Pental’s solid result

The manufacturer of personal care products is heading in the right direction and investors are now looking for increased growth.

Pental’s FY15 result provided further evidence that the strategic focus of the last three years continues to be driving the company in the right direction. Underlying net profit before tax was up 15.6 per cent to $8.02 million.

As a reminder the company only just survived an extremely difficult period in 2012, where the highly cyclical Oleo Chemicals division became loss making, just after the company geared up the balance sheet to buy “White King” and “Janola” in 2011. This was also a period where Coles and Woolworths ramped up the pressure on suppliers by increasing the costs to gain shelf space. 

After a highly dilutive emergency capital raising the company began a significant re-structure. The first step was to close the Port Melbourne Oleo Chemicals site and re-locate the bleach plant to Shepparton. With the need to gain exposure to private label the company is invested in supply expansion at the Shepparton site.

Charlie McLeish became CEO during 2014 and has succeeded in product upgrades and refreshing the marketing of the company’s key brands. At the same time a large investment has been made in upgrading the company’s Shepparton plant with the objective of a pay-back through reduced operating costs.

With much of the heavy lifting done, the question now is whether the company can use its strong balance sheet ($11m cash) to increase growth and lift the profile of the little known stock that has a $63m market capitalisation. 

The focus of driving the brands and reducing costs will continue. But management is on the lookout for new sales channels and also investigating a material opportunity to export into Asia. They also haven’t ruled out acquisitions but are very focused on risk minimisation, especially given the near fatal events of 2012.

FY15 highlights

During FY15 strong branded sales growth of 5.7 per cent was achieved in Australia. New Zealand operating conditions were much more difficult but management tactically defended their market position despite aggressive promotional campaigns from competitors.

New products promote sales growth and marketing campaigns protect margins. With this in mind, the White King TV advertising was successful with the cost worn in the first half.

Given the decision was made to invest significantly in the Shepparton plant upgrade, it was also decided that a cultural change was required with a refreshed team of increased capability. The new cultural change is driving core values around customers, people, quality, fairness and safety. It has already promoted an improved site performance and leveraged the manufacturing improvements. One-off employee re-structuring costs of $0.43m were included in the result.

The capital investment of $5.3m announced in February this year is on track and expected to be operational in the third quarter of FY16. This program resulted in a non-cash $0.55m impairment charge for equipment that will be replaced.

The repayment of the investment program will be seen via both reduced operating costs and increased production capability.

Operating cash flow was very strong, increasing by $4.82m to $11.8m. But the last of the tax credits was used, with tax payments to increase next year.

Private label continues to be an important growth channel but as with the branded products the focus will be on continuing to compete on value rather than price alone.

The last of the loyalty and piggy back options were exercised raising $6.64 of additional capital and contributing to the strong end of year cash balance of $11m.

A 1 for 15 share consolidation was completed in December large year to address the large amount of shares on issue relative to a company with a market cap of $63m.

The company has a very large franking balance and paid out 60 per cent of earnings for the year which was 2.58 cents per share.

Outlook

The early days of the restructure three years ago included a very restrictive banking relationship as well as a need to focus on risk minimisation given the large destruction of shareholder value that occurred in 2012.

Now management has a new banking relationship that includes an un-utilised $16m debt facility, and a balance sheet with $11m cash. For the first time in recent years, there is no more optionality around how they target growth.

The plant upgrade at Shepparton has been very focused on achieving pay-backs of less than three years. We would expect any acquisitions or other expansion opportunities to include the same focus on pay-back and improving the return on equity.

The exporting to Asia opportunity is of particular interest, given it is being investigated with minimal risk and material upside if the company gets it right. The larger global soap manufacturers provide products to Asia with the local branding. The differentiation opportunity for Pental is to provide premium soap products that leverage Australia’s good name in the region. Early indications are that there is strong demand and management believe they can achieve strong returns from the exporting.

The job of supplying Coles and Woolworths is certainly not easy but CEO Charlie McLeish has done a good job in promoting the company’s brands and remaining disciplined in only investing in what will achieve an adequate return. The decision to invest in private label has also paid off, as has the decision to work closely with Aldi.

Pental is trading on a PE of 9.5 times FY15 and a fully franked yield of 5.6 per cent. Although there won’t be the benefit of tax credits next year, the stock is still on a low PE multiple and secure above market yield. With minimal downside it is worth holding onto PTL to find out if the company can execute on its objectives of securing more meaningful growth opportunities.

With conservative forecasts that only consider current operations, we have a slightly increased valuation of $0.52 and maintain our hold recommendation.