Small Caps | Mar 10 2014
-Strong earnings growth trajectory
-North American market targeted
By Eva Brocklehurst
Freedom Foods ((FNP)), a supplier of cereals, snacks and non-dairy beverages had a stellar first half. Revenue was up 14% and the earnings margin expanded 30%, with greater operating efficiencies coming from the Leeton plant in NSW, as well as sales growth.
The company has not provided formal FY14 guidance but Morgans is confident that the company can generate strong profit growth over the next few years as the various brands gain traction. Increased volume and fixed cost leverage is also expected to come from additional capacity expansion. Earnings were up 30% in the half and underlying profit up 106%, amid robust demand for allergen-free cereals, snacks and almond milk. The Pactum division's earnings were up 66%, on increased volume and more value-added UHT product. Earnings are seasonally skewed to the second half and there will be new capacity coming on line as well. It augurs well, in Morgans' view, and the broker has an Add rating and $3.27 target.
Morgans recommends investors concentrate on the FY17 multiples, as there are strong opportunities from leverage to high growth sectors in the healthy and allergen-free food and beverage industry, which won't fully contribute to earnings until that year. Underlying earnings are forecast to rise to $37.7m in FY17, compared with $17.0m in FY14 forecasts and the actual $11.6m recorded in FY13. In FY14, underlying profit, before the preference dividend, is expected to rise 61%. The interim dividend of 1.5c was in line with the broker's forecast and up from 1.0c last year. Morgans expects the pay-out ratio to stay low in the short term, as the company focuses on growth initiatives.
The fledgling US operations produced a $250,000 loss. The company has spent the first half establishing business connections with distributors, brokers and retailers. Morgans thinks the US expansion plans are smart, as the company is leveraging a unique point of differentiation – the non-allergen, non-genetically modified sources of its cereals – to a very large market. The company is targeting up to 1m cases of branded cereals and snacks over the next three years in North America.
Other growth projects include cereal packaging capability at the Leeton site, which Morgans expects to result in around $1m in efficiency benefits, with no material increase in overheads. Snack bar manufacturing capabilities will also be upgraded later this year and this is expected to provide greater volume and improved efficiencies. Freedom Foods is developing new products in non-dairy beverages, snack bars and cereals but also reducing its presence in non-core categories such as biscuits. The company is also launching new formats for the convenience and food service channels. It's the health food floor space that management wants to expand, to facilitate market growth, and, with this aim, the company is actively engaging with retailers.
Pactum, is an independent low-cost contract manufacturer of UHT products for private label and branded customers. Pactum benefited from increased production volumes in the first half and Morgans expects more benefits will be forthcoming from selling value-added UHT milk.The facility at Shepparton, Victoria, will start commercial production next month and export UHT dairy milk to Asia. The broker notes the facility already looks like expanding in the first 12 months of operations because of significant demand.
One area which did decline in the first half was the specialty seafood area – Brunswick Sardines and Paramount Salmon. Revenue fell 26% in the half but earnings dropped by just 4%. The smaller relative drop in earnings was due to management's decision to reduce promotional spending while there was an improved cost of goods. Sales were affected by range reductions by Paramount but margin still rose to 19.5% from 15.1%. Freedom plans to revitalise packaging for both brands this year.
Freedom also owns a 17.9% stake in A2 Corp, listed on the New Zealand exchange's main board. The market value of the shareholding is around $101.5m, compared to Freedom's book value of $10.4m. A2 recently bought out its JV partner in Britain and plans to accelerate fresh milk sales there as well as enter the North American fresh milk market. Morgans would not be surprised if Freedom Foods realised some of its value in A2 in the short term.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
