BAL balance sheet analysis

This post is directed at all the Hot Copperites grappling with the numbers for BAL. I am not a holder in Bellamy’s and have neither a short nor long interest. As you may see from posts I have made on other companies, my aim is to help investors understand the balance sheet.

The first key point about BAL is that it is a virtual company – it doesn’t make the raw ingredients (or own the land/animals from which they come), it doesn’t own manufacturing plant and it doesn’t own any buildings. It doesn’t have any goodwill/intangibles as it has made no acquisitions. The Bellamy brand (which is very strong) has an inherent value but as it was founded when the company started, has no value in the balance sheet.

As such, Bellamy’s net asset value is essentially its working capital position, which is a great position when you have no debt, strong cash flow and great margins (i.e. BAL pre-June 2016).

The problem that arises is when your working capital deteriorates, and you need to borrow money to fund your working capital. The only security you can give your bank is your outstanding receivables and your inventory. You don’t have anything else of value (noting the brand Bellamy’s clearly has value but banks aren’t in the business of lending against intangible assets).

Since June 2016, when Bellamy’s went “all-in” on its growth strategy, the sales haven’t matched the ramp-up in production (and other costs such as sales and marketing staff). Faced with take or pay supply contracts, the working capital position deteriorated, with the cash balance of circa $33 million (as at June 30) the first thing to take a hit. In essence, this cash has been converted into finished goods or raw goods waiting to be manufactured.
Bellamy’s haven’t disclosed their debtor days position but it is also fair to assume that to keep the recently reported $1 million in the bank, they’ve delayed payments to suppliers. (Suppliers probably won’t admit this as they have too much to lose if BAL falls over).

To fund the working capital position, BAL have turned to their banker to provide working capital. Investors shouldn’t be concerned by a working capital facility as most companies use this to fund working capital. It’s much cheaper than the alternative which is to fund it from equity.

The problem for Bellamy’s is that they are restricted in how much security they can give a bank – remembering they don’t have assets such as property, plant or cows to offer as security. Based on forecast sales of $240 million per annum, this equates to $20 million per month. On the basis that wholesale buyers (not direct to consumer over their website) only buy one or two months in advance, they only have forward sales (invoices) of circa $40 million. Likewise, their inventory has some value but only the finished product. So from an asset perspective, they can’t borrow too much.

Banks also lend against cashflow and there is no doubt that Bellamy’s is still producing EBIT and NPAT. Banks will generally lend a multiple of EBIT (or EBITDA, but as Bellamy’s has no tangible assets, there is no DA - depreciation and amortisation). The multiple will depend on various factors, but is unlikely in the case of BAL to be more than 2-3 times EBIT.

Bellamy’s bankers will be reluctant to increase their debt facility size given the financial impact of the Fonterra payments, the risk that EBIT is squeezed due to reduced margins from the excess stock, that fact that margins could stay lower for longer given the excess inventory, and the fact that regulatory and market factors may reduce BAL’s profitability. The banker’s will also see the Fonterra poison pill as reducing the potential buyers for BAL (and thereby reducing the likelihood of their credit position being enhanced).

As such, should BAL suffer any further falls in EBIT, or should their inventory not reduce as quickly as planned/hoped, their bankers are unlikely to provide them with any additional debt.
Given BAL have no assets to sell, a further deterioration in their working capital position will force them to raise equity as they have no other alternative. The issue for shareholders is that because BAL has very few shares on issue (circa 100 million), a capital raise could be relatively dilutive, especially if by the time they need to raise the money, the market is aware of their troubles and this is reflected in their share price. (This is exactly what happened to Santos and Origin shareholders after the oil price tanked).

Assuming Bellamy’s need to raise circa $40 million, that might be at $2 per share, which means an additional 20 million shares. So the small number of shares on issue that drove Bellamy’s to a market cap of over $1.5 billion will now hurt the company IF it needs to raise equity.

The next thing that shareholders need to consider is are they being rewarded for the capital raising risk. Assuming the company can achieve NPAT that is 6% of turnover (as per recent company announcement), this implies NPAT of $14 million on turnover of $240 million. If sales/turnover slows, or if margins get squeezed due to the prices achieved clearing the high level of inventory, not only does NPAT fall, but working capital deteriorates and increases the chance of a capital raising. On the flip side, if sales increase and the inventory clears at a faster rate or better margin than projected, NPAT increases and working capital improves and reduces the need for a cap raise.

I don’t have a view on which is more likely to occur, but investors may as well go the casino and bet on red or black if BAL don’t improve their continuous disclosure. BAL needs to consider moving to a quarterly update (not 6 monthly) given their current predicament, and they need to go “above and beyond” in their transparency around their working capital (debtors, creditors, inventory and debt position), plus provide greater info on their sales, sales channel performance and margins. Greater insight into the Chinese regulatory changes would also help.

What investors do know is that current NPAT is forecast at circa $14 million, and the market cap is circa $420 million. At 30 times earnings, you need a number of things to improve post 2018 to justify that PE, but it looks cheap if both sales growth and margins improve to what was originally projected for 2017.

Like many companies who get in this position, they need a lot more than “hope” and “good luck”. They are fortunate that they have a good brand and sell products for which medium to longer term demand dynamics are clearly in their favour. But they no longer have the wind at their back, and with warehouses full to the brim, they need to execute very well. Their business model also highlights that wide margins may be a thing of the past as other “virtual brands” move in to the space.

Good luck to all shareholders/shorters and those considering on taking a position. I am happy to answer any questions or be openly criticised and hope that this analysis provides some insight into Bellamy’s current and future position/issues.