Opportunities abound for Pental

Pental (PTL) shares have drifted lower in recent times, and now trade on significantly discounted multiples. The third quarter was likely weaker due to competitor discounting – mainly by Unilever, one of Pental’s largest rivals. However, we believe the company remains on track to meet or slightly exceed our full-year forecasts.

At 2.5 cents the stock is trading on a price-earnings multiple of 9 times in 2013-14 and 7 times in 2014-15. We recognise that the industry structure is not supportive; however, the discounted share price is not appreciating the turnaround that is well under way.

Our forecasts are conservative and don’t reflect the opportunity to increase margins from recent efficiency initiatives, such as by relocating the White King bleach plant to the main company manufacturing facility at Shepparton, which was discussed previously in Pental cleans up.

The balance sheet is finally under control, with net debt now under $2 million. As a reminder, debt soared above $70 million after Pental acquired several brands, the largest of which was White King, in 2011. While White King is now a critical product offering, the timing of the acquisition was poor as the company’s Oleo-Chemicals division was already under significant pressure. The closure of the chemicals business, and the $59 million impairment write-down, forced the company into an extremely dilutive equity raising.

The operational and financial crisis destroyed Pental’s credibility with the banks, and management has only just renegotiated a non-restrictive banking relationship. A large franking balance is likely to encourage Pental to reinstate its dividend (if not this year, then definitely next year). Pental can also consider other capital expenditure or small acquisition opportunities.

The majority of Pental’s products are the leaders in their category, and the branding advantage remains strong despite the company only just surviving the perfect storm of headwinds in 2011 and 2012.

Australian Competition and Consumer Commission (ACCC) vs Coles

When considering the wider industry, the news that the ACCC has taken Coles to the Federal Court is a positive development in relation to preventing some of the supermarket heavy-handed tactics that have been well publicised in recent years.

This case relates specifically to breaches of Australian Consumer Law (ACL) from 2011. Coles implemented a program targeting $16 million of rebates from smaller suppliers by increasing the charge to access the Coles product portal. The portal gives suppliers information on product performance.

Increasing the charge is not a trade practices breach; however, some of the Coles buyers pressured suppliers into paying the increased charge within a matter of days, or their products would be taken of the shelf. The ACCC alleges that Coles has engaged in unconscionable conduct towards 200 of its smaller suppliers, in breach of consumer law.

It is our understanding that Pental didn’t participate in the plan, and hence preferred to not access the portal rather than pay the ridiculous prices for access.  

There are two key variables in regards to a supplier falling victim to the bullying tactics from the large supermarket chains. Firstly, how well trained the supplier staff is at recognising breaches, and secondly, the different tactics used by the relevant Coles buyer for that supplier.

In regards to the portal, the Coles buyer responsible for Pental at the time didn’t breach any consumer law, and hence the company won’t be referenced in the current hearing. A number of competitors and other suppliers have been named such as Orange Powder and Stuart Alexander.

These proceedings have arisen from a broader investigation by the ACCC into allegations that supermarket suppliers were being treated inappropriately by the major supermarket chains. The broader investigation is continuing.

Any efforts to restrict the abuse of power by Coles and Woolworths reduce some of the operational risk for suppliers operating in a poor industry structure. 

Buying opportunity                                               

Much of our forecast net profit growth in 2014-15 is from further reduction in interest costs. With a supportive banking relationship finally re-established, there is upside risk for any operational gains as management can now reinvest in the business.

Brands such as White King, Country Life, Softly, Aim, Jiffy, Little Lucifer & Velvet are beginning to see the benefits from investment in product upgrades and marketing initiatives.

The dip under three cents has triggered non-executive director Alan Johnstone to increase his holdings in recent months via on-market trades.

We maintain our buy recommendation, with a 4.6 cent target price equating to a price-earnings multiple of 12 in 2014-15.

To see Pental's forecasts and financial summary, click here.