The Pental (PTL) full year result was above my expectations, with underlying net profit after tax (NPAT) of $5.34 million versus my forecast of $4.6 million, and a surprise reinstatement of the dividend with a final payment of 0.12 cents.
The large growth in net profit from $2.3 million last year was largely due to reduced finance costs as debt was eliminated during the year. With the financial turnaround now complete, management will also look to complete a share consolidation due to the excessive amount of shares on issue.
With earnings per share of 0.34 cents, Pental is trading on an 2013-14 price-earnings multiple of just over 10 times. In forecasting future years, the key uncertainty is just how much the pressures of the highly competitive grocery retail market affect the business. For example, this year management had to make a conscious effort to maintain/grow acceptable margins rather than participating in aggressive price reduction campaigns for the sake of higher sales growth.
Moving forward there is likely to be continued margin pressure due to the large supermarket chains focus on reducing prices and increasing the amount of private label products. Although Pental is participating in private label manufacturing, its major brands remain under duress due to the constant focus on price-cutting.
Nevertheless, Pental’s major brands have managed to maintain market share. On top of supplying private label beach to Woolworths, Coles and Aldi, Pental’s White Kings still has a 79% share of the retail liquid bleach market. It’s other bleach brand, Janola, has a 63% share of the New Zealand retail liquid bleach market, while Softly and Martha Gardener have a 56% share of the retail wool wash category. Cube Firelighters (Little Lucifer, Jiffy and private label) have a 62% market share in the major grocery channel.
The industry dynamic of dealing with continual pricing pressure means that Pental will need to increasingly invest in its manufacturing processes to become more cost competitive. This limits the amount of free cash that can be returned to shareholders via dividends or that can be used for strategic acquisitions.
I first recommended Pental as a buy at 3 cents on February 27, 2014 (see Pental cleans up), and then again at 2.5 cents on May 14, 2014 (see Opportunities abound for Pental). The current 3.6 cents share price represents a 44% increase since that latest recommendation.
Although the share price still trades below my downgraded 4 cents target price and valuation, it may be worth taking profits above 3.5 cents due to the risk of operating in such a poor industry structure.
While the 2013-14 result is mainly good news, moving forward earnings per share growth will need to be driven by operational excellence in an industry with many challenges.
One of the efficiency initiatives that management has focused on is the bleach plant relocation and upgrade in Shepparton. The efficiency improvements have taken longer than initially anticipated.
To make overall manufacturing capabilities and the supply chain more efficient, the business also started reviewing a number of processes, including those which use continuous improvement and lean manufacturing principles.
Two other major projects to be completed in the coming year are the new high-speed liquid line and the soap plant evaluation.
Given the nature of the grocery retail market is likely to remain highly competitive for the foreseeable future, Pental may continue to trade on discounted multiples until it can show evidence of creating shareholder value from its investment in manufacturing capabilities.
I am downgrading my recommendation from BUY to HOLD with a reduced 4 cent valuation and target price. My valuation has reduced due to reductions for forecast revenue growth.
I had previously assumed 10% revenue growth for 2014-15 and 2015-16, but have now dropped this to 4%. Management's outlook commentary suggests similar conditions to 2013-14, with uncertainty on the timing and impact of the manufacturing efficiency improvements.
To see Pental’s financial summary and forecasts, click here.
