Schaffer FY2017 – Howe firing …

For my original post on Schaffer Corporation, see here.

I wanted to wait until the annual report was out before commenting on the FY2017 results. The segment information contains a bit more granular detail than compared to the summary financial report. Anyway, here is my take on the results for the various divisions:

Howe Leather

The results were very strong, revenue growth and margins were ahead of my expectations.  Revenue grew by 10.2% yoy and EBIT margin improved from 3.1% (FY2016) to 9.4% (FY2017). This EBIT margin is based on an EBIT of $16 million (before deducting employee participation unit costs). As indicated in the results presentations, drivers for the margin improvement include:

• Lower processing cost in Slovakia compared to Melbourne.
• Improved yields due to more familiarity with the programs
• Reduction in hide cost.
• Reduced freight cost due to shipping direct from South America to Slovakia. Prior to this, the hides were shipping to Melbourne first to be processed and then on shipped to Slovakia to be cut.

Other more subtle improvement in the business is customer diversification. Howe has reduced their dependence on its largest customer:

Looking forward, I think revenue and margin will continue to improve. I’ll set myself up for regret by making a forecast; based on 2HY17 revenue, it suggest that Howe’s revenue (assuming exchange rate stay the same) can exceed $180 million in FY2018.

Yields should also improve as new programs commenced in FY2017 and it takes time and experience to achieve the efficiencies. Therefore, it is likely that the company can further improve on its EBIT margin.

Longer term, I think the investment made in Europe is important as it shows both commitment and brings Howe closer to its key customers.

Well done Howe and in my opinion, management fully deserves their employee participation units.

Building Materials

This division continues to be a laggard and has been for the last few years. This has not been unexpected with the low level of construction activity in WA. The mining sector appears to have bottomed out but I think we’re still some years away from seeing improvements in WA’s construction sector.

Property division

The most interesting assets here are 10 Bennett Avenue and Lot 702 & 703 Jandakot Road. Landcorp has already sold lots in the Shoreline development and from what I can see from googlemaps, not only have the infrastructure been completed for the first phase, the first residential buildings have being constructed. The beauty about being able to wait till all the infrastructure and residential homes are constructed is that this will greatly de-risk the development and increase its value.

The company is seeking to rezone the Jandakot road property from rural to industrial. I think their chances with the council are good given their neighbours, Jandakot City is a large industrial development. The value from the potential rezoning is significant, after putting in the necessary infrastructure (access, power, sewerage, etc) land values could potentially increase from the current value of $17.50 per sqm to $200 per sqm.

Although the share price has increased since my last post, I still think the market is undervaluing the company and there is more upside to come. I continue to hold.