article 3 months old

Opportunity Knocking For TFS Corp

Small Caps | Mar 02 2017

Indian sandalwood producer TFS Corp is moving its focus to sales of its product and brokers laud the opportunity ahead.

-Prices received materially higher than previously expected
-Efforts being rewarded for diversifying end markets
-Strong competitive advantage should deliver high returns


By Eva Brocklehurst

Indian sandalwood producer TFS Corp ((TFC)) is starting to make significant headway in sales of its product and has embarked on a substantial ramp-up of harvest volumes. The company is in transition from a pure plantation manager to a product sales company. This transition means the company will be re-branded Quintis.

Canaccord Genuity observes TFS Corp is beginning to monetise its asset base at prices that are materially higher than previously expected. The broker calculates that on current heartwood yield expectations and current prices, each hectare is generating marginal revenue that well exceeds its marginal cost and investors' cost of capital. An oil price of just US$1,000/kg is required to generate a 10% pre-tax return on capital.

UBS forecasts a long-term oil-equivalent price of US$2,800/kg, versus current contracts at around US$4,500/kg on relatively low production. There is enormous risk around potential pricing, the broker highlights, after volumes ramp up in FY22, but the company is expected to have a significant time advantage over competing production.

Management has reiterated FY17 guidance for cash operating earnings (EBITDA) to increase by at least 25% on FY16 levels. The first half was the strongest on record, with plantation sales increasing 32% and providing a solid base for the seasonally high second half sales period.

As the company proves up the commodity price with long-term supply agreements, and there is more transparency on the scale of the market, Canaccord Genuity expects a sales process for the company's products to appeal to the larger investment community The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating and $3.38 target.

FY17 total product sales are expected to be in the range of $45-55m, a slight reduction on prior guidance of at least $60m. The difference is explained by lower Australian sandalwood product sales following market disruption associated with the delay to finalising a new 10-year supply contract with the Western Australian government.

There was also some deferral of Indian sandalwood product sales to the company's Middle Eastern counterpart because of complexities with the first timber exported to the region. This issue is now resolved and the group delivered heartwood to the customer in February.

Pharmaceutical Potential

Argonaut notes product sales are ramping up and demand for plantation investment products is strong, while the company's pharmaceutical business is progressing its trials, with four products in phase 2 and one potentially entering phase 3 in 2017.

The broker observes the company has put significant effort into identifying and widening its end-markets for wood and oil. The pharmaceutical market is a case in point and success is expected to not only deepen the market for Indian sandalwood but provide a significant value uplift to the company.

UBS believes pharmaceutical demand will be significant by the time production increases in FY22, although the channel is unproven. Indian Sandalwood has been shown to have anti-bacterial and anti-inflammatory properties and is currently used in acne treatments.

Argonaut notes earnings are typically heavily weighted towards a second half and a strong end is expected to the financial year. Despite a positive trend in product sales the broker pulls back earnings forecasts, partly due to the disruption previously mentioned.

In addition, the sale of wood products, as opposed to oil, has challenges associated with much higher volumes, quarantine requirements and regulations and this has hindered early sales. The broker, not one of the eight monitored daily on the database, has a Buy rating and $3.30 target.

Moelis considers TFS Corp a compelling investment opportunity, with a durable competitive advantage that should deliver high returns on capital. With the expansion of end markets and a considerable ramp-up in harvest volumes the broker believes the company is well placed. Moelis, not one of the eight monitored on the database, also has a Buy rating and a $3.18 target.

The business remains a global leader in the production of Indian sandalwood with a quasi monopoly and high barriers to entry. More detail was forthcoming from the  company on the options for the Santalis subsidiary, including contemplating realisation of value via either an IPO or trade sale.

UBS notes the structure the company is exploring entails retaining 50-60% ownership but providing a funding model for trials. If the company is successful in unlocking value from Santalis, the broker expects it to be accretive to valuation. UBS retains a Buy rating and $3.20 target.

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.

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms