Tandou hits pause on rally

What two guys in a trading room can do for company profits. This essentially sums up the key contribution to Tandou’s (TAN) good results for the 2012-13 financial year.

But it is difficult to get too excited about the water trading and cotton growing group due to the enormously difficult task of forecasting earnings for Tandou, especially after the stock has run ahead by 30% over the past 12-months.

This is why the share price remained flat today despite the group recording a 34% increase in revenue to $65.7 million and a 14% uplift in earnings before interest, tax, depreciation and amortisation (EBITDA) to $11.7 million for 2012-13.

The good result is driven largely by its water operations with profits increasing 14% to $7.3 million last year. This division is made up of two full-time employees holed up in a room trading water rights.

Instead of high-tech computer screens and real time trading platforms, trading profits are generated the old fashion way with these employees constantly on the phones talking to real estate agents. Real estate agents in the country double up as water brokers to service farmers wishing to buy or sell their water rights.

Tandou’s two traders will then attempt to “make the market” and profit from the differences between the buy and sell price.

Weather and the ability of Tandou’s traders to find arbitrage opportunities is notoriously unpredictable, and the fact that this business contributes more than 63% of group earnings means any change in the profitability of the business will have a large impact on Tandou’s bottom line.

The group’s other division is cotton, cereal and lamb farming. Cotton contributes close to 80% of revenue from its farming division.

While Tandou’s chief executive, Guy Kingwill, declined to give a guidance for the group as he is unsure about the profits water trading will bring this year, he is upbeat about the farming division as the acquisition of a new property will expand cotton acreage by nearly a quarter to 8,800 hectares.

Around 60% of the 2014 cotton crop has been sold at an average price of $465 a bale compared with the 2013 average of $455 a bale.

Investors will get a better idea of how profits for 2013-14 are coming along towards the end of the calendar year after the planting season.

Tandou’s volatile earnings may not be ideal for those looking for stable returns, but the stock have a few things going in its favour.

Firstly, Kingwill has managed to deliver three consecutive years of rising net profits, and this track record should give investors some confidence in his ability to manage what is inherently a challenging business.

Secondly, the stock moves independently to the share market. If you look at its five-year correlation to the consumer staples sector or the broader market, the statistical reading is close to zero. This means market rises and falls have little impact on Tandou's share price.

This makes the stock strategically important to investors looking to reduce market risks in their portfolio.

Tandou, which is part of the Uncapped 100, is trading flat at 48 cents in afternoon trade.