Small Caps | Jul 26 2016
-FX headwinds add margin pressure
-Dents stock's defensive reputation
-Emphasis on stable dividend payment
By Eva Brocklehurst
Asaleo Care ((AHY)) has issued a downgrade to its earnings outlook, as a result of intense competition and an inability to pass on higher Australian dollar pulp costs.
The company has suggested 2016 earnings will be down around 10%. The personal care business has historically generated high margins but rival Kimberly Clark has become more aggressive, Citi observes, taking market share. In the tissue category, many of the company's competitors are unlisted and can withstand recent pressure from a lower Australian dollar.
The broker notes Asaleo Care operates in a defensive category, but warns earnings are not necessarily defensive when competition heats up. A lack of revenue growth and persistent FX headwinds will add to the pressure on margins.
The 100 basis point decline in earnings margins in 2016 is unlikely to reverse and Citi notes that while the company called out $1m in one-off costs for its every day pricing initiative in 2016, the reality is lapping this initiative around May 2017 will hurt sales and earnings growth. Citi also cautions investors that more major supermarkets may add private labels in the tissue category.
Credit Suisse downgrades earnings estimates 16-20% because the price competition, which has been apparent since 2015, shows no sign of ebbing. In fact, the broker suspects competition will become even more severe in coming months. The previous optimism that cost savings could offset the revenue pressure has evaporated and the broker suspects the dynamics of the personal care category could remain problematic.
Kimberly Clark brand is battling in the number three market position. Asaleo is number two in toilet tissue behind ABC's Quilton brand and ahead of Kimberly Clark's Kleenex. Credit Suisse maintains, in mature categories such as this, the number three is at risk of a reduction in shelf space and private label substitution. Kimberly Clark Australia reported large losses in its Australian accounts in 2014 and 2015. Hence, the step up in competitive strategies.
Asaleo Care is directly affected by price competition in this area. In the nappy category in New Zealand the broker notes Kimberly Clark is the leader, yet the average retail price of its nappies has fallen 20% over two years. Savings in raw materials will accrue in 2017 as a result of pulp prices falling in US dollar terms but Credit Suisse assumes the industry passes savings onto consumers.
The only earnings growth the broker recognises in its models for Asaleo Care is the partial recovery of one-off restructuring charges. Still, despite the downgrade the broker expects the company to generate $63m in free cash in 2017 and pay $46m in dividends.
Citi notes the company's policy of re-distributing excess cash and balance sheet gearing is consistent with the target range in net debt. The broker envisages limited scope for the current buy-back to continue and expects greater emphasis on a stable dividend payment. The pay-out policy is 70-80% of earnings but a higher pay-out could be sustained, reflecting the free cash flow. Citi lowers earnings forecasts by 16% in 2016 and 17% in 2017.
Macquarie was expecting headwinds in the tissue category but that personal care – feminine hygiene, nappies – would be more stable. The competitive environment at the end of 2016 and into 2017 appears set to get tougher, with Asia Pulp and Paper continuing to try and grow off a small base and ABC commissioning a new paper manufacturing facility.
The broker considers the risk are to the downside and the magnitude of Asaleo Care's downgrade so early in the year highlights the competitive nature of the sales categories in which it operates. The broker believes this will dent the stock's defensive reputation and weigh on ratings for some time. The reinstatement of the buy-back, which has around $25m to run, after the results may be the next potential positive catalyst, Macquarie maintains.
There are three Hold ratings on FNArena's database. The consensus target is $1.58, suggesting 7.2% upside to the last share price. This compares with $2.03 before the downgrade to the earnings outlook. The dividend yield on 2016 and 2017 forecasts is 6.6% and 7.0% respectively.
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