Overview: A manufacturer of health and wellness products with the majority of revenue coming from the contract manufacture of products for private label clients (think healthy snacking, energy drinks, protein bars and nutritional powders).
The share price has been more or less on a downward trend since mid 2019, falling from highs of $0.60 in May 2019 to a paltry $0.11 at the time of writing.
The market’s concerns: There are likely two key drivers of the continued devaluation. The first is performance-related, as the group has struggled to achieve EBITDA profitability from its operations. I think this coupled with current cash burn also likely has some predicting a capital raise in the next 12 months. Secondly there is the departure of the founding couple and the negative market sentiment as a result of their share overhang and continued selling of these shares.The performance related concerns are real, however, I believe the market misunderstands the industry and business model. More on the financial performance later.On the co-founders continuing to liquidate their positions; I think it is probably more about lifestyle than a reflection of the group’s performance. The co-founders set up and ran the New Zealand part of the group, which acquired Omniblend, an Australian business. Ultimately they were removed from management with the CEO of Omniblend (Danny Rotman) taking over. Looking at their respective experience levels, I’m fine with that decision. Furthermore, founders usually sacrifice their personal fair market value now (based on qualifications / experience), for the promise of a payday in the future. Reviewing earlier financials, it’s clear these founders reinvested earnings into growth and paid themselves meager salaries; I’m okay with them realising some of what they have created after an IPO, especially when they are removed from management. In other good news, management’s current strategy of pursuing top-line growth means the founders will almost certainly miss out on their profit predicated class a and class b performance shares. In summary, I think we’ve seen the last of any truly meaningful overhang selling pressures.
Financial performance: FY21 revenue (financial year ending March 31st) was up 125% to $50m. Revenue from their proprietary brands was up 6.5x to 4.2m. They’ve also been reducing costs, with a $1.2m sustainable cost-out restructure and process improvement project recently completed.The group saw normalised group EBITDA of $1.1m for 1H FY22 (the half ending 30 Sept 21), compared to a normalised loss of $0.9m in the pcp. I believe the new debt facility and these (finally) positive normalised EBITDA results make the likelihood of an imminent capital raise unlikely. It’s worth noting that the cost-outs and some of the significant contract wins from 1H FY22 (e.g. the huge USD 40m partnership with Theland China) will only be properly reflected in the 2H FY22 data. On margins: gross margins are perhaps one of the most important indicators of viability and potential in the FMCG contract manufacturer space (e.g. it would be easy for a restaurant to quickly grow revenues if the price of the meal were cheaper than the sum of the ingredients that went into it - the same is true of contract manufacturing). Pleasingly gross margins, along with revenue, are increasing. There are a few curly numbers to adjust for, but 1H FY22 gross margins have increased by ~2% when compared with 1H FY21 and currently sit at ~23%. I think that’s a reflection of management’s strategy targeting growth for operating leverage as well as investments in state of the art machinery built to scale.
Out-of-lockdown tailwinds:Own-brands: the group have seen significant growth in their own proprietary brands, which were up 6.5x in FY21 (albeit from a low base) when compared to FY20 and make up 10% of group revenue. I like this focus. It disproportionately helps group margins when compared to solely focusing on contract manufacturing. Further, this growth was achieved amidst lockdowns and the spectre of ongoing lockdowns. Impressive given their portfolio of branded products includes protein and energy drinks, bars and supplements distributed through chains like Anytime Fitness, Snap Fitness, F45, Plus Fitness, Jetts Fitness and Supplement World. I’m glad to see they’re also bringing some entrepreneurial spirit to the team, with the co-founder of Voost Vitamins (recently sold to Proctor & Gamble), recently coming on board as a strategic advisor. I’m expecting an accelerated growth trajectory for their portfolio of proprietary brands in 2H FY22. Would love to see them bring some of the marketing and branding capability in-house, but they see themselves as a manufacturer first and foremost and I can live with that focus.I’m also bullish about their protein bar plant which commenced commercial operation in September 2021. That’s a rising tide product category, particularly if they can execute on a low / mid price own-brand option. There’s also significant cross-sell opportunities with their contract manufacturing clients; they have already seen multi-million dollar orders with initial total commitments exceeding their expectations.
Key risk: the market’s concern that revenue won’t break away from costs is vindicated. On this, I believe the market misunderstands the operating scale required for profitability in FMCG contract manufacturing and has largely missed the significance of the revenue growth rate and positive normalised EBITDA in the last half.
Summary: In the near future I’m estimating FY22 (year ending March 31st) revenues of $65m, for $2.8m normalised EBITDA on a 15x industry multiple = market cap of $42m. As of writing, the market cap is ~$29m at 11c. I’m anticipating strong top-line revenue, EBITDA and ultimately share price growth to continue through Halo's FY23. Share price movements are often uncorrelated with underlying performance. While I think the market has been right to show concern for Halo’s lack of profitability, I believe their lingering frustrations are getting the better of rational thinking on this one. I’m grateful for the extra pessimism and liquidity provided by the original founders; I believe that, coupled with a misappreciation of how strong revenue growth is often a precursor to strong profitability growth in contract manufacturing has led to a significant undervaluing of the company.I think TEP is onto something with their TA analysis too. I am hoping the $29 million market cap represents the bottom of investor cynicism. Just purchased at 11 cents in SM and in real life.
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