The market values companies from various economic sectors at widely different multiples of earnings, assets and cash flows, and for good reason. In general, non-cyclical sectors receive higher valuations, while industries that are strongly exposed to the business cycle receive lower valuations. It’s a function of cost of capital; industries with deeply cyclical and/or unpredictable revenues and earnings are riskier, and therefore carry a higher cost of capital. Finance 101. One of the most stable market sectors is consumer staples, and that stability is usually reflected in the valuations of companies selling ordinary, necessary products. Manufacturers of toothpaste, soap, cereal, and like products deserve their premium valuation, because consumers will continue to purchase these products in all but the most extreme economic climates.
For this reason, I pay particular attention when I find a healthy consumer staples company trading at a large discount to market averages, let alone the premium valuation that its peers receive. Today’s example is Pental Limited. Pental is an Australian manufacturer of several household brands, including White King bleach, Huggie fabric conditioner, Martha’s wool cleaner and AIM toothpaste, among other brands. Most of Pental’s products are well-known in Australia and New Zealand and command high market share. Household cleaning is Pental’s leading product category, followed by private label products, then personal care products.
Pental has a broad set of quality product offerings, little debt and reasonable operating margins, yet the company trades at a single digit P/E and a discount to book value. In my view, this humble valuation is caused by two major factors.
Outdated Market Perceptions – Until recently, Pental was a highly distressed and indebted company. Then known as Symex, the company operated a specialty chemicals business in addition to its household products business. The chemicals business once produced substantial profits. However, 2012 saw earnings hammered by rising input costs, a strong Australian Dollar, and strong competition. Symex’s large debt load suddenly threatened the company’s existence. At June 30, 2012, Symex carried AUD 59.70 million in net debt, more than ten times the fiscal year’s EBITDA. As part of an agreement with its bankers, Symex agreed to take a number of steps to reduce its debt, including selling off real estate holdings, raising equity capital, and securing receivables financing.
By the end of 2012, the company (now renamed Pental) had succeeded in raising AUD 17.55 million in equity capital, closed down the specialty chemicals business and sold associated real estate, and made principal repayments on its debt. In return for succeeding with these initiatives, the company’s lender wrote off AUD 10 million in debt. The company secured a new credit agreement expiring in 2015. The company also reported improved profitability in its consumer products business.
Today, Pental has reduced its net debt to just AUD 4.70 million, less than half of trailing EBITDA. Consumer products sales and earnings are on the rise, and the company is constructing new bleach manufacturing facilities, which should reduce costs and increase capacity. The market, however, still treats Pental as the heavily indebted and struggling company that is was a year ago.
Capital Structure – In order to fund its equity capital raising, Pental undertook multiple initiatives. The first was a simple share sale to a strategic investor. Concurrent with the share sale, Pental made a rights issue to its shareholders of seven purchase rights per share. These rights, allowed the purchase of one Pental share at AUD 0.015 per right. Three months after the expiration of these rights, Pental distributed one “loyalty option” for each four shares of Pental, which entitled investors to buy one share of Pental for AUD 0.02 for the following 18 months. Finally, Pental encouraged holders of these loyalty options to exercise the options by distributing “Piggyback Options.” For every loyalty option exercised before November 30, 2013, Pental issued one “Piggyback Option.” These piggyback options allow the purchase of one share of Pental at AUD 0.03 for the following 18 months.
Complicated enough? After all those moves, Pental has 1,504.58 million shares outstanding. It also has 87.61 million loyalty options still outstanding with a strike of AUD 0.02, plus 287.57 million piggyback options with a strike of AUD 0.03. Estimating a fair value for Pental’s shares requires adjusting for options exercise, which may obfuscate Pental’s worth.
For the twelve trailing months, Pental reported adjusted EBITDA of AUD 10.66 million and EBIT of AUD 9.11 million. (Results in the first half of fiscal 2014 were substantially improved over the first half of 2013, but I’ll refrain from annualizing these in the interest of conservatism.) Reported net income from continuing operations was AUD 4.97 million for the trailing twelve months. Computing Pental’s trailing valuation requires adjusting for the exercise of Pental’s loyalty options. At Pental’s current share price of AUD 0.027, the piggyback options are anti-dilutive. Full exercise of the loyalty options would raise AUD 1.75 million in cash for Pental.
4.3x EBITDA and 5.0x EBIT is a bargain valuation for a growing consumer staples company with little debt and market-leading products. Moreover, Pental’s already conservatively-estimated results are likely to improve once its new or upgraded production facilities are fully online. Already, the company has won new private label production contracts for Woolworths, Aldi, and Coles on the basis of its new, more efficient bleach plant.
Were the market to value Pental at a more conventional multiples of EBITDA, Pental shares could see significant appreciation. The chart below displays potential share prices and appreciation at various EBITDA multiples, assuming full options exercise. Worth noting is the fact that many other basic consumer products producers currently trade at double-digit EBITDA multiples.
Pental is considering reinstating its dividend in 2014, which could lead investors to take a second look at the company’s much-improved balance sheet and improving profits. The company’s loyalty options expire in late 2014, which will serve to simplify the capital structure and will further reduce net indebtedness. Combined with continued revenue and profit growth, Pental shares could be significantly higher a year hence.
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Thanks for the idea.
What’s your view on how to think about the out-of-the-money options? I typically try to value them and include them in enterprise value on the theory that enterprise value should equal what I’d have to pay to own all the cash flows in perpetuity, and to do that I’d need to buy out the options. See here for Damodoran’s take on the issue: http://aswathdamodaran.blogspot.com/2013/06/a-tangled-web-of-values-enterprise.html
Excellent idea and excellent idea. After doing my own due diligence, I think you may be underestimating the potential of this one. I am now a proud owner of many shares in this company.
Great article and thanks.
Great post once again! When looking at the latest half year report and page 15 of it, I started wondering what the case is with the shares and options. They state having 1791m (1504+287) shares outstanding at the end of the period, with 287m piggyback options and 87m loyalty options outstanding? Am I misunderstanding this, or is it actually so that if all options are exercised the shares outstanding would then be ~2167m?
Thanks a lot for your time and help!
Good catch! I messed up the share count. Still a bargain in my view, but not quite as cheap.
This is a tough call. There are enough catalysts in place and the valuation looks cheap. However,
– The Australian market is controlled by 2 supermarket giants, which are aggressively expanding their private labels.
– The product categories of Pental’s brands portfolio induce less emotional connection with the consumers than things like chocolate or shampoo. We care a lot about things we put inside our mouths or things applied to our bodies. But things like bleach, any brand is a perfect substitute.
Exact same question as Eepi. From what I understand, current shares outstanding is 1,7912M (1504M + exercise of 288M loyalty options. 288M additional piggy back options are issued for early exercise. Another 88M loyalty options still remain. Added together you get ~2167M as Eepi mentioned.
My mistake. I messed up the share count. Goes to show how important it is to doublecheck anything you read online. I still view Pental as a good deal, though of course not as cheap as I first estimated.
I have been following Symex/Pental for a few years now and I think your write-up is fairly balanced. It’s also noteworthy that some prominent value investors in Australia are substantial shareholders.
As to John’s comments on the Australian supermarket scene: yes, there are two major players who dominate the retail market but they are not pushing private labels as aggressively as they pretend. If anything, based on my own experiences, they both appear to be reducing the level of private label items as compared to say 3 years ago. Having said that, John is quite right about the supermarket near-duopoly conditions and how this puts a lot of pressure on all suppliers.