, it’s no secret, as you can see in our disclosures, that the family continues to buy shares of D&L. We see the current depressed valuation as a limited window of opportunity for shareholders who, like us, seek long-term value,” Lao added.
All segments showed encouraging QoQ volume growth
With the gradual easing of restrictions and economic reopening, all the segments of the company witnessed a meaningful bounce in volume on a quarter-on-quarter basis.
In addition, Chemrez, Specialty Plastics and Consumer products ODM (previously referred to as Aerosols), which combined account for 75% of total earnings, are already operating either close to or above pre-COVID levels.
Consumer Products ODM: Boost from higher demand for sanitation products
Consumer Products ODM, which was previously referred to as the Aerosols segment, is the key performer this year, with its income for the quarter exceeding year-ago pre-COVID level by 72% y-o-y. This was mainly driven by the massive increase in demand for various sanitation products due to the pandemic. Under this division, the company formulates and manufactures various personal, home, and industrial products which can be used for sanitation purposes. These would include alcohol, sanitizers, and disinfectant sprays, among others.
For the quarterly presentation purposes, the company decided to change the name of this division from Aerosols to Consumer Products ODM (Original Design Manufacturer) to reflect the increasing share of non-aerosol products being sold under this division from virtually zero several years ago.
Chemrez: A play on economic reopening and strong coconut exports
For Chemrez, which is composed of Oleochemicals and Other Specialty Chemicals, the improvement in earnings was fuelled by 1) the gradual reopening of the economy and 2) strong demand for high value coconut-based products in the international market.
The gradual easing of the quarantine restrictions in the country has allowed various sectors of the economy to reopen. Industries such as transportation and construction have been allowed to operate, albeit at still limited capacity, under a General Community Quarantine (GCQ) starting June 1 for Metro Manila and most of the nearby provinces. This resulted in the resurgence of demand for biodiesel (used in the transportation industry as an additive to diesel) and various construction-related products that the company sells under the Other Specialty Chemicals division. Meanwhile, high margin oleochemicals which are coconut-based products mainly for export continue to gain traction in the global market. In the third quarter alone, Chemrez total volume jumped by 42% q-o-q. (see section on exports on page 5 for a more detailed discussion)
Specialty plastics: Demand for packaging materials continues to rise; green shoots in the auto industry
For Specialty Plastics, the improvement mainly stemmed from the higher demand for additives and colorants for plastic packaging applications. The pandemic resulted in a massive increase in parcel delivery which requires a great deal of packaging materials. In the third quarter alone, volume for colorants and additives doubled q-o-q and was just 5% shy of year ago levels.
On the engineered polymer side, which are predominantly export-oriented raw materials for automotive wire harnesses, demand seems to be gradually coming back as more customers are reportedly going back to a regular 5-day work week with 24-hour shifts. This comes as green shoots start to emerge in the global auto industry, with China reporting higher YoY monthly auto sales from July to September. To a certain extent, the pandemic has increased the public’s interest in purchasing vehicles given the possibility of virus exposure when using public transportation. In the third quarter alone, engineered polymer volume jumped by 145% q-o-q and recorded a lower y-o-y decline of just 11% vs the 57% y-o-y decline reported in 2Q20.
Food: Significant sequential recovery albeit still lower vs pre-COVID level
Lastly, the food ingredients segment, which now accounts for 25% of total income, saw a significant quarterly improvement with 3Q20 profits higher by 421% from a really low base in 2Q20. This was largely due to sequential recovery in both volume and margins as more food establishments were able to operate during the quarter and with the corresponding increase in capacity utilization for dine-in under GCQ. In the third quarter alone, overall volume and margins increased by 6% q-o-q and 5.8 ppts q-o-q, respectively.
However, compared to year-ago pre-COVID level, earnings for this segment are still lower by 38%, as various food companies still feel the impact of the lockdown; foot traffic in malls and other commercial establishments remain well below pre-COVID levels. Nonetheless, as the general direction is to gradually reopen the economy and as people adapt to the new normal, the food ingredients segment should continue to see quarter-on-quarter improvement in performance.
Export business continues to post resilient growth
Export sales continued its positive momentum in the third quarter as it jumped 58% y-o-y, bringing 9M20 growth to 37% y-o-y. Export contribution to total revenues in 3Q20 posted again another record high of 32%. This brings 9M20 export contribution to 28% compared to just 20% over the same period last year.
Coconut-based products under food and oleochemicals were the main drivers behind the robust export growth. Coconut oil continues to gain traction in the global market due to its perceived natural antiviral, antibacterial, and antifungal properties. In addition, coconut-based products are great sustainable substitutes for petroleum-based raw materials used in many applications such as personal hygiene and home cleaning products. The company sees continued strong coconut oil exports, which should offset some of the weakness in the domestic market in the near term.
Batangas expansion comes at an opportune time; construction in full swing
D&L remains committed to its Batangas expansion which is deemed to come at an opportune time. Construction is currently in full swing with capex spent as of 9M20 amounting to P1.7 billion, already exceeding FY19 capex of P1.5 billion.
The said expansion facility will mainly cater to D&L’s growing export businesses in the food and oleochemicals segments. It will add the capability to manufacture downstream packaging, thus allowing the company to capture a bigger part of the production chain. For instance, while the company primarily sells raw materials to customers in bulk, the new plants will allow it to “pack at source”. This means that D&L will have the ability to process the raw materials and package them closer to finished consumer-facing products. This will enable D&L to move a step closer to its customers by providing customized solutions and simplifying their supply chain, which is of high importance given logistical challenges in general.
D&L’s Batangas expansion will be instrumental to its future growth as it plans to develop more high value-added coconut-based products and penetrate new international markets. The company to-date has successfully made in-roads in supplying various raw materials and even finished products in several relevant fast-moving consumer goods (FMCG) categories in the new normal. It plans to further expand its global footprint and target export sales to account for 50% of its total sales in the long-term.
The Batangas plant was originally slated to be completed by the middle of next year. However, given the delays associated with the community quarantine, construction completion and start of operations have been pushed back by several months, likely to end-2021.
Commodity margins bounced back to a more normal level
The third quarter also marked a stark sequential recovery in commodity margins with both biodiesel and straight oil sales posting margin expansion. This resulted from better market conditions and improved demand for biodiesel and straight oil, still underpinned by the gradual economic reopening.
This improvement is consistent with the company’s long view that commodity margins will eventually recover. The company believes that its strategy to continue to supply these essential commodities despite depressed margins during the worst part of the lockdown has further cemented the company’s position as the most reliable supplier in the market and improved relationships with the most valuable customers of the company. Over the long-term, D&L believes that its unparalleled commitment to customers should pay off not just on the commodity side but also on the HMSP side as the good times come back.
Built to last
With appropriate adjustments and operational contingencies in place, the company believes that its operations will remain resilient amidst the possibility of further extensions in the quarantine period and protracted economic recovery. Moreover, as the majority of the products that the company manufactures cater to basic industries such as food, oleochemicals, plastics and sanitation chemicals which are considered essential, the company sees continued strong demand ahead.
From a capital structure perspective, the company is in a solid position to withstand external pressure. As of end-September 2020, it remained lightly-geared with net debt at just 8% and interest cover at 16x. In addition, the cash conversion cycle for the period was lower at 146 days vs 161 days in 2019 given lower account receivables and inventory days, as well as higher payable days.
Overall, the company remains profitable. Return on Equity (ROE) and Return on Invested Capital (ROIC) stood at 10.7% and 12.9%, respectively, in 9M20.
-end-D&L Industries is a Filipino company engaged in product customization and specialization for the food, chemicals, plastics and consumer products ODM industries. The company’s principal business activities include manufacturing of customized food ingredients, specialty raw materials for plastics, and oleochemicals for personal and home care use. Established in 1963, D&L has the largest market share in each of the industries it serves, as well as long-standing customer relationships with the Philippines’ leading consumer and manufacturing companies. It was listed on the Philippine Stock Exchange in December 2012. For more information, please visit //dnl.com.ph/investors/.