I spoke with the company earlier and here are some notes from my conversation and my general thoughts about the investment case for Capilano.
Margins
As I suspected gross margins rose slightly in the half reversing the recent trend. When you consider operating profit was steady despite flat revenues and Beeotic investment, this was obvious really.
The Australian honey retail market has been flat for a number of years on a volumes basis. CZZ has increased its market share over the past few years from c50% to 70%+. However, high inflation means the value of the domestic retail market has grown considerably over this time with consumers paying up for Australian honey. Capilano's strong sales over recent years is a product of these two factors as well as growing export and premium variety sales.
At the same time the price Capilano pays to its beekeeper suppliers has gone up as Cain said previously from less than $3 to over $6.
Capilano tries to maintain its % margins but as you can imagine a 100%+ rise in a few years is not so easy to pass on. But given % margins have only been eroded a few percent, margins in $ terms would be higher today than they were previously. So margin erosion is not something to worry about in my opinion.
Inventory
As Cain said, Capilano primarily likes to maintain high inventory because a bad honey season means domestic supply can fall away very quickly. It makes sense to keep high inventories to maintain sales through the cycle and avoid leaving equipment idle. This is especially true in light of the inflationary dynamic described above. Cash will lose value over time but the chances are honey prices will rise ahead of inflation.
A couple of other reasons to keep high stock levels:
1) The company has 3 packing facilities in WA, VIC and QLD. It is expensive to transport honey between these so the company makes sure each has enough honey that a bad season in any particular region will not disrupt sales/equipment utilisation.
2) Various different varieties are required to create the correct blend for each product. These are dictated by the flora that the bees feed from. Keeping a number of different types of honey obviously increases overall inventory requirements
The company has now replenished its stores sufficiently so operating cash flow should improve from here.
Other notes
Receivables are slightly up because of the change in sales mix towards higher priced Australian honey.
Payables are down as inventory and hence purchases have stabilised.
The $2 million in non-current assets relates to part of the consideration paid by the Medibee JV. As I mentioned before you can see that only $7m was received in financing cash flows but the total consideration was $9m.
There is no funding pressure. The company has an open line of credit with its lenders of up to $30 million.
NZ peer Comvita recently announced that sales and profits will be down this year due to low honey supply in turn because of adverse weather. Some on here have suggested this represents an opportunity for Capilano as Comvita has a large export business into China and Capilano could step in to fill the void. This isn't really correct as Comvita is primarily a Manuka provider whereas only 5% of Capilano's receivables relate to Manuka.
The fact Comvita is currently going through such difficulties again reinforces the case for holding high honey stocks.
The two JVs set up this year are yet to reach profitability. The commentary accompanying the half yearly explained that this is because they are splitting the hives to reduce disease risk and improve volumes over the longer term. This requires the sacrifice of reduced production in the short term.
Growth
These JVs are important because they give Capilano direct control of its honey supply. Given the prices it pays to beekeepers have doubled in the last five years for standard honey it makes a lot of sense to vertically integrate.
Not to mention the fact that the Medibee JV with Comvita will see Capilano increasing its sales of the much more valuable Manuka varieties. Capilano currently sells its Manuka honey into the retail market but this JV also opens up the lucrative healthcare market where this antimicrobial honey is used to treat wounds.
Finally, the recently launched Beeotic product is the world's first prebiotic honey. Probiotics are a rapidly growing consumer market segment and unlike most product in the category, Beeotic does not require refrigeration.
Then there is China where sales were up 87% last half.
There are plenty of growth levers here.
Management
Under Ben Mckee's leadership, Capilano has grown from a $2m to $10m npat company in a few years. This has been achieved in a market where volumes are stagnant. I think that this implies a great deal of skill.
The company has achieved this partly by offering smartly packaged premium honey varieties to consumers and thereby differentiating what is essentially a commodity. This is clever marketing.
Ben Mckee has shown he is committed to supporting the company's beekeeping supplier base. The purpose of the JVs is partly to provide training facilities for beekeepers. Beekeepers remain loyal to Capilano because Capilano doesn't squeeze them on price and buys honey from them in both good times and bad. This again reiterates why margins and inventory levels far from being a problem are actually in the best interests of the company. This is a sustainable approach and is evidence of long-term thinking by management.
Moat
There are four parts to understanding Capilano's moat:
1) Beekeeping is difficult and unpleasant for most people. The fact it is a trying industry (more so than most agribusinesses which all have plenty of challenges) means it is less likely to attract competition.
2) Most of Australia's beekeepers supply Capilano today. As previously mentioned Capilano looks after them and so it would be very hard for competitors to replicate this network.
3) Capilano has by far the strongest brand in the market both in terms of recognition and share.
http://www.capilanohoney.com/au/new...warded-most-trusted-in-reader-s-digest-awards
4) Capilano has the largest packing capacity in Australia and therefore can process honey more efficiently than anyone else.
Summary
So overall we have a business with a sustainable competitive advantage, more than competent management and lots of growth opportunities. I think a 15x multiple is quite reasonable.
