Indofood and First Pacific: The Noodle Narrative

For anyone who follows me on Twitter, this writeup won’t be a surprise, as I’ve been very publicly researching this for a while. However, I do my best thinking in long form and this situation is complicated and deserving of a full write up. The companies I’m referring to are Indofood Sukses Makmur ($PIFMY) and First Pacific ($FPAFY). I have grouped them together as they both represent different ways to play the same core assets, popular noodle brand Indomie and other Indonesian staple brands. With First Pacific owning 50% of Indofood and both being run by the Indonesian Salim family the two are interlinked, however both still represent distinctly different situations with unique upsides and risks. On the surface both companies look very cheap and hold high quality, defensive assets with a long runway for growth, however are plagued with poor corporate governance, complicated business structures and geographic risk. Before I start, a quick shoutout to @ReturnsJourney on Twitter who has covered both of these in the past and whose work was useful in researching for this.

Indofood

Indofood Sukses Makmur is the largest instant noodles maker in the world known for their signature brand Indomie. Along with noodles, Indofood also sells various snack foods, drinks and wheat based products while being vertically integrated in all of these segments. Indofood is an attractive business due to being a consumer staple in Indonesia with a strong brand and reliable sales. However, the core of the business thesis comes down to the noodle segment. With 50% of their revenue and a large amount of their growth coming from the noodle segment, the success of the business is intrinsically linked to the success of Indomie. So what’s so special about this random Indonesian noodle brand?

A core teaching of Peter Lynch’s revolves around investing in what you know and I’m currently writing this idea up at my desk with a belly full of Indomie noodles. There are multiple reasons to like the Indomie brand. Firstly, Indofood will benefit from being the largest player in a segment with strong tailwinds. The global instant noodle market is expected to grow at middle single digit rates due to changes in demographics and eating habits. Along with this Indomie will likely continue to take share due to its strong brand and popularity amongst young people. Within Indonesia, Indomie has become a staple household food choice. Meanwhile, internationally it has achieved cult-like status amongst young people and dominates on social media relative to its competitors. Anecdotally, Indomie is really the only noodle brand anybody I know eats, it has taken a huge amount of Australian market share within my lifetime from relative obscurity.

Finally, while a strong, iconic brand is great, Indomie backs it up with a truly differentiated product. Having sampled many different instant noodle flavours, I can say with confidence that none come close to Indomie’s Mi Goreng in my opinion. For whatever reason I’ve personally found all of the knockoffs and home brand alternatives really don’t stack up. Additionally, Indomie actually comes cheaper than many competitors due to their advantages from scale. A significant part of their appeal, especially in poorer countries and amongst young people is their price making them essentially recession proof. So altogether we have a differentiated product with a strong brand in a segment with solid tailwinds diversified with various other Indonesian staple brands, that sounds like the ingredients for a quality business.

Before I dive into the financials I want to look at First Pacific and their other business segments. First Pacific has a huge amount of debt, with $8b USD net debt ($11.5b debt, $3b cash) sitting on top of a $1.6b market cap and $1.8b operating profit. Firstly, the majority of that debt is long term, with only $5m of that debt due within 5 years. Much of the debt is held within their subsidiaries, with only $1.5b at head office. Almost half of First Pacific’s operating profit ($137m for the half year) is generated by Indofood, which I consider to be a safe, stable business.Their other significant contributors are Philippine Telco PLDT ($73m HY), Philippine based infrastructure company MPIC ($79m HY) and Singaporean power company FPM Power ($63m HY). While they have other segments, they are small relative to the company so I will be ignoring them. PLDT stands out as the scariest of these segments. While it is profitable, it is FCF negative with increasing debt. For the most recent half year their net debt climbed from $4b to $4.6b while debt/EBITDA rose from 2.25 to 2.5. Telcos aren’t a fantastic business and this is a segment to watch. The other two segments both seem much safer based in utilities and critical infrastructure. Both subsidiaries generate power, which should be a stable and reliable income stream. FPM power only has $130m of net debt which is comfortably covered by their profits. MPIC has a much larger $5b of debt but is diversified in various safe sectors. Along with power generation, they also operate toll roads, water and waste services and multiple hospitals. While their debt to net income is scarily around 27, much of the debt has maturities as far out as 2037 and these income sources are critical infrastructure and should be both resilient and stable. As a whole, First Pacific is certainly riskier than Indofood itself due to its debt profile, however the assets are still attractive and the valuation makes up for it as we’ll soon discuss.

The Financials

Indofood has TTM revenue of $7.3b USD with 4% YoY growth (following a very strong 2021). This translates to $800m in net income, $570m after minority interests. The company has compounded revenue and net income at a solid 6% and 10% over the past 6 years respectively with a decent 12% ROIC. This all sits with a reasonable $2.5b of net debt over the top. These are solid numbers, and what makes this situation so attractive is the valuation you are paying. With a market cap of $3.6m, Indofood is trading at a P/E of 6 for what is a defensive consumer staple with a solid runway for growth. While there may be concerns around capital allocation, the company is still paying a respectable 5% dividend yield which will likely grow over time.

First Pacific is even more interesting. Revenue currently stands at $10.6b and has compounded at a reasonable 7%. Their net income was $500m (after -$800m of minority interests) and has grown at an impressive 30%. With a market cap of $1.6m this puts them at a ridiculous 3 P/E ratio. The obvious caveat to this is the scary $8b of debt over the top of that. In reality, with only $5b of the $11b being due in the next 5 years, $3b in cash and $1.3b of annual earnings to the company, assuming no drastic issues they should be fairly comfortable. Finally the company has a trailing dividend yield of 7.5% along with a negligibly small buyback. While the debt is scary as a whole, if the company can remain stable it will be able to steadily pay it down over the next decade while still paying a dividend and investing for growth. In this scenario it is easy to envision the company having multibagger potential.

Risks

Management

Both companies are controlled by the Salim family, the richest family in Indonesia. This naturally comes with the usual benefits of investing in family run businesses like aligned, incentivised management, a solid track record and a passion and care for the company. On the other hand there are risks associated with this. Firstly, minority shareholders really have no say in how the companies are run and are really just along for the ride. First Pacific seems focused on empire building, with constant expansion both within their subsidiaries and into new subsidiaries leading to increasingly large debt balances and capital expenditures. Indofood has also invested in acquisitions with the $3b purchase of their African manufacturer Pinehill at a P/E of 23. While this is their only major acquisition, questions were raised due to Pinehill being controlled by Anthony Salim. While this kind of related party dealing is concerning, the acquisition seems to have been a success with strong revenue growth and a significant increase in ROIC in the 3 years since.

The other key risk around management comes from the questionable structures and dealings of the Salim Group. We’ve already seen with Adani in India how these large EM conglomerates can get messy. Salim group is a complex web of different businesses all under their umbrella with subsidiaries within subsidiaries within subsidiaries. There’s little transparency so investing with them is simply a leap of faith. Additionally, the company has a history of poor ethical conduct. In 2018 they were exposed for using a complex web of ‘shadow companies’ to illegally clear lands in Indonesia and Borneo in violation of both labour and environmental regulations. This in itself presents a clear regulatory risk, while also presenting ESG related headwinds for both the stock prices and future financing. Additionally this demonstrates both their use of complex business structures to cover up illegal activities along with a general lack of ethics. For ESG conscious investors this isn’t the investment for you and for the rest of us we should be wary. I believe management is the most significant risk to these companies and the main thing stopping me from making these outsized positions.

The next key risk is obviously the debt, which is concerningly large for First Pacific and still significant for Indofood. The first thing to note is that both companies have been consistently profitable historically which will make refinancing easier. Additionally, both companies have very long duration debt. While Indofood has $1.2b of short term loans that is comfortably covered by their $1.8b in cash, while the large majority of their $3b in long term debt matures after at least 5 years. Similarly as mentioned earlier First Pacific only has $2b (after cash) of maturities in the next 5 years on top of over $1b of annual earnings. Furthermore, with the exception of PLDT for First Pacific, the segments these companies are in should be resilient to downturns. Indofood is a consumer staple at a low price point while MPIC and FPM power provide critical infrastructure to the Philippines and Singapore respectively. With all this in mind, the risk in the debt comes down to zeroing the equity in some sort of tail risk scenario, a risk I think is reasonable to take.

Another risk can be generally classified as emerging market risk. Both entities are heavily exposed to emerging markets, with heavy concentration in Indonesia and the Philippines especially. This comes with it concerns around transparency and economic resilience along with currency risk that most developed markets don’t share. While Indofood and First Pacific are in fairly resilient industries, they will and deserve to trade at a discount for this risk. I would argue that their current valuations are simply too cheap and that this risk is comfortably priced in.

The final risk is worth mentioning and is only relevant to First Pacific being geopolitical risk. First Pacific, despite having no operations there, is listed in China. While I think it’s unlikely that China invades Taiwan (in the near future at least), if they were to I’m unsure what would happen to Hong Kong listed stocks such as First Pacific. There’s certainly tail risk there after seeing what happened to Russian stocks in 2022, though I think that risk is probably small.

My thoughts

I find both of these ideas very attractive at current valuations. While Indofood isn’t as cheap and has a lower dividend yield, it has considerably less downside and is a highly defensive asset. In my opinion Indomie is one of those rare unicorn assets that manages to combine a dominant brand with an incredible product at a low cost. While First Pacific is very exposed to it, Indofood is a purer, less risky way to play it. I could see myself building a large position in this if I didn’t have other attractive ideas available (which I currently do). On the other hand while there is certainly more risk in First Pacific it is offset by more upside. They consistently spend more on acquisitions (more capital allocation risk), are listed on the Hong Kong exchange and most importantly have a huge mountain of debt. While I do believe they can cover the debt with cash flow, if the thesis goes wrong there is significant downside that doesn’t exist in Indofood. On the other hand, the company is absurdly cheap for what are decent quality, growing assets and deserves a speculative position in the portfolio in my opinion. While Indofood is an underappreciated gem, First Pacific is more of a 20 cent dollar with a bomb attached to it. Full disclosure that I currently own both in modest size. I currently have the position structured as 3% First Pacific and 8% Indofood. I may add more Indofood but I’m not interested in increasing the First Pacific position. Obviously I find both ideas very attractive at current valuations. I think that the largest risk revolves around the management of the Salim family. While they are incentivised to run the companies well due to their ownership, I worry about the potential skeletons in their closet.