“The company faced a tough year in 2019, brought on by a confluence of external factors,” remarked President & CEO Alvin Lao. “Nonetheless, we see reasons to be more optimistic this year given 1) early passage of the 2020 government budget and extension of the validity of 2019 budget, 2) expectations of further cuts in interest rates, and 3) abatement of the US-China trade war tensions. At the same time, however, we are also cognizant of the fresh risks brought on by the COVID-19 outbreak which may have implications on the global economy that may be hard to quantify at this point. As a company, we continue to focus on initiatives that will allow us to grow the business while building resilience. The construction of our next generation expansion facilities, which will be the foundation of our next leg of growth, is on-track and set to be operational by the second half of 2021. We continue to believe in the long-term prospects of the business and we see the current sell-off in the stock as a limited window of opportunity for shareholders who, like us, seek long-term value.”
Food and Aerosols business continued to recover while Chemrez & Specialty Plastics’ performance remained soft
The emerging signs of recovery in 3Q19 for food and aerosols continued in the fourth quarter. Food ingredients and aerosols reported 13% and 12% YoY increase in net income in 4Q19, respectively. In terms of volume, HMSP food and aerosols, posted 8% and 2% YoY growth in 4Q19, respectively. Meanwhile, on a quarter-on-quarter basis, total sales in 4Q19 increased by 6%. We believe much of the recovery can be attributed to better domestic consumer sentiment during the period brought about by lower inflation and further cuts in interest rates. This, however, was not enough to offset the soft results of the other segments.
In summary, the decline in earnings for the year mainly stemmed from the weak performance of the non-food businesses – Chemrez & Specialty Plastics – which were more closely affected by the 1) lower infrastructure spending due to the delayed passage of the budget 2) uncertainties in the global trade market due to lingering effects of the trade war, and 3) slowdown in the global auto industry.
The late passage of the budget this year resulting in lower public infrastructure spending, directly impacted demand for industrial and construction-related chemicals, of which Chemrez is a supplier. Additionally, it had an indirect impact on general economic activity and consumption. Meanwhile, the slowdown in the global auto industry has put pressure on the company’s specialty plastics business. About half of specialty plastics’ revenues come from export-oriented raw materials used in wire harnesses for automotive applications.
As US-China trade talks produced limited upside, 2019 was predominantly marked by global economic uncertainty. This resulted in cautious projections and muted demand from customers across various industries regionally and in the Philippines as well.
Because of negative impact that the above adverse conditions caused, D&L ended the year with a 7% y-o-y volume decline with High Margin Specialty Products (HMSP) and commodities posting a decline of 3% y-o-y and 12% y-o-y, respectively.
Segment Performance Summary
Weakness in non-food business dragged profit in FY19
Progress on key strategic initiatives
On a company-wide perspective, despite a challenging year, we made progress in key strategic initiatives which are fundamental and are indicative of future growth. The impact of the company’s investments in R&D can be seen in the margin recovery in several business segments. This is also a sign of the company steadily progressing up the value chain. In FY19, blended gross profit margins expanded by 1.7 ppts to 20.9%. HMSP margins for the period stood at 25.6%, up 1.4 ppts y-o-y, while commodity margins stood at 10.4%, up 0.4 ppt y-o-y.
D&L Historical Blended Margins
Another area of progress is the improvement in HMSP sales contribution which stood at 69% in FY19. The company continues to focus much of its resources in growing the high margin side of the business. Assuming improvement in the macro environment, positive momentum in both margins and HMSP revenue contribution should translate to better growth moving forward.L
The company’s return ratios remain healthy. In FY19, Return on Equity (ROE) and Return on Invested Capital (ROIC) stood at 15% and 19%, respectively. Meanwhile, the balance sheet remains robust with net gearing at 8% and interest cover still comfortable at 18x. As of end-December 2019, net debt stood at P1.4 billion with average cost of debt at 4.76% (inclusive of DST). The company generated positive free cash flows of P3.2 billion for the period due to lower average commodity prices.
Long-term growth story remains intact
Overall, the company continues to believe that its long-term growth story remains intact and its prospects remain stable. The expansion plan in Batangas is on schedule to be completed and operational in 2021. This will support the company’s long-term strategy to 1) add value to its current product line-up by offering more sophisticated and customized formulations, and 2) increase its export sales to 50% of total revenues.
The upcoming facilities will add the capability to manufacture downstream packaging and will allow 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. All these investments and strategic efforts should lead to a more entrenched relationship with customers while providing an additional runway for growth.
While export sales were down 26% y-o-y in FY19 largely due to 1) indirect effects of trade war, 2) slowdown in global auto industry, and 3) lower average coconut (down 27% y-o-y) and palm (down 6% y-o-y) oil prices for the year which were passed on to customers, it remains as one of the key pillars of growth. The company remains optimistic that it will reach its long-term target export contribution of 50%. The new plants will add a significant amount of capacity, focusing mainly on higher value and higher margin products which will allow the company to cater to more customers in both local and overseas markets in the future.
The food ingredients segment posted meaningful margin expansion for the year, as both HMSP and commodity margins showed improvements. Blended margins expanded by 3.1ppts y-o-y in FY19. Meanwhile, volume in 4Q19 saw a sharp recovery as it grew 15% YoY, bringing total volume decline for the year to just 4% YoY from a 10% YoY decline recorded in 9M19. Net income in 4Q19 was up 13% YoY, bringing FY net income growth to 2% YoY.
Oleochemicals and Other Specialty Chemicals
Chemrez group saw its total volume decline by 13% for the year. This was mainly due to the confluence of external factors such as the delayed passage of the budget for they year and uncertainties in the global export market related to the trade war which dampened demand for most of the year. Moreover, expiration of income tax holiday for Oleochemicals, a sub-segment of Chemrez, and forex losses resulted to a steeper decline in income. Overall, the group posted a 35% YoY decline in profits for the period.
Specialty plastics net income was down 18% y-o-y in FY19. This was mainly due to the 12% decline in total volume as demand for both engineered polymers and colorants and additives remained soft. This segment continues to feel the effects of the slowdown in global auto industry as about half of its sales come from export-oriented raw materials for automotive wire harness applications.
Aerosols segment has shown signs of recover in the fourth quarter as net income increased by 12% YoY, bringing full year net income growth to 1% YoY from a 2% net income decline recorded in 9M19. Blended gross profit margins improved by 2.4 ppts while total volume grew by 2% YoY for the year.
-end-D&L Industries is a Filipino company engaged in product customization and specialization for the food, chemicals, plastics, and aerosol 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 longstanding customer relationships with the Philippines’ leading consumer and chemical companies. It was listed on the Philippine Stock Exchange in December 2012. For more information, please visit www.dnl.com.ph.