Micro Cap Rising Stars – Clover

This story features CLOVER CORPORATION LIMITED. For more info SHARE ANALYSIS: CLV

(This story was originally published on 16 June 2009. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

By Greg Peel

Microequities is an Australian financial adviser specialising in in-depth research of listed “micro caps” – those companies of low capitalisation too small to register on ASX indices or to attract research coverage from leading stockbrokers. In June Microequities hosted its Rising Stars conference, at which selected companies presented their wares. FNArena was invited to attend, and over a period of time is providing conference highlights. This is the second in the series.

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Clover Corporation ((CLV)) kicked off this year’s Mircoequities conference, but the company also presented at last year’s conference. To that end, readers unfamiliar with Clover are directed to Micro Cap Rising Stars – Clover (2008) published this time last year, for an extensive company profile. What follows is an update.

One might be tempted to ask why a “rising star” of last year has not yet “risen” so to speak, but the truth is at the time of publication Clover shares were trading at 14.5c and today they are trading at 20c. That’s a 40% increase, but the stock hit 27c last year at its peak before Lehman went under and everyone started jettisoning  their small caps in panic. Nevertheless, Clover’s progress since last year is enough for Microequities to consider its star to still be rising out of the GFC ashes.

What the GFC did do for Clover was to expedite its shift from an R&D based, developmental company into a more mature operation focused on cost controls and higher margins. The company posted less than $1 million in net profit in FY07 but achieved just under $3 million in FY08, plus a tax credit against its development costs to take total net profit just above $4 million. The GFC has nevertheless forced Clover’s customers to run down inventory rather than demand fresh stock, such that Clover’s revenue in the first half of FY09 was down 4% from the same period in FY08.

However, restructuring towards a higher margin enterprise has meant 1H09 earnings before interest and tax (EBIT) was up 76% in 1H08 and net profit after tax (NPAT) up 134%.

The fact that Clover’s customers were indeed able to run down inventory is a case in point. Clover specialises in nutritional additives for processed foods, with a particular emphasis on omega-3. Omega-3 oils are sourced mostly from tuna and soy beans. About 80% of Clover’s revenue comes from provided additives to infant formulas. The problem with natural food additives is they oxidise over time, which gradually renders the product ineffective and also more immediately leads to strong odours. When you’re talking tuna that odour is a distinct problem, but soy beans don’t exactly emit Chanel No.5 when they break down either. It’s a bit hard to sell someone a box of breakfast cereal with added omega-3 if it stinks of fish, and even newborns would turn their noses up if their mothers hadn’t already.

Fundamental to Clover’s value is its proprietary powder encapsulation process which it developed in conjunction with the CSIRO. This encapsulation prevents oxidisation, thus neutralising odour and drastically increasing shelf life. This time last year Clover had just signed a five-year supply agreement with US-based Mead Johnson – the world’s leading supplier of infant formula. It took Mead Johnson four years to assess Clover’s products and encapsulation process, including a two-year, real time shelf life trail.

Clover’s two-year shelf life capacity is a point of difference from its competitors, and clearly barriers to entry in the field are high if one is to snare the big contracts.

We also left Clover last year looking to improve its US distribution. Currently Australasia accounts for 39% of sales, Asia 52%, Europe 8% and the US 1%. While Asia is the growth market from a population point of view, few Americans are aware there is such a thing as fresh food. There is thus huge scope for Clover to expand its footprint among the world’s greatest lovers of processed food, and in March the company signed a distribution agreement with US-based GTC Nutrition to promote that expansion.

And when we left Clover last year it was sourcing nearly all its tuna oil from American Samoa, while developing local sources for soy beans. The company has now de-risked its supply by opening up new sources, and furthermore has expanded its range of sources of omega-3, including algae, of all things.

Indeed, Clover’s near term goals are all about expansion in all parts of its business – sources, products, geographical reach. The focus is on increasing and diversifying sales and also increasing margins. The company is looking to reduce its reliance on infant formula sales as a proportion of total sales. One step has been to expand the “brain food” concept to take in the other side of the scale from infants – the aged. Omega-3 is vital in preventing brain deterioration, and also the deterioration of eyesight.

There are also exciting developments on the soy bean front. Using its proprietary technology, Clover is producing a range of tasteless soy bean additives for flours, grits (the sort of corn porridge so loved by those in southern America), flakes (used in breakfast cereal), and toasted flakes. The latter category has great promise, given the soy-added toasted flakes taste remarkably like peanuts, apparently. This opens up possibilities in the face of rising peanut allergies.

But overriding all of these positive strides is the encapsulation technology itself. It is not limited simply to omega-3 powders or other specific food additives. The process has an endless range of potential uses for any process where protection of the encapsulated contents from oxidisation or other forms of environmentally driven deterioration are a necessity. Clover is out there waving its banner to the world.

Broadening the scope of its technology is thus Clover’s primary focus as we enter FY10. Then the emphasis can move to new technologies, as well as continuing to expand the company’s global footprint.

Clover’s star was rising last year until it ran into the GFC. By implication, Microequities is sure that star can rise again.

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