Schaffer – cracker 1HY18 result

See my original post on SFC here.

Howe Leather

Howe Leather hit the ball out of the park with it’s 1HY18 result. The biggest surprise to me was the improvement in earnings margin. To illustrate how big an improvement this was, the table below compares my estimate of the 1HY18 EBIT margin to historical EBIT margins.

Management attributed the strong margins to an appreciating EUR:USD exchange rate as 60% of their variable cost are denominated in USD. Based on historical exchanges rates, I compared the change in average EUR:USD and the prevailing EBIT margins for various periods.

If EUR:USD continue at these levels till the end of the FY18, I won’t be surprised if 2HY18 EBIT margins exceed 20%. Current EUR:USD levels are still below average levels if compared to the past 10 years. EUR:USD maybe back on an uptrend since the decline in 2014.

Revenue for 1HY18 was $105 million and management announced that “steady state” volumes have been achieved. The company looks set to easily beat my previous revenue forecast of $180 million for the full year. Although management has indicated the expected revenue for Howe Leather in 2HY18 to be similar to 1HY18, I noticed that since 2015, there has been a seasonality factor which wasn’t previous present; see table below:

If this seasonality pattern continues in 2HY18, a combination of this seasonality factor with the current EUR:USD exchange rate would an even better result in 2HY18.

Building materials

In my opinion, management achieved a good price for the Limestone quarry assets and Urbanstone business; which were not making money. The selling price was approximately 1.5x of the net asset value.

Property division

Not much material change on this front except that the company has gotten state approval for rezoning of the Jandakot property. The next step is getting a local development plan. The Jandakot property development will be a few more years in the making.

SFC Capital

The company announced the formation of a new division to invest the cash generated from Howe Leather. I’ll wait till we get better clarity on how the capital is being invested before giving my opinion on this.

This has been a stellar report by SFC and the share price has acted accordingly by rising to a 12 year high. In many ways, you could have predicted the strong results due to:

• Management guidance during the mid November AGM for further increase in volumes and profitability in 1HY18
• The Chairman then proceeding to buying $1.37 million worth of shares two weeks after the AGM. An important lesson here!

Bottom line

I still think the company is undervalued. At Howe’s current volumes and profitability, the market capitalisation of $172 million still only mostly represents the value of Howe Leather. There is value upside from 1) revaluation of the Jandakot property to recognise conversion to industrial use, 2) future cyclical upturn in construction 3) development of the North Coogee and Jandakot sites.