Schaffer Corporation Limited (SFC) has been listed for over 50 years on the ASX. It was started by George Schaffer who arrived in Australia from war torn Europe. Today the Company is run by the founder’s son and is still very much a family owned business. It has never missed a dividend in each year that the company has been listed; this puts it in a very elite group.
So why do I like it?
- It’s cheap, I believe there is an adequate margin of safety at current share price of $5.17.
- Management is open and honest plus shareholder’s interest are aligned (family controls 30% of the business),
- Company owns some strategic real estate in WA where positive development in the surrounding area has taken place.
- Howe Leather’s volume may grow by 50% in FY2016 with future savings from streamlining operations.
SFC is made up of three divisions:
- Howe Leather, this subsidiary is 83% owned by SFC and supplies automotive leather upholstery to automotive brands such as Land Rover, Audi, Mercedes, Nissan, Toyota and Ford. The company purchases its hides from South America and processes the hides in its finishing facility in Victoria before being shipped to its cutting facilities in China and Slovakia. Howe’s focus is to supply high quality product to European luxury car makers and competes against large American companies as Lear, GST Auto Leather and smaller European based companies such as Bader and Boxmark. Exports account for 95% of sales.
- The building materials division consist of 2 businesses; Schaffer Building Products and Delta Corporation. Schaffer Building Products manufactures and retails a range of paving, walling and landscaping products. Delta Corporation manufactures a range of precast and prestressed concrete floor, beam and wall products together with custom made precast panel and beams product for infrastructure, building and resource projects.
- The property division owns a mix of properties commercial properties that are both investment properties and development sites.
Howe’s financial results from 2011 – 2015 is as follows:
Revenue has been on a general uptrend since 2011 with sales over the period being driven by new and continuing vehicle programs from European car manufacturers. The abnormally high earnings in 2014 was due to purchase of hide stock prior to the depreciation of the A$:US$ which temporarily reduced the cost of goods sold in that year.
Howe has started 16 new programs (Mercedes Benz) over FY15 and FY16 which have resulted in sales volume being 41% higher in Dec 2015 that the previous corresponding period. In 2015 the company has started a new hide processing and finishing facility including an expansion of the cutting facilities in Slovakia which will reduce working capital and increase profitability once it’s ramped up due to economies of scale and the lower labour cost. All this has caused an abnormally high level of inventory on hand.
Those are the rosy bits. This business however, is not without its challenges. The key ones being:
- Howe’s sales are dependent on actual vehicle sales which Howe has no control over. For e.g. Howe supplied the Land Rover Evoque model which achieved good sales which benefited Howe’s sales from 2012 – 2015.
- Howe is a relatively smaller player compared with Eagle Ottowa (owned by Lear) and GST Auto which are approximately 8x – 10x larger. These competitors are able to produce at lower cost given their larger economies of scale.
- There are more leather suppliers than automotive makers which tips the bargaining power towards the car companies.
- Foreign exchange. Howe buys the hides in US$, sells the finish product in Euros. So a high US$ and a low Euro hurts the bottom line. Currency fluctuations are out of management’s control.
The industry has undergone consolidation over the past few years. Automotive Leather Company (ALC), Seton and Eagle Ottowa were acquired by Exco Technologies, GST Leather and Lear Corporation respectively. I believe one of the factors why Howe has managed to increase its sales is because of the shrinking pool of tier 1 leather suppliers and the automotive manufacturer’s desire to keep the balance of power in their favour by keeping the smaller suppliers.
Howe is of similar size to ALC and is currently also experiencing a ramp up in growth from the new Mercedez programs. For the purposes of valuing Howe, I’ve selected an EBITDA multiple of 5.5x.
Building materials division
This division is currently underperforming given the downturn in WA’s economy. Although this division has exposure to the Eastern States, WA’s resource and residential construction and renovation sectors are still significant markets. With the market downturn in both markets, this had resulted in declining sales and profits since 2014. Profits have suffered more than sales due to increased competition eroding profit margins.
Financial performance over the past 5 years:
For the purposes of valuing this division, I was not able to identify any comparable transactions. Listed building material suppliers are much larger (e.g. Boral, Fletcher, James Hardie) and in my opinion not very comparable.
This division is debt free and as at June 2015 has assets of $48.3 million and liabilities of $15.8 million which results in a net asset position of $32.5 million. For the HY16, the asset position increased slightly but the liabilities were undisclosed.
This division has the potential to surprise on the upside given the continued subdued expectations. For example, in HY16 this division performed much better than expectations, which was one of the reasons why SFC’s share price rose after the HY16 result announcement.
This division holds the company’s investment properties and development sites. The company has a mixed of properties that are either directly owned or owned through a syndicate. The table below shows the properties owned by Schaffer.
For the purpose of this analysis, I have ignored the value of the properties used by SFC as these are required for ongoing operations and not held for investment purposes.
The market values provided in the above table are sourced from the company’s HY16 investor presentation. I understand that the company has sought the advice of external property valuers in presenting the numbers above. I haven’t verified each of the property values but I believe the above market values are reasonable given:
- In Dec 2015, SFC sold a property in Melbourne (Oce House) for approximately $9.5 million. In June 2015, this property was valued by SFC at $9.7 million.
- I have performed some analysis on 10 Bennett Avenue, North Coogee and believe that the above market value is understated.
- Overall management has been shown to be honest and transparent. There is not much incentive for management to overvalue these properties as all the properties are all carried at historical cost on the books.
The two interesting properties are 10 Bennett Avenue, North Coogee (North Coogee) and Lot 103 – 104 Jandakot Road, Jandakot (Jandakot). The North Coogee property is a 2.1 hectare site smack in the middle of the Cockburn Coast Redevelopment Area. The Cockburn Coast Redevelopment is a State backed project which will be developed over 10 – 20 years and will transform the former industrial area into residential and commercial community with up to 12,000 residents. Check out the details here: http://www.landcorp.com.au/Residential/Shoreline
Land for the first phase of the development called Shoreline has already been released to developers. Landcorp has advertised sale of a 2,875 sqm apartment development lot at $2.6 million ($904.35 per sqm). SFC have stated that the North Coogee site could potentially house 175 residential units.
The Jandakot property is a large property over 500,000 sqm, is about 15 minutes south of the CBD, close to major transport routes (Kwinana Freeway) and adjacent to Jandakot City. Jandakot City is a project to develop 150 hectares of commercial land which forms part of the 620 hectare Jandakot Airport site. Although the project still has some way to go, so far the Jandakot City project has been successful and has managed to attract some large multinational companies (e.g. Aldi, Schlumberger) to the area. Jandakot City is an example of what SFC’s Jandakot property could become but it is still very early days.
I have used the sum-of-parts method by valuing all 3 divisions separately.
The above forecast EBITDA is not an estimate of FY2016’s EBITDA but an estimate of the EBITDA’s run rate based on the new volumes. Management has mentioned although volumes are higher in FY2016, there are set up, testing and “learning” costs associated with the new vehicle programs which will dampen the EBITDA in FY2016. Note that the above EBITDA has not taken into consideration the savings from the expanded Slovakian’s facility.
Given the lack of information available on the valuation of comparable companies and transactions and the fact that the division is not current returning an adequate return on its capital, I have simply valued this division by applying a discount to its net assets.
I’ve tried to triangulate the value by sense checking against an implied return on equity. The value seems reasonable albeit on the conservative side but is still only a very rough estimation. The relatively smaller size of this division makes it less of a concern.
I’ve adopted all of SFC’s presented market values with the exception of North Coogee. I’ve based North Coogee’s value on the sale of comparable property at $904.35 per sqm. Therefore, I’ve assessed the land to be worth $19 million assuming full ownership (SFC owns 83% of the land). The net increase in property value is as follows:
This implies a 30% margin of safety at current share price of $5.17. This margin of safety could potentially be larger as Howe’s profit margins is likely to improve with the expanded plant in Slovakia and if SFC’s manages to develop residential units on the North Coogee property.
So why doesn’t the market appreciate SFC’s value?
I think the simple reason is the low trading liquidity of the shares; low number of shares compounded with the founding family owns 30% of shares and at a market cap of $72 million, it’s far below the radar of institutional investors.
I think this is a good investment with a positive growth potential, a margin of safety, diversified business and a nice 4.8% dividend yield at current prices.