A solid half-year result and more favourable macro factors (lower pulp prices and strengthening Australian Dollar) have supported Asaleo Care’s (ASX:AHY) share price over the last two months. Despite the share price now heading south again, patient investors are likely to get the shares at cheaper levels.
About Asaleo Care
Asaleo Care manufactures personal care and hygiene products. These products are distributed through retailers, distributors, and directly to corporate accounts. Following the sale of the Consumer Tissue Australia business in March 2019, the Company now reports across two segments – B2B and Retail. They contribute roughly evenly to both revenue and earnings. The revenue base is slightly more skewed to the BSB segment, which generates a higher margin than the Retail segment.
The Company’s major shareholder is Essity, who hold a 36.2% stake in AHY. In addition, AHY pays Essity an annual royalty for the exclusive licence to use certain brands (including Tork and TENA), technology and other intellectual property.
Key Fundamental Considerations
1. 1H20 Results Highlight Defensive Qualities
The Company reported a strong increase in sales (+10%) and EBITDA (+24%) on a continuing business basis for the six months to 30 June 2020 (1H20). The strong sales growth and margin expansion reflected industry-wide stockpiling due to COVID-19, as well as a return on AHY’s recent investment in CAPEX and brand.
The impact from COVID-19 on the B2B segment was largely neutral. Around 40% of the B2B segment’s revenue is derived from healthcare, food processing and manufacturing. As these sectors are considered “essential service”, sales growth rates from these sectors are expected to be maintained in 2H20 despite COVID-19-related restrictions. The Retail segment benefited from COVID-19 panic buying, as well as market share growth in all key categories. The Company continued investment across all brands and benefited from new products (including new Libra packaging, Tena Men and Tena Discreet).
2. Pulp Prices Expected to Remain at Lows
Although the Company’s exposure to pulp has effectively halved following the sale of the Tissues business, pulp still represents ~20% of the Company’s total cost of goods sold (COGS). A 6-month lag of pulp pricing into COGS still applies. AHY still uses pulp in all paper products manufactured.
Lower pulp costs accounted for approximately 1/3rd of the expansion in gross profit margin in 1H20. Pulp prices remain at a low point in the cycle. This is driven by over-capacity and falling demand. Hardwood pulp prices appear to have stabilised at a low of ~US$460/t. While there are some expectations that an increase in pulp prices is imminent in order to ‘catch-up’ with currently strong demand for tissue and packaging, it is worth noting that pulp prices are still in decline in Asia. Significant supply of low-priced pulp from non-regular sellers is also placing pressure on prices. Further, the US is the only market where demand has remained above pre-COVID-19 levels
3. Gearing Levels Are Below the Target Range
Gearing (on a net debt to EBITDA basis) declined from 1.95x as at 31 December 2019 to 1.4x as at 30 June 2020, as a result strong free cashflow. The level of gearing is currently below the target gearing range of 1.0x-2.0x.
The improvement in gearing has come at the expense of dividend payments (which have been suspended). This is because the Company is allocating cashflow towards reducing debt.
Acquisitions Are Needed as Organic Earnings Growth Remains Low
A potential game changer for AHY is if the Company uses the balance sheet to make accretive acquisitions to compensate for low organic earnings growth. While the Company is likely to target acquisitions in the personal care space and has the balance sheet capacity to make small bolt-on acquisitions, we consider acquisitions to be more likely in the medium-to-longer term. This is given AHY’s current focus on reducing debt levels.
It is worth remembering that it wasn’t that long ago that AHY’s high levels of debt – which were only alleviated by the sale of the Consumer Tissue Australia business in March 2019 – were a key concern for investors.
Outside of potential acquisitions, we find it challenging to see any real catalysts for the shares.
Firstly, for the Company to achieve FY20 guidance, a strong 2H20 performance is needed. This is despite the Company facing different trading conditions and challenges in 2H20. Secondly, despite macro factors (i.e. low pulp prices and appreciating A$) being favourable for earnings growth in FY21, EPS growth in FY21 and FY22 is likely to be only low- to mid- single digit. This is underpinned by:
i. Sales growth for each of the two operating segments over the FY21/22 being low single-digit % as well as
ii. Expectations that a potential recovery in pulp prices over the next 12-18 months and would impact earnings in these periods. Any impact from rising pulp prices is likely to be magnified in the event of unfavourable currency movements.
Finally, the current 1-year forward P/E multiple of ~14x is unattractive in the context of EPS growth expectations in FY21 and FY22.
AHY’s share price has been range bound for the last year. At the moment it is right in the middle of the range, so unless it breaks to the upside, there is no need to chase it here. At this rate it looks as though it will drift back towards the bottom of the range. This means that there is a good chance that we see it back in the $0.95, which would be a better entry point.
Michael Gable is managing director of Fairmont Equities.
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