"One query is whether you have allowed for the increased WC to...

"One query is whether you have allowed for the increased WC to support the extra sales? I can't tell whether its allowed for in your net receipts figure. Specifically for every dollar of extra sales they need to invest around 25c in inventories."

Yes, I provide for this by running Working Capital-to-Sales in the model as a fixed value (so as Revenue rises, it drags Working Cap up with it). As can be seen in the graphic below, I provide for an increase in WC-to-Sales from FY24's 34% (to account for the fact that there is likely to be some inventory lock-up during the commissioning period), to 37% going forward (which is not far off the level during and following Covid (2020/21/22), a period when the company's supply chain became very extended.)



Note that you are able to see the evidence of this Working Capital build in the difference between EBITDA in the abridged P&L and Net Receipts in the abridged Cash Flow Statement from that table in my previous post. Over the four year forecast period, the cumulative difference between EBITDA and Net Receipts amounts to $8.6m ($99.2m cum. EBITDA between FY2025 and FY2028 vs $90.6m cum. Net Receipts).

So a conservatively chunky provision for future Working Cap, I feel.


"My previous statement that a cap raise looks quite likely is on reflection more a statement on my own aversion to debt than on the companies inability to fund Montrose without new equity. Quite possibly the board does not share my aversion, though i kind of intuited from the results call that funding options haven't been finalised.
IMO 40m peak debt isn't an insignificant sum for the size of the business. It may be manageable in a completely benign business environment but "things" can occur. I do get that this is probably good debt in terms of it hopefully leading to a much more efficient manufacturing base."

Yes, it certainly is what I'd class as "good debt" because they are bursting at the seams in the Brunsdon St factory which has caused all kinds of diseconomies of scale because it has become a rabbit's warren. So they have to do this expansion. In fact, I thought they would have to commit to it years ago, but somehow they somehow kept juggling plates in the air, but I think they are now totally out of wiggle room.

But, like you, I prefer to not own businesses that are beholden to lenders and I think some of the directors are of the same view (including the Chair of the board) but at the same time I think the Cheetham family have an aversion to being diluted (that aversion is what has kept the Issued Capital account largely unchanged for more than 20 years and absolutely unchanged since 2009). So, if equity funds are required, I am sure it it will be to an extent that the controlling family are able to take up their entitlements. I therefore don't think it will be a very big one at all, of it happens.

I mean, consider a 1-for-10 raise, to bring in maybe $8m. That would mean the family would need to cut a cheque for close to $3.5m and I'm not sure they have that kind of liquidity sloshing around under the family mattresses.


"While I have your attention on this business that I am trying to understand more I have one quick question. The investment in intangibles over the years haven't lead to higher rates of profitability as measured by ROE or ROCE. From the period I have modelled the business struggles to break into double digit ROE. Do you see potential for this to change?"

Good pick-up. Yes, this is one of by biggest brickbats about the company, and which has always limited how much of my family's capital can be invested in it.

Despite doubling Revenues over the past decade, it has not scaled very well compared to business economics theory, i.e., Asset Turnover and Operating Margin should rise as a business expands (hence, so should ROCE, being the product of Asset Turn and Operating Margin, rise).

But while Asset Turn has gone up (it was 1.86x in FY2022 [*] compared to 1.65x a decade ago), the EBIT Margin hasn't done much at all over time (well, until the cracker of a result in FY2024, that is.)

The healthy top-line organic growth has therefore not translated into a fractionalising of fixed cost overheads (which is what one expects from classical business economics).

CoDB-to-Revenue has bobbed up and down in a cyclical fashion, but is largely unchanged over many years.


This has had a dampening impact on earnings growth relative to revenue growth and has hamstrung ROCE, which is a pity because just about everything else is a good story.
(You can do the basic maths; if CoDB-to-Revenue had amortised lower as theory dictates, to say 35% today from the latest 42%, we'd be talking about 50% higher profitability today, and ROE in the mid-to-high teens.)


Having been a shareholder since 2010, this sluggish CoDB-t0-Revenue is something to which I've been able to devote considerable thought, and I've concluded there are three main reasons for this:

1.) I don't think it is a strong management focus from a corporate culture point of view. Remember this is really a family run business with strong R&D DNA. None of the people around the boardroom table are hard-nosed finance and valuation theory types.

2.) Even if addressing CoDB was a management focus, it is not just the founders that are a family, but the entire workforce resembles a sort of extended family, with plenty of long-serving employees. The business is not run very hard and employees aren't made to sweat too much, is my clear sense on the occasions that I visit the factory. Of course, the trade-off is a happy and contented workforce which is loyal and doesn't present too many dramas.

3.) Even if it was a management focus and even if management felt employees needed to be driven harder, and headcount needed to be reduced, the sheer physical constraints in the factory would make this very difficult to do.

Without knowing for certain, I suspect that the factory which has been operating at full capacity for a number of years is a meaningful contributor to CoDB remaining stubbornly higher than it otherwise could/should be. It has constrained operational flexibility.

So it will be interesting to see the extent to which the new factory will provide some step-function change in CoDB-to-Revenue, leading to higher ROCE. It stands to reason it will, but it will be at least a 3-year wait for that extent to become manifest.


[*] Note that any asset productivity metric from FY2023 is meaningless as a comparator with history, because of the purchase of the Montrose property in FY2023, which contributed to a big (+30% increase in the Asset base in that year)