The article:Keytone Dairy: Tone your portfolioASX: KTDMarket...

The article:
Keytone Dairy: Tone your portfolio
ASX: KTDMarket cap: A$56.5M
Share price: A$0.22552
-week range: A$0.195 / A$0.46
Keytone Dairy mainly operates in Sydney, Melbourne and Christchurch (New Zealand). With its headquarters in Sydney, Keytone is a manufacturer and exporter focused on dairy and nutrition products as well as the company’s proprietary health and wellness brands. What makes this company unique among its dairy focused peers is its lack of focus on China. Keytone has seen phenomenal growth over the last financial year and FY21 has been no different. While its products specialise in health and wellness, we think Keytone’s stock will offer investors a great chance to bulk up.
Turn the product over and get at the stats
Keytone has two main divisions: the sale of proprietary brands and contract manufacturing but the company only moved into Australia during FY20 (running from February 2019 through March 2020). The only countries where Keytone generated revenue during FY20 were Australia and New Zealand. This is important to note, because, as we will focus on later, FY21 has seen Keytone drastically expand its geographic footprint.
Keytone currently has four main proprietary brands focused on milk powder, ready-to-eat meals and snacks, high protein ready-to-drink solutions, and for a bit of variety, fudge. While this division’s total revenue of $2m only represented 9% of FY20’s total revenue, the year-over-year growth was 78%.
The contract manufacturing division generated $19.1m in revenue during FY20 and, at 84.8% of FY20’s total revenue, Keytone is clearly a contract manufacturer. To quickly summarise what this means, contract manufacturing is when the company uses its facilities to produce products for third-party private labels. During FY20, due mostly to the expansion into Australia, this division’s revenue saw staggering growth of 1,932% year-over-year. However, we expect the proprietary brands division to overtake this division in size in the coming years. You see, Keytone’s main focus is on expanding the sale of its proprietary products through introduction into new markets and retailers that did not previously stock Keytone Dairy.One of our concerns when we first looked into Keytone was what portion of its revenue growth was due solely to entering new markets. As a quick recap, the company’s proprietary brands division and contract manufacturing division increased revenues by 785% and 1,932% respectively during FY20, i.e. including new markets. However, just in New Zealand these divisions still grew 20.8% and 140% year-over-year, respectively.
Where’s China? Many of Keytone’s dairy peers, like A2 Milk (ASX: A2M) and Nuchev (ASX: NUC) are focused heavily on China for growth. Therefore, the geopolitical conflict with China that Australia has found itself in of great concern for them. Keytone, meanwhile, derived the majority of its revenue from Australia and New Zealand during FY20. In the company’s 2Q21 report (Ending 30 September 2020) it was mentioned the company had seen significant orders out of China, though, specifically for the contract manufacturing division, after an order from Walmart China. The company’s overall 1HY21’s recordbreaking $25.9m in revenue represented a year-over-year growth rate of 250%. While China certainly has the potential to offer strong growth opportunities going forward, the majority of revenue growth comes from Australia and New Zealand with the company’s proprietary brand Tonik and Super Cubes in Australia recording $11m in revenue during 2Q21 alone. It’s very difficult for companies in the dairy industry to avoid China, the growth is just too enticing. The reason we think Keytone stands above its peers is because the company’s significant growth is not reliant on China, but it is prepared to benefit from the opportunity there.
Keytone’s New Zealand business saw a record quarter as well with $3.3m in sales, representing 172% in growth versus 1Q21.While Keytone certainly has exposure to China, we believe the majority of the company’s growth over the next couple of years is slated to come from Australia and expansion into the Middle East, Malaysia and other geographical locations. Give me the risksThe risks facing Keytone investors currently focus mostly on the lack of profitability. During FY20 the company saw its EBITDA losses increase from $3.2m in FY19 to $5.9m. Unfortunately, there is no clear timetable for when Keytone will enter EBITDA profitability and we believe the company’s continual expansion will likely inflate its expenses over the next year at least. This situation does lead to the risk of the company issuing additional equity to fund its expansion. However, we remain confident that Keytone’s continual growth will more than make up for any dilution investors may have to face. Let’s bulk upLike Keytone, Nuchev is not yet profitable either. However, the latter has significantly more exposure to China. The market currently expects Nuchev’s revenue to grow by 5.6% during FY21. Nuchev’s FY21 EV/Revenue currently sits at 2.9x. While we don’t have any FY21 estimates for Keytone, if 1HY21 is any indication, the company is looking for another strong year of revenue growth, i.e. in the triple digits. It is also important to remind our readers that Keytone does not have nearly as much China-specific geopolitical risk associated with it as Nuchev. Yet, if we were to just take the $25.9m of revenue generated during 1HY21 and assume flat growth for 2HY21 as the company’s full year FY21 revenue (an absurd prediction we are using for effect), Keytone would have a FY21 EV/Revenue ratio of 1.5x. In reality, though, this will turn out to be a lot lower, given the expected revenue growth in 2HY21. In our view, Keytone seems to be a clear-cut case of the market not realising that this company even exists, which makes this a strong four star rating for us.