Investors Are Missing The Beauty In McPherson’s

This story features MCPHERSON'S LIMITED. For more info SHARE ANALYSIS: MCP

By Chris Shaw

Current market conditions are difficult for discretionary retailers, so operating in more resilient sectors such as beauty and healthcare and having strong market positions in major product lines is an advantage for McPhersons ((MCP)), reports stockbroker Moelis and Company.

A meeting between the broker and management at McPherson's indicated the consumer products division, which accounts for more than 92% of group earnings, has to date delivered solid performance in the first half of 2011 despite a volatile market.

A key reason behind Moelis retaining its Buy rating on McPherson's is the broker sees only limited implications from further increases to interest rates in Australia, as the company's products are primarily at low price points and have a counter-cyclical bias.

As well, Moelis points out unlike for many retailers Christmas is not a particularly important trading period for McPherson's. At the same time, company management remains confident consumers do have money to spend, so some modest earnings growth in FY11 should be achievable.

The update from management also indicated McPherson's is looking to restore EBIT (earnings before interest and tax) margins to historical levels of around 14% over the next 12 months, even allowing for current competitive pressures.

These pressures include some rising costs out of China, though as Moelis notes this trend is consistent for all retailers. The existence of some currency hedging should help with respect to margins, while Moelis also notes McPherson's continues to develop new products, so creating new product pricing points.

One attraction of McPherson's, according to Moelis, is the company generates strong cash flows, which in FY10 meant a significant strengthening of the balance sheet. Operating cash flow of $28.9 million for the year was better than Moelis had expected and allowed for gearing to be reduced to 37%, down from 67% in FY09.

This gives McPherson's options with respect to pursuing acquisitions, suggests the stockbroker, while also allowing for dividend payments high enough to produce a yield of better than 7%.

The strength in cash flows was achieved despite major customers Kmart and Coles reducing the company's shelf space allocation in FY10. This decision meant around $2 million in lost revenues and management indicated this situation has so far continued into FY11. To offset these lower revenues, Moelis notes management at McPherson's is moving to streamline operations, so lowering associated costs.

Looking forward, Moelis is forecasting earnings per share (EPS) for McPherson's of 38c in FY11, 40.9c in FY12 and 44.6c in FY13, which compares to consensus forecasts according to the FNArena database of 38.8c in FY11 and 42.3c in FY12.

For Moelis, the combination of an earnings multiple of less than eight times in FY11 and the attractive yield on offer imply value at current levels, especially given the resilient nature of McPherson's Consumer Product brands.

Compared to the Buy rating from Moelis, the FNArena database shows Credit Suisse also rates the stock as a Buy, while RBS Australia has a Hold rating. The average price target (two brokers) according to the database is $3.49.

Shares in McPherson's today are unchanged with a last trade of $2.95. this compares to a range over the past year of $2.35 to $3.48 and implies upside of around 18% to the average price target in the FNArena database.

Click to view our Glossary of Financial Terms