Washing our hands of Pental

Warren Buffett said that “turnarounds seldom turn”, but personal care product manufacturer Pental clearly missed the memo. We first identified its turnaround potential in Pental cleans up (January 2014) when the company was recovering from its 2012 near-death experience.

Two and a bit years later and Pental has rewarded shareholders with a 53 per cent total return, including dividends. In a market that has travelled sideways, that's impressive, but it triggers a question: what now?

The company has returned to profit, the $8.2 million in pre-tax earnings in 2015 a sharp improvement from the $4.8m loss in 2012. The trouble is that this improvement came entirely through cost cutting. In 2012, revenue was $80m. It's pretty much the same figure today. Cost cutting can maximise profits but there's a limit to its usefulness. Squeezing a lemon delivers only so much juice.

Management has targeted further refinements in the coming year (indeed, two of the five “growth opportunities” from the recent presentation were cost cutting measures), but the future benefits are more incremental than transformational. Pental must now shift to growing revenue if it is to post higher earnings.

Given the revenue stagnation of the last few years, that seems unlikely. Pental competes for shelf space with foreign imports and the supermarkets' own home brands. Without a clear competitive edge, it may be destined to a future of mediocre returns.

The company seems to appreciate that perception, which is why China hoves into view. Pental wants to export its home and personal care products to Asia, seeking to tap the success of 'Chinese consumer stocks' like Blackmores and Bellamy's. Just 0.1 per cent of Pental's total sales are made in Asia but even if we assume the company is successful, it's likely to take longer than most investors are prepared to wait.

Exporting to China is hard yakka. A key feature of the successful Chinese consumer stocks like A2 Milk and Capilano Honey is the ingestible nature of their products. Chinese consumers are willing to pay a premium for safe, high quality imports that they eat. Whether they're prepared to also pay a premium for soaps, firelighters and bathroom cleaners remains to be seen.

Yet the current trailing PER of 15 indicates a company that will manage to carve out some growth. We're not so sure. If a stock isn't cheap, or growing rapidly, it's hard to see how you can make money from it. That's why we're getting out. This has been a successful recommendation and we're happy to leave it behind with a handsome return.

We recommend members SELL Pental and build their cash pile ready to deploy in our next buy idea, which won't be too far away.