Schaffer Corporation

Slovakian operations progressing nicely

SFC announced its half year results a few days ago and on the key issues, things are progressing as planned. The market seems to be recognising it’s value with the share price moving up quite nicely before and after the half year result announcement. Key items from this HY result for me are:

1)  Margin improvement at Howe Leather

Profit margins increased from last year as indicated by the EBITDA margin improving from 4.6% (FY16) to around 6.7% for the 6 months to December 2016. The Slovakian operations are producing operating efficiencies which I expect to continue. In my previous post for the valuation of SFC, I have assumed a run rate EBITDA margin of 7.8% and management has flagged further efficiency gains from finishing and cutting so I think this is achievable.

Although lower hide prices supported improved profit margins, adverse foreign exchange movements had a double whammy negative effect on margins, due to the appreciation of the AUD against the EUR (SFC’s sales are in Euros) and depreciation of the AUD against the USD (SFC’s purchases are in USD). So if the foreign exchange movements don’t worsen then I expect the earnings for the full year to be significantly higher than in FY16 (fingers crossed).

2)  Cashflow generation

SFC generated strong operating cashflow of $15.6 million for HY17. This has caused net debt to fall from $58.2 million (FY16) to $46.7 million (HY17). Cashflows were generated from profits and improvements in working capital as shown below:

The move to consolidate the hide finishing operations in Slovakia has improved both profit margins and working capital requirements by shortening production time. Based on my analysis, I believe SFC has cycled through all of it’s excess inventory (I may have overestimated the excess inventory in my last post).

3)  Sharp downturn in the building material sector

I was surprised by the extent of EBIT falling ($1.2m – HY17 vs $2.4m – HY16)  for this sector especially since things appeared to be improving in FY16. Nonetheless, in the last post I have already taken a conservative approach to valuing this segment (30% discount to net assets).

In summary, the bedding down of operations in Slovakia is going well which I expect to continue. The building material sector is continuing to suffer due to the overall contraction in WA’s construction sector which is expected to worsen this year with the completion of a few major projects.  SFC mentioned that there are no current plans to start developing the land at 10 Bennett Avenue, which is prudent given the soft prices and the oncoming supply of new apartments in the Shoreline development area. Overall, I have not changed my valuation of SFC of $6.50 – $7.70 and at the current share price still happy to hold on to the stock.


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