Rudi's View | Feb 15 2017
This story features BWX LIMITED, and other companies. For more info SHARE ANALYSIS: BWX
In this week's Weekly Insights:
-Trend Spotting: Natural Skin Care
-Gold And Trading Opportunities
-Conspiracy: China & Miners' Debt
-FNArena's New Website: Take A Walk On The Walk Side
-Who's Afraid Of The Big Bad Bear?
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
Trend Spotting: Natural Skin Care
By Rudi Filapek-Vandyck, Editor FNArena
Is it possible the next narrative to entice investors into jumping on board is "natural skin care"?
Melbourne headquartered BWX Ltd ((BWX)) certainly knows how to make an entrance. Upon listing on the ASX in mid-November 2015 the shares gained 51% on the first day of trading. The IPO, priced at $1.50, raised $39.3m to assist in further expansion for the company's suite of natural skin and hair products, of which Sukin attracts most attention.
Sukin is already a top five brand selling through pharmacies in Australia. Admittedly, the more bathrooms I visit these days, the more Sukin bottles I encounter. The marketing machine clearly is working. Both in the real world as well as in the share market.
After rising from $1.50 (IPO) to $2.26 on the first day of trading, BWX shares continued on a rally that didn't stop until August 1 last year. By that time the share price had reached $5.63. Needless to say, by then it had landed on many an investor's radar.
Then came the Big Switch that saw funds managers selling out of small and medium cap industrials to jump on board resources and banks and BWX tanked together with ARB Corp, NextDC, and just about every single popular midcap growth stock that had up until that point suited its shareholders well. By December the share price was struggling to stay above $4.
Fast forward to last week and BWX, whose share price had recovered to below $4.50, reported a strong financial performance for both domestic (+48.7%) and international sales (+115.7%). The share price effectively "did a Carsales", jumping to $5 on the day, no doubt helped by management's guidance for FY17 operational growth (EBITDA) of 30%.
Unfortunately, none of the eight stockbrokers monitored daily by FNArena covers the stock, but several others do, and all seem quite enamoured by this little Melbourne Champion of the natural skin care cause. Moelis sees ongoing strong growth potential for the next 3-5 years. This "accelerated growth" will facilitate robust increases in dividend payouts, though yield is not something that is adding to the allure of owning BWX equity. The shares are trading on Price Earnings multiples of 26.5x (FY17) and 22.0x (FY18) so the yield on offer is more like CSL's (less than 2%) rather than challenging Telstra or the banks.
What pleased Moelis is that domestic Sukin sales grew 48.7% on the pcp to $24.3m, higher than the “underlying” growth rate of 42% in FY16. Sukin's offshore sales are projected to double in FY17 to $14m on the back of UK penetration. Moelis rates the stock a Buy with a $5.45 price target (twelve months).
Analysts at Canaccord Genuity have been equally impressed, but they foresee pressure on margins on the back of higher marketing costs in Canada and China. Canaccord's price target sits at $5.28, good for a Hold rating.
Bell Potter is on Moelis' side, arguing BWX has an opportunity waiting to be explored with its Sukin products in the UK, China and Canada. If management is able to genuinely make inroads in only one of these three markets, it'll change the dial significantly, argues Bell Potter. Bell Potter also rates the shares a Buy with a price target of $5.75.
All brokers are banking on double digit growth for the years ahead. Don't be surprised if you hear/read a lot more about BWX and natural skin care from here onwards. Moreover, I think there's potential for a new popular narrative given the combination of "natural", "high growth" and some meaty share price gains to date.
Within this context it's probably worth pointing out conglomerate-in-restructuring McPherson's ((MCP)) is also active in skin care products and so is New Zealand's Trilogy International ((TIL)), since three months listed on the ASX. Trilogy's share price has gone in the opposite direction. Clearly, investors are taking the view that BWX's success is inflicting pain on competitors such as Trilogy.
Moelis last week initiated coverage on Trilogy with a Buy rating and a 12-month target of NZ$2.90, implying upside potential of circa 15%. Equally important, Moelis believes Trilogy trades at a 48% discount relative to BWX. Trilogy also has the largest exposure to offshore markets where its opportunity awaits in countries such as Canada and Germany, where consumers demand affordable, organic skincare, says Moelis.
Admittedly, Trilogy's FY17 forecast on Moelis' projections is nothing to write home about, certainly not when compared to BWX's release from last week, but its time to shine should come at a twelve months' delay. That is, if current projections don't have to be reset between now and FY18.
Assuming Moelis' assumptions prove correct and Trilogy's share price starts to catch up in the months ahead, while McPherson's might do a great job in highlighting its own presence in skin care, we might just be witnessing the birth of a new narrative in the local share market. Of course, all companies involved are on the smaller side and recent history shows popular themes such as infant formula, honey and vitamins can (and will) run into serious bumps alongside long term growth potential.
Investors should never forget that small cap growth stories come with a significantly higher risk profile. In case anyone needs reminding, look up Nearmap ((NEA)), Impedimed ((IPD)) or Capilano Honey ((CZZ)). These were companies that not so long ago could do no wrong.
Gold And Trading Opportunities
I remain of the view that gold's outlook is overshadowed by the prospect of successive Federal Reserve interest rate hikes in the second half of 2017. But, of course, while the Federal Reserve, or the US bond market for that matter, are lingering somewhere in the background, gold is doing what gold does best: offering traders plenty of opportunity through above average volatility.
With this in mind, I stumbled upon an excellent gold sector report released by Shaw and Partners. I use the term "excellent" because it doesn't contain all the quasi-religious clap trap many a gold bug uses to drag interested investors into their church community. This whole idea that one buys gold as protection against inflation will be put to a real test when US bond yields start moving higher, but this won't happen just yet.
In the meantime, Shaw and Partners lines up four reasons to jump on board the gold bandwagon this month:
1. Mergers & Acquisitions
Low prices or elevated prices, it doesn't really matter for the global gold sector which in recent years has proved to be among the more prolific when it comes to divestments, mergers and acquisitions.
2. Corporate Leverage
Share prices in listed gold producers tend to move much higher during an up-trend, and fall much deeper in a correction phase. On Shaw's calculations, share prices historically move between 4-6x fluctuations in the price of gold. Based on historical numbers, Shaw is of the view gold equities look significantly undervalued (but don't forget my opening sentence).
3. Corrections Are Normal
Don't be put off by the sharp reversal that shows up when looking up Northern Star ((NST)), Evolution Mining ((EVN)), and others, between July-December last year. Gold price corrections typically run for 24-118 days and average -25-30% reports Shaw. Make sure you are on board when the tide has turned for the positive! The latter is by now the case, reports Shaw, implying the most recent correction lasted circa two months (58 days).
4. NPV Cycle
Gold equities' valuations move through cycles which tend to mimic the economic cycle. Assuming that correlation holds, and 2017 delivers better economic growth, gold equities should now move into a phase whereby share prices reflect a premium versus Net Present Valuations (NPVs) for the sector. The underlying suggestion here is that gold equities moved from low cycle discounts (December 2014) to high cycle premiums (July 2016), but also that, after the correction that is obvious on most price charts, the sector should see higher share prices ahead.
Shaw seems to have a preference for Northern Star and Evolution Mining, but there are plenty of other gold stocks listed on the ASX. This is also an ideal opportunity to guide all subscribers to FNArena Windows on the freshly launched new FNArena Website. Start with "Commodities" then select "Mining", "Precious Metals" and "Gold & Silver" for the opportunity to analyse and compare 22 small and large corporate gold exposures on the ASX.
Alternatively, I note there's a discussion raging among economists whether US inflation is merely a mirage in the absence of real fiscal stimulus from the new president and his administration? In that case, irony oh irony, one would like to own some gold because of the lack of sustainable inflation and the subsequent deflation in US bond yields. Not that this will stop many gold groupies from touting bullion's inflation protective characteristic…. but hey, who cares as long as the price moves into the right direction…
Conspiracy: China & Miners' Debt
Investors love a good conspiracy theory and I have a strong suspicion four years of The Donald at the White House is going to deliver us plenty.
But let's stick to financial markets. One year ago, global miners, smelters and oil and gas producers were left staring into the abyss. Five long years of down trending prices had exhausted room for further cost reductions and efficiency measures. Debt levels were too high for many but supply remained plentiful and thus the outlook remained dour, or so it seemed.
Australian investors like to think back about the situation back then for Whitehaven Coal ((WHC)), Fortescue Metals ((FMG)), and the like, but the situation looked arguably much worse for their peers inside China where corporate debt levels even today remain too high for many. But they do look a lot better than twelve months ago. It's literally a world of difference post the rally in prices throughout most of 2016.
Macquarie's China watchers on the ground, who collect their own data on corporate China's debt, have noticed significant improvement in corporate China's ability to service outstanding debt, albeit with the observation the situation in general is still worse than in 2014, not to mention the years prior. All in all, Macquarie's data suggest deterioration kicked in from 2011 onwards and started to become genuinely worrisome in 2015.
Of course, it's all pure coincidence the situation turned around so quickly in February last year on the back of significant liquidity injections by Chinese authorities.
The way things are trending, China's debt-to-GDP may well rise above 300% in a few years but Macquarie doesn't think there's a crisis building. Most of this debt sits with the central government or with controlled businesses and there is no need to address non-performing loans on balance sheets of Chinese banks.
The problem lies more with the fact all this debt makes for lazy and non-efficient allocation of capital, and Beijing is finding it increasingly difficult to stimulate domestic demand by simply re-opening the liquidity tap, as should be expected given circumstances.
China is trying to restructure its economy and alleviating domestic industries from companies carrying too much debt is part of the plan. It's probably a fair assumption that corporate mergers, debt-for-equity swaps, and the likes are much easier to instigate when things seem a lot less dire than they were this time last year.
As far as the actual numbers are concerned, Macquarie believes the size of accumulated debt inside China's corporate sector increased by nearly four times over the ten year period from 2007 to 2016. Back in 2007, only 7.3% of companies surveyed was believed to be unable to cover its debt because operational cash flows seemed insufficient. This percentage grew to 13.1% by 2010, and to 17.5% by late 2015. By then, so suggest Macquarie's data analysis, EBIT uncovered debt for the coal mining sector in China had exploded to 65%, to 66% for the steel sector, and to 92% for base materials.
These numbers have all improved considerably over the first nine months of 2016, with exception of the steel sector where, apparently, 63% of total debt is still not covered by operational cash flows. Given the noticeable improvement in general sector dynamics, that seemingly stagnant percentage is expected to drop a lot lower in the year ahead.
In case anyone is wondering: total debt not covered by cash flows from normal operations for the base metals sector in China had dropped to 45% by September last year. Still high, but way, way, way below that astronomical percentage Macquarie recorded for late 2015.
Judging from the rapid improvements in debt/cash flows and profits for Whitehaven, Rio Tinto ((RIO)), and others in Australia, the above numbers should decline a lot further from here onwards, on the general premise that commodity prices are not about to collapse back to where they came from.
FNArena's New Website: Take A Walk On The Walk Side
Well, we launched the new website and everything is working.
Not everyone is as enthusiastic as we are, but it's only fair to report most feedback has been positive, with responses received overwhelmingly supportive, with here and there a compliment or two, plus some handy tips and ideas to add next.
Your appreciation/disapproval/ideas for further improvement remain welcome at [email protected]
My best advice to all subscribers is to live dangerously this week and take a tour through what is available and immerse yourself into the many new and refreshed tools, data and applications that are on display on the new website. I am sure you are going to discover new and exciting things.
To all who have tried our service in the past and would like to have another peek post new website launch: send an email and we'll facilitate. It's a time for celebration. You might as well be part of it too.
Who's Afraid Of The Big Bad Bear?
Market speculation is rife about when exactly giant international retail disruptor Amazon will be opening its doors in Australia, so to speak, and what kind of impact, devastating or not, this might have on the likes of Harvey Norman ((HVN)), RCG Corp ((RCG)), Premier Investments ((PMV)), and others.
But every internet shopper in Australia already knows there is a dot com dot au Amazon market place where products can already be purchased in exchange for local dollars. Differences with the US-based Amazon website remain prominent, however. This also includes the availability of my latest book, Who's Afraid Of The Big Bad Bear?
The Australian Amazon allows the purchase of eBook version only, while foreign Amazon websites also offer the paperback version. It's an antiquated legal thing, originally meant to protect local content.
Paying subscribers should note a free copy in pdf is included in 6 and 12 months subscriptions. Look up "Special Reports" on the brand new FNArena website, where you'll also find prior publications, as well as PowerPoint slides of my on-stage presentations. The slides from last week's visit to Perth have been added.
All-Weather Model Portfolio
In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.
This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: [email protected]
Rudi On TV
This week my appearances on the Sky Business channel are limited to:
– Tuesday around 11.15am, Skype-link to discuss broker calls
– Friday around 11.10am, Skype-link to discuss broker calls
– Friday 7-8pm, guest on Your Money, Your Call Fixed Interest
Rudi On Tour
Your Editor has been invited to present at the Australian Shareholders Association's (ASA) 2017 Securing Your Investing Future Conference to be held at the Grand Hyatt Melbourne from 15-16 May.
The conference details – www.australianshareholders.com.au/conference-2017
Speaker information – www.australianshareholders.com.au/speakers
Program information – www.australianshareholders.com.au/program
Those who register before 31 March 2017 will receive $70 off the registration fee. Telephone: 1300 368 448
For more info SHARE ANALYSIS: BWX - BWX LIMITED
For more info SHARE ANALYSIS: EVN - EVOLUTION MINING LIMITED
For more info SHARE ANALYSIS: FMG - FORTESCUE LIMITED
For more info SHARE ANALYSIS: HVN - HARVEY NORMAN HOLDINGS LIMITED
For more info SHARE ANALYSIS: IPD - IMPEDIMED LIMITED
For more info SHARE ANALYSIS: MCP - MCPHERSON'S LIMITED
For more info SHARE ANALYSIS: NST - NORTHERN STAR RESOURCES LIMITED
For more info SHARE ANALYSIS: PMV - PREMIER INVESTMENTS LIMITED
For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED
For more info SHARE ANALYSIS: WHC - WHITEHAVEN COAL LIMITED