Small Caps | Aug 25 2020
Demand for metal detection products continues unabated, given surging gold prices, but Codan is also benefitting from recreational metal detection as a pandemic-safe outdoor activity.
-Minetec to return to profitability in FY21
-Higher freight costs likely to be unresolved in the short term
-Resilient demand for Codan products
By Eva Brocklehurst
Supply chain disruptions notwithstanding, Codan ((CDA)) managed to complete a strong FY20 amid growing strength in demand for its metal detection products, courtesy of the flourishing gold price.
Still, Macquarie points out sales rates are being held back by shortfalls in inventory across higher-volume detectors and demand is running ahead of sales. The company's revenue grew 30% in FY20, also underpinned by radio communications where there are a large number of military contracts in the wings.
Minetec is expected to return to profitability in FY21, given the system implementation at the Newmont Tanami mine, a refreshed agreement with Caterpillar and the delivery of Minestar applications for major mining customers.
Gold mining remains the main source of demand and gold price strength is likely to underpin earnings over the next year, Canaccord Genuity assesses, along with price increases of 5-12% in metal detection product ranges.
There are also new products across both metal detection and communications. Offsetting this is the lower order book for tactical communications. Codan continues to invest in new product development and expenditure increased to $31m in FY20 with a similar level expected in FY21.
One issue that affected margins was the higher costs for freight as a result of the pandemic and this is unlikely to be resolved in the short term. Management is planning to move to sea freight but this is expected to take a while.
Recreational metal detecting rose 11%, amid benefits from annualising the release of Vanquish. Minelab is expected to take 20% market share within 12 months of the launch of the Vanquish model. Unit sales were 30,000 in FY20 and a further 15,000 have been shipped so far in FY21.
The new GPX model boasts significant technical improvements and will be priced closer to the most expensive detected GPZ7000. The usage is different and Macquarie assesses this should prevent material cannibalisation of existing sales.
Of particular note, the broker also highlights demand has flowed to metal detecting emanating from the shift to those outdoor activities which have the benefit of being a pandemic-safe option. Macquarie retains an Outperform rating and $11.20 target for Codan.
Several large military contracts supported the business in FY20 and Macquarie notes two government deals are pending. Tactical communications remain an addressable market that the company can service over time with potential for more than double revenues if successful. Brokers were disappointed with the order book as this has slowed, although the pipeline for military contracts is typically lumpy.
Codan has acknowledged slower closing of deals in tactical communications could hamper the contribution from new products and the turnaround in Minetec.
Restructuring Minetec involves transition to a software business in tracking solutions that will deliver the technology to Caterpillar. Caterpillar will cover the costs of engineering and product delivery and remove the majority of the cost base for Minetec. Codan has decided to write down -$7.5m as a result.
Canaccord Genuity highlights the case for continued strong growth and increases the target to $10.25, although downgrades to Hold from Buy in comparing the target price relative to the current share price.
Moelis asserts its $11.48 target implies a 16x enterprise value/FY22 earnings (EBIT) multiple. Earnings visibility is low because of the nature of the products and distribution, but the broker considers this multiple appropriate because of a growth trajectory that is supported by a long pipeline of self-funded new products and the potential for large and highly accretive acquisitions.
There is also the current bull market in gold and resilient demand. Potential inclusion in the ASX200 is another bull point given recent increases in size and liquidity. Moelis retains a Buy rating and notes more than 25% return on equity and 60% return on incremental capital since invested in 2016.
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