Good post,
@Cain Treanor; good to see some hard numbers forming the basis for opinion, as opposed to the somewhat wild, unsubstantiated assertions that so often get made on a forum such as this.
I just have a few points of disagreement with some of your interpretation of things.
On
"Claim 1", which deals with the level of Inventories, you say that "Inventories are not overly high", and that they are at the levels where "we want them".
At 27% of Sales (or 25%, for that matter), no matter which way you cut it, that's high; I know of companies that have very long supply chains, involving multiple manufacturing and distribution nodes in multiple geographies around the globe, and they run with Inventory-to-Sales levels in the low-20%'s.
And then you say, "
We can run them (Inventories) down anytime we need to", well, that's not quite right; market conditions need to be right for that to happen. Being able to liquidate stock equivalent to 3 months' sales will not occur at the election of Capilano management [*], demand will need to exceed supply for a period for that to happen; and when that might occur is very difficult to predict. But really, its an extraneous factor that is outside of management's control.
([*] Unless, of course, they shut in some capacity, but I don't think the honey manufacturing industry lends itself to that course of action);
Finally, on this topic, for completeness, I have added the 2012 metric to your comparison of Inventory-to-Sales
2012 - 19.2%
2013 - 25.39%
2014 - 15.97% (shortage)
2015 - 19.31% (slight recovery)
2016 - 29.03% (full recovery)
2017 - 27.5 % (optimal)
Also, for added colour, I have presented these figures on a half-yearly basis (based on Period-End Inventory-to-Half-Early Sales figures that have been annualised):
JH12: 18.4%
DH12: 17.5%
JH13: 24.0%
DH13: 16.3%
JH14: 17.5%
DH14: 15.8%
JH15: 18.6%
DH15: 24.3%
JH16: 29.2%
DH16: 28.8%
As can be seen, the period of Inventory build (i.e., in JH2013), which you referenced as a comparison to today's situation, was quite short-lived, before normalisation of the Inventory position soon resumed. That's not the case today.
What causes me some concern is that the current oversupply situation (to the extent that's what CZZ's inventory build represents) has been in place for the past 4 half-year periods, which is a reasonably protracted period, I would have thought.
And given that this Inventory-to-Sales metric has been at elevated levels compared to the company's history, for some time, I'm not sure that I share your conclusion that it is simply not a problem.
I also can't see why a stock position equivalent to more than 3 months' worth of Sales is "optimal". It's plain crazy talk to be happy have all that capital tied up for so long.
On
"Claim 2", where you argued that operating margins are intact, on that point you are absolutely correct.
But the beef some people are having with CZZ is not with Operating Margins overall, it is with
Gross Profit Margins (GP Margins).
The two are totally different things, because Operating Margins take into account the Cost of Doing Business, as well as Cost of Sales, as a proportion of Revenue (whereas GP Margin relates only to Cost of Sales relative to Revenue).
And what you have missed by looking at just Operating Margin, is what is happening to the individual
components of Operating Margins, namely Gross Profit Margins and Cost of Doing Business Margins.
Starting with Gross Profit Margins, which have been undergoing a decline which I find to be concerning, as follows:
2012: 45.3%
2013: 46.1%
2014: 43.9%
2015: 42.0%
2016: 41.4%
This unfavourable trend (and its not just a one-off event; it has been in place for several years now), combined with the Inventory build suggests to me that the company is having a bit of a pricing power problem and - related to that - is struggling to sell what it produces.
But back to your original position about Operating Margins being intact, yes that certainly is the case, but that's not because of an absence of pricing pressure on the product; rather its because the business is experiencing the usual "fractionalisation" of fixed costs that occurs when Revenue grows strongly:
To wit, Cost of Doing Business to Sales is as follows:
2012: 35.6%
2013: 36.4%
2014: 34.6%
2015: 31.1%
2016: 30.4%
(Note: these figures have been derived after the elimination of non-recurring items, such as profits on asset sales, Beeotic start-up expenses, fore insurance claims, etc.)
And that sort of trend in falling CoDB-to-Sales is quite typical, and indeed to be expected arithmetically, from businesses whose Revenues grow faster than their fixed cost bases
But, as you can see, the
500pb positive contribution to Operating Margin from the CoDB-to-Sales, has been mostly neutralised by the 400bp fall in the GP Margin.
So, in the classical textbook case, for rapidly-growing companies, assuming they are able to maintain GP Margins, their Operating Margins should increase over time as their CoDB-to-Sales falls naturally.
In CZZ's case this hasn't happened, because of the pressure on GP Margin.
So when you say Operating Margins are stable, you need to scratch beneath the surface somewhat in order to be able to understand what is really happening inside the business.
And I don't think there is any way that you can argue that falling GP Margins is an OK thing the be happening, especially when that is still leading to increases in the levels of unsold product.
As for
"Claim 3", dealing with Receivables, here I agree with you fully; there is nothing untoward or unusual about this aspect of the company's financials.
They've got a few very large domestic customers, meaning that payments terms will always be on the terms of those gorilla customers, not CZZ's.
On "
Claim 4": you say that it is false that they are not generating cash because they have been investing in worthwhile things.
I disagree strongly with this statement, and I do so based on the financial facts, as I'll lay them out below.
Let's look at what has happened to the capital flows of the business over the past 4 half-year periods (not chosen randomly but because this is the period over which the Operating Cash Flow line has had a negative value in each period):
Over that four half year period, the company reported a cumulative EBITDA of $32m, which,
prima facie, is impressive.
Out of that, it had non-discretionary calls on capital of $9.6m in total tax payments, and about $1.0m in total interest payments.
That left some $22m in total for discretionary allocation.
Out of that $22m (and supplemented by $16.8m of fresh equity capital raised in 2016, as well as $8.0m higher borrowings), the following was how the discretionary capital was allocated:
- cumulative capital expenditure consumed around $4.5m,
- Payment for Intangibles totaled $3.0m
- $2.2m was invested in Net Trade Working Capital (i.e., change in Receivables less change in Payables over the review period)
- $24.6m was invested in Inventory
- acquisitions totaled a modest $0.5m (the recent sale of Manuka assets to the JV with Comvita offsetting the purchases of the stake in Western Honey Supplies last year and Kirksbees in July 2105)
- dividends accounted for $7.0m.
So as you can see from the above assessment of the sources and uses of the company's capital over the past 4 years, the largest item of capital consumption - by an order of magnitude - has been to fund the build-up of Inventories.
Indeed, the Inventory increase, on its own, came to almost 50% more than all the other items combined(!)
So, no, I think that it is clear that it is not "mostly worthwhile things" in which they have been investing... overwhelmingly, as the numbers how, it is in stock.
(In fact, cynical observers of CZZ's capital flow situation could be forgiven for interpreting it as a case of CZZ having to raise capital from shareholder because the company has been unable to sell all that it produced over the past 2 years.)
Finally
"Claim 5":
Yes, here I agree with you as well; demand is still growing, albeit not as strongly as it was a few years back. But - given the acquisitions that have been made, as well as assets that have been sold in recent periods, it is a bit difficult to get a sense of the organic growth in the business.
But, for the record, here are the half-on-half growth rates by geographic segment, based on reported Revenue numbers:
Half-Yearly Revenue Growth (on pcp)
A. Domestic
DH13: 24.9%
JH14: 16.7%
DH14: 37.8%
JH15: 47.9%
DH15: 12.2%
JH16: 4.3%
DH16: 5.2% (I assume that this was impacted to some extent by the the non-recognition of Manuka revenues for the first time)
B. Export
DH13: 39.5%
JH14: -4.0%
DH14: 20.5%
JH15: 40.4%
DH15: 32.0%
JH16: 13.2%
DH16: -23.2% (I suspect this reflects the non-recognition of Manuka revenues for the first time)
Whenever I analyse businesses with a view to investing in them, I always like to pretend that I am the sole owner of a company, but with no involvement in the day-to-day running of the business, instead preferring to hire people to run my business for me, leaving them to do so without interference and meddling from me with the exception that they need to, twice a year, report to me what they have been doing with my business, and why.
If I was the sole owner of CZZ, and my appointed managers came to me for 4 successive occasions telling me that no cash was coming out of my business (especially since they just 6 months ago asked me to put more of my capital into the business)... if that was the situation, I can tell you that the last thing I would be about it, was relaxed.
On the contrary, I would be asking those managers I had appointed so very serious and aggressive questions.
