Small Caps | Sep 03 2015
-Ramp up in harvests
-Unique supplier position
-Earnings to accelerate
By Eva Brocklehurst
TFS Corp ((TFC)) is adeptly expanding from a grower of Indian sandalwood to a product development and distribution company. Brokers welcomed the FY15 results which suggest earnings are about to accelerate.
The 2016 harvest is expected to be at least 10 times 2015. While this ramp-up in volume is likely to deliver strong earnings down the track, even more upside is probable over the next decade, brokers suspect, emanating from new pharmaceutical products.
The first pharmaceutical – a treatment for acne – is likely to be on offer by the end of this year and treatments for eczema and warts are also in train. Should the new products offer long-term pricing contracts, UBS believes the stock could be significantly de-risked as an investment.
The broker increases long-term forecast plantations to 22,500 hectares and FY17-25 earnings estimates by 5-18%. The 2016 harvest is unlikely to materially affect the FY16 result, which will also reflect a higher net interest expense as a result of a falling Australian dollar. Free cash flow is not expected until FY17. UBS has a Buy rating and $2.80 target.
TFS Corp is setting up its end markets for this increase in production, intent on servicing the Chinese wood market as well as oil. The company has a unique listed exposure to a scarce product. There are limited regions where this tree can grow – the plantations are in Western Australia – and the tree is semi-parasitic so management is complex.
Hence, the company's 20-year lead time advantage in becoming a sole supplier of sustainable Indian sandalwood in commercial quantities is significant.
Over the next four years Canaccord Genuity estimates TFS Corp will generate $265m in Indian sandalwood product revenue at lucrative margins. The broker also envisages a hidden value in the company's pharmaceutical subsidiary, with potential for it to be worth more than the plantation management business.
The company has secured a monopoly supply contract for Galderma's Benzac (acne) product. Two fully developed products (eczema and HPV) are now awaiting commercial distribution partners while there are another two in phase 2 clinical trials (MSV and eczema) and one in a phase 3 trial (HPV).
Canaccord Genuity estimates the company is currently selling oil to Galderma at an effective price of $7,750/kg, which compares favourably with all-in-production costs over the past 15 years of $500/kg at current yields.
The broker also expects TFS Corp to enter the Chinese wood market over the next 12 months at similar prices to its current oil price, estimating that around 50% of the harvest proceeds will be sold to the Chinese wood market in FY17-20. This leaves around 30% for pharmaceuticals and 20% for the cosmetics/fragrances industry.
TFS Corp appears one of the most leveraged stocks to the depreciating Australian dollar listed on ASX, as it generates US dollar product revenue off an Australian dollar fixed cost base. Canaccord Genuity has a $3.02 target with a Buy rating and believes the stock is in the best shape on all fronts since it listed in 2004. The broker expects TFS Corp will likely control over 80% of the commercially available Indian sandalwood heartwood over the coming decade.
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