Two Small Caps With Big Consumer Brands

This story features FARM PRIDE FOODS LIMITED, and other companies. For more info SHARE ANALYSIS: FRM

By Tim Boreham, Editor, The New Criterion

Two small caps with big consumer brands promise better times ahead

In the world of small cap investing, a well-known consumer brand does not necessarily equate to a generous market capitalisation. In contrast, the custodians of some of our best-known names easily fall into the ‘microcap’ category.

We’re not implying that that these beaten-down stocks are always worth buying, but with some diligent renovation it might be the case. Our starting point is that it’s better to own a brand with entrenched goodwill that sings from the shelves, rather than a generic knock-off.

This leads us down the supermarket aisles to the egg shelves, where Farm Pride is synonymous with these ovoid delights. Yet for Farm Pride ((FRM)), there hasn’t been much egg-citement for investors in recent years.

Formerly the Victorian Egg Marketing board, Farm Pride has always been a quiet outfit, which has much to do with the fact its major holder West Coast Eggs accounts for just under 50% of the register and the top 20 holders account for 75%.

The company’s market worth is a paltry $14m.

It’s been tough times in the coop, with the company’s operations last year struck by avian influenza – covid for birds – which wiped out one-third of Farm Pride’s chooks.

The disease – which was bought in by migrating birds — resulted in an -$11.9m loss for the year to June 30, 2021, on revenue of $76.9m (down -15%).

 “12 months later we are still standing, which is testament to the early turnaround work we have done in the business,’’ CEO Daryl Bird told a recent investor briefing.

(And no – we’re not making that name up).

“We have carried out balance sheet repair and most importantly we have increased working capital and recovered all affected farms.”

Meanwhile the egg industry is being forced to adapt to the supermarkets’ collective pledge to eliminate cage farming by 2025, to be replaced by barn-laid or free-range production.

Four years ago, the commoditised industry was grappling with oversupply and a supermarket egg war erupted with price reductions of up to -40%.

Now the sector has swung to undersupply and Farm Pride is selling as many eggs as it can hatch. But retail prices remain down, down: a carton of large free-range eggs could be bought for as little as $3.90 compared with well over $5 five years ago.

Farm Pride has a circa 8% share of the retail sector that turned over $1bn last year. It’s a dominant supplier to home-brand (supermarket) labels which account for 60% of the sector.

The company’s owned or operated farms churn our one million eggs a day from 1.4m chooks, graded at facilities in Sydney and Melbourne.

Farm Pride is also leader in the circa $200m a year industrial sector, supplying ingredients such as egg liquids to mayonnaise makers.

Bird rues that as cage-laid facilities are phased out, production cost will rise but the retailers will demand less for more.

“Their endeavour is to push prices down and our endeavours as suppliers is to keep prices up,” he says.

“But given long lead times for rollouts, there will invariably be mismatches and we are planning for those.”

Bird admits the industry’s challenges won’t exactly egg on investors, but argues Farm Pride is well positioned to overhaul its core business and develop innovative products in an otherwise staid sector.

The latter includes higher margin convenience products (such as hard-boiled eggs), sports nutritional drinks and other forays into non-egg foodstuffs.

The pandemic, not surprisingly, has highlighted the potential of egg-based ingredients for home cooking.

 “While we are an egg producer of significance, we are primarily an FMCG (fast moving consumer goods) business and that gives us a good evolutionary track as far as innovation goes.”

Bird says that since he flew in to the top job in 2019, the company has stabilised cash flow and cleaned up its balance sheet. A superfluous facility was sold and in July the company entered a $18m sale and leaseback deal for its main facility and HQ in Melbourne’s Keysborough.

Farm Pride shares have gained 68% over the last year, which recognises the corporate renovation efforts and the tight supply.

Still, crestfallen investors have seen the value of their investment fall by -83% over five years.

Given the Farm Pride register is as tight as a battery cage the shares are as rare as hen’s teeth and scarcely traded.

The stock is capable of doing much better, given strong population growth and the egg’s status as key source of non-meat protein (and not the cholesterol bomb they were suspected to be).

McPherson’s ((MCP))

With a suite of popular personal care brands including Dr LeWinn, Manicare, Lady Jayne and Swisspers, McPherson’s has had more facelifts than an ageing Hollywood star but remains mired in mediocrity.

As with Farm Pride, as a supplier to the supermarkets McPherson’s has been pushed around by the big guys over the years and can also be hostage to currency movements.

That said, McPherson’s full year reported loss of -$5m for the 2020-21 year belies an interesting value proposition for the $120m market cap stock.

At the company’s late November AGM, chief executive Grant Peck described the year as “one of the most challenging in a decade”. And – boy – the company has sure had some challenging years.

The chief culprit was an -82% plunge in Dr LeWinn sales to China, which wiped -$15.7m from earnings and more than offset an increase in domestic home-based beauty sales.

The reported loss stemmed from significant items, including a -$6.7m write down of hand sanitiser inventory because of a market glut.

We should have seen that one coming!

The company has told shareholders to expect lower first (December) earnings, but in earnings before interest and tax (ebit) terms the full year should be $1-2m higher.

In 2020-21 the company reported ebit of $11.3m, -55% lower on revenue of $200m (down -10%).

In November last year McPherson’s acquired alternative medicine outfit Global Therapeutics for $27.5m, with this business chipping in $9.5m of revenue and $1.39m of earnings.

McPherson’s balance sheet is in fine fettle, which supports a generous dividend payout equating to a circa 5.3% yield, fully franked.

The shares have lost half their value over the last year, but all will be forgiven if management hits its target of $300m of annual sales and $50m of ebit by 2026.

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