Do you have a view as to whether the company is doing the right thing stepping up investment into PP&E, thereby depleting cash, at a time when the resources sector is under significant stress?
Transversal,
I think far too few investors think enough about the stewardship of the capital of the business
in which they invest, so your question is most apt.
My observation is that, generally, company executives are woeful allocators of capital. Both the frequency and size of write-downs that are made willy-nilly in many companies bear full witness to that.
But what I can say, without hesitation, is that when ARB management decide to invest shareholder capital to some or other end, a superior return on that capital invested is assured.
The reason I say this is based purely on precedent which shows that the board presides over capital deployment in a very judicious manner. Take the decision in 2005 to invest in manufacturing capacity in Thailand. That first plant (which cost around $4m in then money-of-the-day terms) has been expanded twice since then due to demand for its products, and a new factory was also commissioned in 2013 which - in turn - has been increased in capacity since then, along with associated warehousing and distribution capacity.
I am convinced that the rise in the group's Gross Profit Margins over the past decade - from around 51% in 2005 to just on 55% today is largely attributable to the operational flexibility from the company's low-cost Thai manufacturing capability.
In terms of the $48m invested overt he course of FY2015, I interpret this largely to be of what I like to call a sales facilitation nature (i.e., infrastructure required to support higher levels of sales into the future). This is centered on mainly on warehousing capacity in Australia, Europe and the US, as well as establishing 3 new ARB stores in Australia during the year (taking the total number of stores to 30, of which I think just a little under half are directly ARB-controlled).
One thing ARB management have done very well, I have observed, is to invest well ahead of the demand curve so that when demand growth does occur, the company has ample capacity - manufacturing and across the supply chain - to meet that demand increase.
Note that most of the additional warehousing capacity invested in during the past 12- to 18 months has only been commissioned in the past 6- to 9 months, so its impact on driving higher level of sales is only just starting to be seen (witnessed by 11% sales growth in JH2015 vs pcp), but will have continued momentum in the years ahead.
Also, be aware that included in the $48m capex spend (which, incidentally, had a DH2014/JY2015 split of $39.6m/$8.5m) was $19m incurred in DH2014 for the purchase of the property on which the company's factory in Victoria is located. My sense is that the company's management wants to restructure/upgrade/reconfigure that factory but the previous landlord wasn't keen to support it, so the board decided to simply buy the property outright so that they could do with the factory as they saw fit.
So, in summary, I think that what we are seeing here with this capital expenditure ramp up is what I call an investment in facilitating sales growth. We've seen this before from the company.
And finally, and this is one of the most important points of all with this result, I think: just as there is a capex investment ahead of sales growth, so too is there a cost investment.
It stands to reason that when new sales or warehousing facilities are being established they have to be fully resourced (i.e., manned and equipped, and with full utilities being in place and utilised, eg. power, water, services) from day one, but they do not immediately operate at optimal steady state conditions from a business activity point of view. So there arises a temporary mismatch of Costs and Revenue.
Certainly, this result has several hallmarks of this "cost front-loading" (e.g., while Sales growth was up 10.7%, Employee Expenses rose by 15%) . The result was EBIT margin falling to 17.2% in DH2014 from 18.5% in pcp, and to 19.3% in JH2015, from 20.0% in pcp. (Note that margins in Dec half-years are are always seasonally lower than June half-years.)
So, the FY2015 result looks to me like it is quite heavily padded with operating expenses ahead of matching sales.
As capacity utilisation increases within these new pieces of supply chain infrastructure without a required commensurate increase in costs, expect this margin diminution to reverse in upcoming financial periods.
For what it is worth, my modelling points to around 10% Revenue growth in FY2016, and 18% Pre-Tax Profit growth as the operating leverage (which was missing in the FY2015 result per the discussion above) starts to come through.
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