Ocean One (8476.HK)
When the ocean is your prawn, scallop, oyster and surf clams
Written on: 02 Jul 2023
2023 June: Ocean One (8476.HK) purchased at an average price of HKD 0.678 is a importer and wholesaler of frozen seafood in Hong Kong China. Seafood include 1. Crab and roe, 2. Fishes, 3. Octopus and cuttlefishes, 4. Prawns, 5. Processed seafood products, 6. Scallop, oyster and surf clams. Prawns, Scallop, Oyster and Surf clams makes up more than 50% (FY 2023) of their revenue. In addition 8476 also operates in Macau and Mainland China.
Bet:
On the short term, the easing of the pandemic, the improvement in inbound travel from Mainland China and the general rebound in sentiment in Hong Kong should provide a continual improvement in mid-high end restaurants which should benefit niche importers like 8476.
On the longer term, 8476 seems capable to grow their revenue through growing their revenue in their other categories like Crab and roe, Fishes, Octopus and cuttlefishes and processed seafood products.
The cold storage supply in Hong Kong also seems to be still in short supply. 8476 by virtue of owning and running their own cold store should have the adequate capacity to import and store frozen seafood giving them an edge-margin over other smaller seafood importers.
There are also ample opportunities to grow in Macau and Mainland China, thou the probability of success is much lower.
Risk:
There are three main risk within 8476,
Margin compression,
Product-Country-End Customers Diversification and
Impairment of business model
Margin Compression:
The main question floating in my head is if 8476 could continue to grow at this margin?
Would 8476 be tempted to sell lower margin products which could lower their margin and ROE?
Or if the higher revenue could compensate the lower gross margin by having higher inventory turns?
Another aspect to maintain margin will also come from their ability to build upon more exclusive distributorship. The more exclusive the product, the higher the perceived quality and the higher the ability to control margin?
Product-Country-End Customer Diversification:
Another potential worry is their reliance on Prawns, scallop, oyster and surf clam.
Prawn farming is a high risk venture which often lead to supply disruption and high volatility in raw material prices.
Shell fish are subjected to contamination risks which may affect consumption demand.
8476 needs to increase revenue in other segments to diversify their risk.
The same can also be said on diversifying away from Japan as a major supplier of seafood, though a lot of the food imported from Japan may not originate from Japan.
The company is also highly dependent on the Japanese food as an addressable market. As Japanese food continue to rise in popularity in Hong Kong, 8746 is expected to continue to grow along with it.
Business Model Impairment:
Will the business model of selling through resellers help 8476 to maintain their competitive edge?
8476 distributes most of their seafood through resellers and intend on continuing that way. 8476’s ability to forecast their business depend on the up to date feedback from the resellers with the risk that one day a major reseller may just become their competitor.
Competitive Advantage:
The main competitive advantage of the 8476 is their sourcing capabilities and their long established brandname through their cold logistics warehouse facilities.
Sourcing Capabilities:
Sourcing capabilities only come about through a building of a long term relationship with multiple suppliers for a very long time. While any frozen seafood suppliers would be willing to sell their goods to anyone, 8476's ability to source from all over the world at the right right price can only be done through an importer and wholesaler of a certain size. Resellers would not be able to take up such a job unless they have the volume to justify doing so.
Cold Logistics:
Cold logistics is a high Capex, highly operational business which meant that resellers would be reticent to get into that game. The lack of available cold storage capacity in Hong Kong also meant that cold storage rentals are expensive and companies like 8476 who host their own cold storage facilities have a certain level of competitive advantage.
In addition, resellers is essentially buying the confidence that goods sold by 8476 are fresh due to the high turnover of goods and the assurance that the their cold storage operates at around -22°C to -40°C (which are lower than the temperature of -18°C for frozen cold storage warehouses recommended under the Code of Practice for the Processing and Handling of Quick Frozen Seafood).
8476 has also been using external cold storage as their main facilities are fully utilised. That should also meant that the coming quarters should be good for 8476.
Gross Margin:
The improvement in gross margin and operating margins has been improving for quite some time. Has 8476 reached the top of their margin expansion?
I am unsure on that but…
Economies of Scale:
But I am pretty sure that 8476 has hit a higher level of economies of scale. They are now able to go direct to the biggest suppliers of seafood in the world and is less dependent on the middle man. That meant higher margins and with…
Exclusive Products:
8476 is able to source and secure certain exclusive premium market segment like arctic clams and Argentina red prawns, which also meant that they are more in control of their selling price which leads to…
Dynamic Pricing:
Increasing their ability to reprice their goods in a dynamic manner throughout the month to cater to the demand and supply dynamics will help them to squeeze out extra margin.
While there is no doubt that 8476 operated in a highly competitive industry, the business model are underpin by some strength which looks permanent in nature.
Operational aspect such as a lack of supply of industrial cold store facilities and a lack of investment in the sector, the economies of scale from direct purchasing and dynamic pricing meant that 8476 could continue to operate with decent margin.
Valuation:
8476 is currently valued at HKD 201m, earning HKD 50m on equity of HKD231m. Equity is backed by cash of HKD 79m, cold storage plant bought in 2019 for HKD 52m, networking capital of HKD 100m.
On an income statement basis, there is a possibility to underwrite a 5%-10% revenue growth while betting that 8476 would continue to maintain current margin with capital allocation maintaining the ROE at > 20%
8476 would be a sell if the gross margin compresses significantly due to an intensification of competition or if the 8476 starts ignoring logical capital allocation and start to accumulate excess cash on its balance sheet.
Portfolio Update:
Written on: 20 Jul 2023
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