IGL (ASX) my latest thoughts on IGL

Originally posted by MarsC: ↑

IVE Group (ASX IGL) has been savaged by the market in the last couple of months, with the price down 30% from the highs reached in Feb. What has gone wrong?

On my viewing, a few things have disappointed and even spooked the market. Off the top of my head and in no particular order, I see the following (others may disagree or wish to add):
The value of the Ovato acquisition is now being revised down & associated “restructure” costs seem to be getting revised up(?) (I personally don’t remember the need for retrenchments being articulated, at the time of the acquisitions. Something that is now being provisioned for).
Working capital needs (especially wrt inventories) have destroyed cash flows in FY23.
Margins are struggling to regain pre-covid levels – even remotely, and even before we account for the continuing restructure costs.
Management seems to be pursuing too many “growth strategies” and now seems to be juggling too many balls. Prospects for further acquisitions and the likely demands on capital loom, and the current very high dividend is looking more & more like a promise that the business will not be able to sustain.
I will make an attempt to address each of these, in the numbered order.
My inspection indicates that whilst the acquisition of the Ovato assets is not looking like the mouth watering morsel that it promised, it is still looking like a valuable & rational acquisition. Not only did it provide cheap assets with synergistic value to IVE, it also helped consolidate the market into the hands of IVE and served the purpose of reducing market competition. The value it will deliver to IVE may be greater than the headline numbers suggest. In truth, I think this was an opportunity that was too good to pass up, and had to be executed at short notice.
Demands on working capital have suffered a multi-pronged assault. Firstly the Ovato acquisition has increased WC needs, substantially. Secondly lingering supply chain issues have only recently started receding, and management made the wise decision to increase inventory levels in what are long lived assets. Thirdly, inflation has raised WC needs, in nominal terms. I see no compelling reason why WC should not normalize soon, as management has stated. I also see no reason why the recent headwind to operating cashflows caused by WC won’t become a tailwind soon.
It is true that operating margins are well below the level achieved prior to covid. However my own estimates indicate that organic growth is still recovering quite strongly, though revenues are still well below pre-covid levels on an organic basis (especially on inflation adjusted terms). This trend is clouded by the various acquisitions – especially the recent Ovato acquisition. My numbers indicate that over time, organic growth mirrors retail sales, especially in the household-goods space (representing nearly a quarter of IVE’s revenue)(see my chart below). The picture over the covid period is complicated by the lockdowns. For instance, HVN & JBH did not markedly change their magnitude of marketing expenditure during covid (even though their sales went through the roof), but they did shift expenditure from traditional channels to the online space, thus hitting IVE’s revenue (taking JBH & HVN as proxies for broader national patterns). Whilst it could be argued that traditional retail should already have normalized in FY23, I think we are still in a very dynamic situation. My sense, on my viewing of ABS data, is that retail sales are now soft mainly because of a renormalizing of the crazy spending seen during covid. In short, I think there is likely still a lot of opportunity for B&M retailer behavior to get back (or at least closer to) the patterns that existed pre-covid, which may help to “re-normalize” IVE’s revenues. In short, I suspect there is a reasonable opportunity for margin expansion from current levels.
TRT = total retail trade value (ABS)
TNFRT = total non-food retail trade value (ABS)
HHG = household goods retail trade value (ABS)
I have may concerns about the continuing pursuit of “growth” opportunities. I particularly have concerns about the folded carton packaging space and the apparel space, and even about the Lasoo platform. That said, it needs to be acknowledged that IVE’s diversification and acquisitive strategy to date has been highly successful and that hey have placed a lot of emphasis on sensible expansion that either have synergistic attributes, or that provide competitive muscle in a fragmented space, or that leverage existing assets & capabilities.

It’s probably worth mentioning that IVE’s most aggressive, and thus arguably most risky, acquisitions are well behind it (such as the acquisition of Franklin WEB in 2016). These have proven very successful.

The Lasoo platform leverages existing relationships with retailers & their customers, and IVE’s existing creative marketing capabilities (essentially a digital version of their existing printed catalogue activities). The folded carton packaging space is essentially a printing activity on carton instead of paper, and management have emphasized that they will be avoiding competition with the largest players by focusing on the “short run space”.

Their stated objective of expanding their creative content capabilities is really just an evolution of what they have been doing for many years now, initially with their Kalido division.

The workwear apparel business I’m less convinced by – but again, management has made much noise about leveraging their existing customers and their existing warehousing & distribution assets. I’m cautious, but I also accept that management has earned the right to be given the benefit of the doubt – for now.So where does all that leave us? I have made an assessment that takes a very conservative view of where things stand today, as follows:
Assuming current sales revenues.
Assuming current operating margins.
Assuming restructure and “one-off” continue at typical rates (my assessment of) indefinitely.
Assuming acquisitive outgoings continue at typical rates (my assessment of) indefinitely and add zero value.
Assuming fairly aggressive ongoing capex requirements (my assessment of).
Assuming modest benefits from the acquired Ovato assets.

The above gives me an estimated yield, at current prices (essentially a current free-cashflow yield) of circa 7.5% (depending on the degree to which we factor in imputation credits, and assuming reduced dividends due to the subdued nature of my assumed “earnings power”).I don’t consider this compelling value, especially given all of the uncertainties in the business and in the Australian retail space generally. On the other hand, given the very conservative nature of my assumptions, I also don’t see it as terrible value. As stated, given all of the ructions over covid, and indeed the post covid dynamics that we are now living with, I see substantial possibility for an eventual renormalization (at least to some degree) to pre-covid margins, and thus for positive surprise.

A final observation. Given all of the acquisitions that have occurred over the last 10 years or so, whose objective was not just to diversify the business, but more to consolidate a fragmented sector into the hands of IVE, why have unit costs not come down at IVE, and why have margins not improved? My answer is that they had been doing so, right up until covid. I strongly suspect covid is now clouding much of IVE’s progress and likely even its current trajectory. I however see no compelling reason to believe that the post-covid world will be dramatically different form the pre-covid world in the spaces that IVE operates. What’s more, IVE is now essential to customers in certain printed segments of marketing spend. This will make it an essential partner for many retailers for the foreseeable future, and provides a natural leverage to multi-channel marketing spend and creative output.

In conclusion, whilst I don’t see the compelling value that I saw when I first acquired it in November 2020, when it was selling for less than 95c per share, I see substantial opportunity for positive surprise.

Expand

I should state that my estimated yield, above, is on a net-debt adjusted basis.

(20min delay)
Last $2.06		Change 0.060(3.00%)		Mkt cap ! $319.0M

Open	High	Low	Value	Volume
$2.02	$2.06	$2.00	$750.7K	369.7K

No.	Vol.	Price($)
1	3930	2.040
2	5830	2.030
2	22900	2.020
2	11500	2.010
2	6302	2.000

Price($)	Vol.	No.
2.060	6350	2
2.070	3930	1
2.080	3930	1
2.110	14700	1
2.150	976	1

I should state that my estimated yield, above, is on a net-debt...

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