An Updated Analysis

Given the shorting action on TFC and continuing concerns being expressed on this forum, it is timely to consider TFC in detail as an investment. I believe the facts speak for themselves and I will let readers make their own conclusions. I will continue to trade 25% of my long-term holding to take advantage of price fluctuations, while steadily building my long-term holdings.

GROWTH

* The biological assets have increased by more than 3 times in 3 years to December 2016 from $261M to $839M. These assets are very real, and should not be ignored by investors concentrating only on cash EBITDA, as important as this measure is.

* Net tangible assets were up by 118% in 3 years to June 2016.

* Plantation establishment fee per hectare has increased by 38% in 3 years to June 2016, and another 8% since then. This is a sign of increasing demand from plantation investors.

* Total planted area has increased by 60% in 3 years to June 2016, and total owned area has increased by 74% over the same period.

* Management fees have increased by 60% in 2 years to June 2016 (3 year data not readily available).

* Product sales revenue has increased by 62% in 3 years to June 2016, before revenues from the greatly increased 2016 harvest.

FINANCIAL LIABILITIES

TFC’s total financial liabilities of $555M deserve further scrutiny.

This total includes $163M of external MIS grower liabilities, which are only settled when the relevant external MIS plantation interest is monetised, and will not require any additional cash contribution from TFC. It is therefore reasonable to exclude this MIS grower liability from the assessment of financial risk and gearing. The remaining financial liability of $392M is balanced by cash of $90M for net (non MIS) liability of $302M, or gearing of 28.2% on a net debt / (net debt + equity) basis. This is hardly a cause for concern with the amount of cash starting to come in, and the long maturity date for the corporate bonds to August 2023, when there is a huge step-up in harvests.

VALUE

The current price-to-book value is 0.72, a 28% discount. The current P/E, including the very real growth in asset values, is around 6.5 assuming a FY17 NPAT of $85M.

Providing the price of its products do not decline as the market grows in size (and I have previously made the case for why the price will not decline), what will NPAT be when the harvest increases by a further 10-15 times by mid next decade? Also what would be the P/E when this happens? My conservative estimate is an NPAT of 5 times and a P/E of 2 times for a true Disallowed.

Once TFC has the sustainable forest area of 22,500 Ha, they will not have to establish new forest areas with irrigation and other capital works, and will be able to harvest 1,500 Ha per annum over the long term. Alternatively, they could target 15,000 Ha by December 2018, and move to a sustainable average annual harvest of 1,000 Ha. I assume this would require grower agreement as it may delay a portion of some harvests. Once a sustainable operation is achieved, there will be reduced capital requirements and improved margins.

SHARE PRICE ACTION

A recurring theme on Hot Copper is that many investors do not want to invest now on a 5 to 10 year timeframe for peak harvests and revenue. Yet it is my considered view that the share price will rise steadily as:

* Shorters retreat on increasing certainty about the depth of the sandalwood market and TFC’s increasing value and financial outlook;

* Net asset values continue to rise strongly, making the price-to-book value even more attractive to investors. As TFC becomes better understood by the market, I would expect the discount to book value to reduce through share price increase.

* By mid 2017, Santalis expects to have results from four Phase 2 trials and to have commenced Phase 3 trials on one product. There are two further OTC products ready for launch, and one already on the market and selling 2 million units in the USA in FY16. TFC expects these OTC products to be licensed during 2017. In my experience with pharma companies, positive Phase 2 results are usually very positive for the market value of shares.

* A new $35M banking facility (the first since the GFC) for better managing the seasonality of revenues is a vote of confidence in TFC and will be at a lower cost of debt (subject to contract). TFC has confirmed the potential for capital management. In my view, this may include a new interim dividend in FY18.

* There should be further positive news this year about the purchase of more grower plantations from the 2018 to 2022 harvests.

* Announcements of further customer expansion and new commercial developments are likely during 2017, according to the latest presentation. This includes likely contracts for oil sales to China and India.