This week we will be looking at the US cannabis industry and talking about a stock in the ‘picks and shovels’ side of the industry, a real blue jeans to miners story. US cannabis stocks have been in a relentless bear market, hovering near all-time lows despite the industry showing huge growth.
Before we continue, this is not an industry that TAMIM currently invests in and it may never be. That being said, we do acknowledge the potential in the industry and, given its current changes in legalisation, it currently presents as a perfect example of the benefits of identifying ‘picks and shovels’ or ‘blue jeans to miners’ companies.
Cannabis operators face enormous constraints as a result of cannabis not yet being legal at a federal level. These constraints include higher taxes, no access to capital and an inability to list on the primary exchanges. The ancillary companies that provide services to the industry get the benefits of the industry growth without suffering the constraints.
Ancillary Companies
An alternative way to gain exposure to the growth in cannabis is to invest in ancillary companies; the companies that provide goods and services to the cultivators. They are the ecosystem that facilitates the growth of the cultivators. As the cannabis industry grows, it’s not only the operators that grow and sell cannabis that will benefit. The companies providing finance, equipment, and other goods and services will also be winners. Farming businesses have never been overly attractive; they tend to be cyclical, reliant on external factors like weather and so much can go wrong. On top of this, the risk of crop contamination is always present. As many of these cannabis companies are essentially just farmers, investors may prefer to allocate to the companies that provide equipment or even software to optimise crop growth. These companies typically come with less risk and, since they don’t grow or sell cannabis, they usually can trade on the primary exchanges.
Scotts Miracle-Gro (SMG.NYSE)
SMG manufactures and sells products to the consumer lawn and garden market, the company was founded in 1951 by Horace Hagedorn and is now run by his son Jim Hagedorn. SMG is a family-run business with the Hagedorn’s owning around 27.1% of the business still. While SMG has been a steady business that benefited from Covid, what we are interested in is their ancillary cannabis segment, Hawthorne. Hawthorne has built a portfolio of leading hydroponics companies (i.e. the systems used to cultivate cannabis in a greenhouse). Hawthorne supplies the nutrients, lighting equipment, and other essentials to cultivate the crop. As the industry grows, so does Hawthorne. With the rapidly expanding footprint of cannabis legalisation across the east coast, where cannabis needs to be cultivated indoors, Hawthorne will further benefit from increased demand for their products
Source: SMG company filings
SMG is a safer way to gain exposure to the cannabis sector and it’s listed on the primary exchanges. It has an Apple-like presence in the lawn and garden industry. SMG also has first-mover advantage when it come to the picks and shovels in the cannabis space, their Hawthorne segment has quickly grown to a billion-dollar business.
Source: SMG company filings
SMG’s business will also benefit from changing demographics; millennials have been proven to spend more on their home as opposed to boomers. Pandemic-related stay-at-home orders resulted in a lot of consumers developing new hobbies, igniting the huge shift towards DIY driven by millennials. These trends will support SMG as well as boost their ecommerce activity. Scotts Miracle-Gro’s recent Super Bowl ad was leaning into this growing demographic: the millennial gardener.
Source: SMG company filings (ORC Engine, January 2022)
SMG saw its share price come down from US $250 on 1 April 2021 to around US $117 today. Their core business was a huge beneficiary from Covid with the shift to DIY but their Hawthorne segment has struggled with the oversupply of cannabis and fractured supply chains, leading to a 38% decline in sales for the first quarter. SMG provided a $150m convertible loan to Canadian cannabis investment company RIV Capital (RIV.CNSX) who have taken stakes in a portfolio of different Cannabis-related companies. This convertible note gives SMG shareholders further exposure to the broader cannabis theme.
SMG is currently trading at about 12x NTM EBITDA. When you compare this to other hydroponics companies like Hydrofarm (HYFM.NASDAQ), who are trading at 17.2x EV/EBITDA, you can see that there is some value here with the Hawthorne business. At current prices, the market isn’t ascribing any value to the Hawthorne business; investors are essentially paying for a steady gardening business with the potential upside of cannabis exposure.
Potential Catalysts:
Further/ongoing legalisation throughout the US
Uplisting of cannabis stocks from OTC markets to the bigger exchanges – i.e. the value of their investments through RIV Capital will go up
Spinning off of Hawthorne; this would come with a few dis-synergies but, if done at the right time, it could create serious value for shareholders
Continuing our Talking Top Twenty series, this week we take a look at a pair of retailers, Woolworths (WOW.ASX) and Wesfarmers (WES.ASX), and a biotech giant in CSL (CSL.ASX).
CSL continues on the mixed results train though broadly in line with guidance and expectations. What has been pleasing is the return of plasma collections to pre-covid levels (up +18%). Longer term, the number to watch is the immunoglobulin portfolio and diversification of revenue streams. Plasma alternatives will act as secular headwinds for the business’ traditional revenue streams and, in our view, higher margin speciality and niche verticals will be where the next generation of growth is. The recent acquisition of Swiss headquartered Vifor Pharma for a price tag of about $16.5bn (pending regulatory approvals) fits nicely within this broader move, Vifor being crucial in building a significant renal franchise (i.e. kidney disease related).
Getting to the numbers, group revenue was up +4% to $6.041bn while NPAT declined -5% to $1.427bn over 1H22. Looking closer, of particular concern was declines in albumin (immunoglobulins) in the EU and less then stellar numbers in the US, though China has seemingly offered some respite. This is one number we will continue watching. On the other hand, specialty was rather pleasing with sales up +2% and hospital products back to pre-pandemic levels.
Overall, while results are mixed, we think that management has been doing a competent job on delivering in an increasingly competitive environment with added supply constraints (Covid-related). With that in mind, CSL presents as a good allocation in any portfolio over the long run with forecasted high single to double digit revenue growth along with a stellar R&D pipeline, the most interesting being a licence agreement for a late stage haemophilia B gene therapy candidate.
Red Flags & Risks: At the time of our previous notes, our biggest red flag was the rate of plasma collection. This time around we move to the competitive landscape, Roche’s (ROG.SIX) Hemlibra in haemophilia for example. The business faces significant headwinds and uncertainty in its primary plasma market. CSL’s historic investment in this infrastructure could leave it vulnerable to newer treatments and alternatives. Even on the collections front, CSL’s main competitor, Grifols (GRF.BME), is set to substantially increase its own collection centres to 520 by 2026 (compared to CSL’s 306).
Expectations: The company continues to be a long-term hold in our view. Target: AU $280.
Dividend Yield: 1.11% assuming a share price of AU $262. Expectation remains that dividends continue to grow at double digits over the long-term.
Wesfarmers (WES.ASX)
Despite management patting themselves on the back after the results, the market (as holders may be aware) wasn’t having it. The security was down almost -7% on announcement. So, what were the numbers? Revenue down -0.1%, NPAT down -12.7% to AU $12.7bn and EPS down -14%. This business has been a rather disappointing watch. Particularly interesting was the lack of disclosure around Target’s performance (it was consolidated into Kmart Group), Target, as we have said before, is the problem child. Add in the fact that very little detail was given in terms of the core Bunnings business and the intrigue levels get higher.
While the Covid-related operating environment has been a little messy for brick and mortar retailers, we still didn’t expect the results that were put forward. The one upside was the CEF business; this is one positive aspect of having a conglomerate structure (if done well). Fertilizer revenue in particular growing +35.6% to a AU $183m. On the positive side, we do expect the numbers to stabilise given a rather buoyant consumer propelled by generous stimulus and a still expansionary monetary policy. That said, the business does seem overvalued at 27x earnings despite the sell off.
Red Flags & Risks: The biggest issue for us was the nature of the earnings presentation, the lack of insight into the specifics of divisions and a rather self-congratulatory tone. Target remains a problem for the business while supply chain disruptions and a softening housing market also doesn’t necessarily bode well for the flagship Bunnings business.
Expectations: Disappointing overall, at the time of our previous examination we were particularly positive on management’s vision. The business seems to be a little shaky and the lack of disclosure and self-congratulatory nature in which a less then pleasing result was couched didn’t help. In any case the business remains overvalued in our view.
Dividend Yield: 3.36% assuming a share price of AU $48.51. Expectation is that this will stay stable on a nominal basis.
Woolworths Group (WOW.ASX)
WOW continues to please with its recent announcement of the demerger of Endeavour Group. WOW now represents a pure-play food retail exposure. While the Covid-related supply chain issues and inflation have presented a challenge, management has shown the capacity to move forward. We expect that the business offers a uniquely defensive proposition given their much more localised supply chain and ability to pass on price increases, which been reflected in the results.
Getting to the numbers, EBIDTA down -6% to AU $2.485bn while sales was up +8% to $31.814bn. This may seem less than stellar but it showcases the nature of the issues faced by the business; it would be rolling off a particularly high comparable half in 2020 (Covid-related hoarding and short term spike) as well as major supply chain disruptions. What was pleasing is the reduced inventory turnover and clear strategy on the part of management in terms of omnichannel.
All that said, food retail remains a competitive business in Australia, especially given the Coles-Ocado deal along with increased market share taken by the likes of Aldi. We feel that the wiser focus would be in regional and sub-regional along with a focus on convenience. This will be especially hard for pure-play online retailers and newer entrants to replicate.
Overall, management continues to deliver on its outlined strategy and we remain convinced that it has a better investment thesis/case than Coles.
Red Flags & Risks: Having exited liquor and fuel, WOW is now a pure-play food business and with that comes the risks associated with a less diversified revenue stream. The cost pressures from the likes of Aldi and Coles (COL.ASX), as well as the potential entry of global giants like Amazon, could continue to exert significant margin pressure going forward.
Expectations: Top notch management that continues to deliver and offers a considerable inflation hedge for a portfolio. Strong earnings stability while future upside will be contingent upon cost efficiencies in logistics and supply chain.
Dividend Yield: The current yield stands at 2.6%, assuming a share price of AU $48.51.
This week we continue our run through the Top Twenty by looking at the miners, beginning with BHP Group (BHP.ASX) and Fortescue Metals Group (FMG.ASX).
We remain of the view that the significant tailwinds for commodities in general will endure for some time yet given global impetus towards the green transition and fiscal expansion (which, despite roadblocks in the form of inflation, looks set to continue). We first published this view even before the recent Russian invasion of Ukraine and it has only been affirmed since. Further detail on this can be found here.
Perversely, the relentless upward pressure on the price of both WTI and Brent, despite jawboning from policy makers and the Biden administration, may in fact create a tailwind for base metals and commodities in general. Without going into too much detail, the price action not only increases global reserves (defined as economically retrievable oil) but also increases the economic incentives to speed up the energy transition (i.e. demand destruction). Even in the short-run we are likely to see tremendous momentum for iron ore (driven by demand for steel), coal (especially coking coal, steel again), copper (i.e. transmission and electric vehicles), uranium (i.e. nuclear power generation), natural gas (i.e. bridging power generation during the transition) and agricultural commodities such as potash (both fertilizer demand and uses in shale production).
With that, some price targets for the above categories over the next 12 months:
Those interested in how we reached these price targets, please don’t hesitate to get in touch.
Finally, we have seen rather disappointing price action from the yellow metal; accounting for the current geopolitical uncertainty, it could be argued that the shiny metal has shown meagre performance given its traditional status as a safe haven in times of uncertainty. Despite this and given the above prices and inflation implications (along with implications for real yields), we could argue that it may still be reasonable bet on the balance of probabilities. Price target: 2200 USD/Oz (this may seem optimistic for the more cynical amongst you given recent performance).
Note: We have intentionally left out some other crucial commodities (rare earths along with the likes of nickel, cobalt and lithium) given the group of securities being discussed discussed. We are looking towards the largest revenue streams for the companies in question.
BHP Group (BHP.ASX)
More than pleasing results from BHP with EPS of 211cps US (up +77%) and margin of 64%. Most importantly for the yield hunters, an AU $4.55 p/s dividend (estimated). For us, the company has seemingly learnt from its mistakes in terms of balance sheet discipline (many of you may remember the Capex bonanza during the peaks of the China-driven iron ore boom). The company has reduced net debt by 49% to $6.1bn US, though the payout ratio of 78% seems overly aggressive in our view. The market has seemingly rewarded the performance, the share price returning close to 20% since the beginning of the year.
Digging a little deeper into the strategy side, we maintain that the sale of the petroleum assets was a great move and allows the business to shift focus to core assets while the move into potash is rational, especially given reductions in global crop yields (we will see another long term tailwind here). On the sale front, we are certain that longstanding shareholders would be pleased given the performance of their scrip which has returned close to 50% since the beginning of the year. Looking at the segment breakdown, beats across all three major segments; Metallurgical Coal, Copper and Iron Ore. We were slightly disappointed with the EBITDA margins on coal but with a 71% margin on Iron Ore, this may be overlooked. Unit costs on the Escondida deposit of 1.2 USD/lb, well within guidance.
Red Flags & Risks: We were disappointed that the company has been rather slow in looking to new projects, especially in the copper space (has the company gone to the opposite end of the spectrum in terms of risk appetite?). The election of Boric in Chile adds a new element of risk for the Escondida mine, which remains the flagship project for the business, while headline price volatility based on newsflow from Russia could also see some risk.
My Expectations: Cost front continues to be pleasing and, while any short term peace talks with Russia could see some selling pressure in commodities, we still think the business offers a good risk reward given our outlook on prices across both iron ore and copper. For the dividend investor, certainly a better proposition for the financials. Still a hold with a price target of AU $63.
Dividend Yield: Assuming a share price of AU $51.41, then BHP has a great dividend yield of 8.2% (i.e. as expected).
Fortescue Metals Group (FMG.ASX)
The last time we wrote about this particular company we were at AU $22.26 and were of the correctly of the opinion that the business was too expensive (for those astute investors who then bought the stock close to $14 – well done). But, with the share price having bounced back to similar levels now (AU $21.66 at time of writing), it no longer seems so. What’s changed? For one, we continue to see disciplined management; the number that stands out here? Guidance of 180-185 mt shipments (this will be a new record on top of the one set last year) and 70% realisation of the Platts 62% CFR Index (this bodes well for discounts given historically lower grades). The addition of Iron Bridge, with its average 67% grades, should be beneficial in the long run for margins (i.e. lower grades and higher coking coal costs means higher discounts compared to peers whereas the opposite is true with higher average grades). In the long run, the company’s well touted ESG ambitions should make the business more palatable for bigger valuation premiums. These ambitions include carbon neutrality by 2030 and Net-Zero Scope 3 emissions by 2040 (something which we were concerned about given historic low grades).
With that, to the numbers. EBIDTA of US $4.8bn. Importantly (and rather pleasingly), gearing came in at 23% (given FMG’s history this is one metric that has been satisfying to see). The business continues to rapidly cut costs in order to keep up with peers, including BHP and RIO. Operating cashflow stands at US $2.1bn while the payout stood at 70% of NPAT.
Red Flags & Risks: FMG is a leveraged exposure to the iron ore spot price and Chinese growth. As such, the biggest risks will be a potential slowdown in Chinese growth, escalation in Covid related policies and property related slowdown (i.e. construction). While spot prices were certainly catalysed by sanctions on Russia, we still feel that any pullback, even in the most optimistic of scenarios around peace, will be short-lived.
Expectations: FMG seems to be ticking all the right boxes and, with Vale (VALE3.BVMF) still going through its own issues, we think that the medium to long term outlook for the price of ore remains promising. What must be watched however is China (to give some context about where they are in the cycle, the PBOC is the only outlier amongst major economies in terms of having an expansionary monetary policy). The price also remains somewhat at a premia compared to peers but this may just be a long-term investment. We remain fans of Liz Gaines.
Dividend Yield: The current dividend yield stands at an exceptional 8%, assuming a price of $21.66 AUD (as expected).
Disclaimer: FMG is currently held in TAMIM individually managed account (IMA) portfolios.
This week we will be writing about an underappreciated metal that is crucial to the energy revolution and shift to electrification. Regardless of your position on the timeframe, just about anyone could tell you that electric vehicles are the way of the future. The real question is do we currently have enough supply of the crucial commodities needed to develop and produce these vehicles on a mass scale?
The metal we are focusing on here is tin, an often forgotten commodity in the hype surrounding the incoming proliferation of electric vehicles. We will be covering two listed tin producers, the only two producers listed on “first world” exchanges.
Source: Elementos (ELT.ASX) company filings
Tin and Electric Vehicles
When a lot of people think of tin the first thing to come to mind is the tin can. However, tin is a key electrical contact in electronic circuits (solder), printed circuit boards and semiconductors, accounting for 50% of tin demand today. It is the electric glue connecting key components. Tin plays a role in battery chemicals, battery anodes, alloys and, obviously, the humble tin can (i.e. tin plate).
We are currently in the midst of a global semiconductor shortage like never before which has seen billions of dollars enter the sector in an attempt to rapidly close the gap. Yet, it seems that no one cares about investing in additional tin supply to meet this demand. Tin is commonly known as the ‘spice metal’ because a little tin is in virtually everything.
The main focus for tin is in the positive anode electrode of lithium-ion batteries, usually made from graphite on a copper foil today. Tin will also play a big role in renewable energy with solder ribbon being used to join solar panels. Current global consumption of tin is around 360,000 tonnes p.a. but the International Tin Association is forecasting a 60,000 tonne increase in demand by 2030 for lithium-ion batteries, a whopping 16% increase in consumption. That’s just accounting for electric vehicles.
Source: Rio Tinto (RIO.ASX) company filings
Tin Supply
As you can see, the demand for tin is seeing significant tailwinds. But what about the supply side? Tin deposits are few and far between, the pipeline of projects is underwhelming and the fact that there are only two listed Tin producers in the world says it all. There are two main sources of tIn: alluvial mines, usually found in places like Indonesia, and hard rock mines. Tin from alluvial mines is extracted from clays and is very low grade. Currently, half of our tin comes from these mines. Hard rock mines are much higher grade but most of the easy ore has been mined and finding new economically viable deposits isn’t easy given how hard it is to process. Mine disruptions due to the pandemic have cut supply from the 350,000t p.a. range to around 320,000t. With demand for tin forecast to skyrocket, we are staring down the barrel of a supply deficit for yet another EV metal. Right now there are four countries that produce ~85% of tin concentrate globally. This includes Myanmar and China, both of which are probably not sources the world can rely on.
Source: International Tin Association, 2021
There are some that argue that these prices for EV metals are unsustainable as they will make electric vehicles unsellable due to higher prices. An EV battery typically uses around 1.5kg of tin, which would cost $64.5 per EV. The price could quadruple from here before making a material impact on prices.
Metals X (MLX.ASX)
MLX is one of few listed tin producers in the world. Metals X owns a 50% equity interest in the Renison Tin Operation through its 50% stake in the Bluestone Mines Tasmania Joint Venture (BMTJV). Renison is one of the world’s largest and highest grade tin mines. It currently has about 120,000 tonnes of Proved & Probable Reserves of tin at a 1.4% grade. Renison is located on the west coast of Tasmania, approximately 15km north-east of Zeehan and has access to fully sealed roads to the Burnie port.
Over the past twelve months the mine has produced 8,452 tonnes of tin at an All-In Sustaining Cost (AISC) of $22,248 p/t. The mine is expected to ramp up to producing 10,000t p.a. and, with tin prices today hovering around $43,000 p/t, MLX’s 50% stake will bring in around $175m of EBITDA to the business.
MLX are also progressing the development of their significant growth opportunity in Rentails, a tailings stockpile accumulated from previous Renison processing, i.e. Ren(ison)tail(ing)s. Rentails is the second largest undeveloped tin deposit globally when measured by tin content in the mineral reserve.
Nickel Spinoff
MLX divested their nickel assets, including the Wingellina Nickel-Cobalt Project located in Western Australia and the Claude Hills Project located in South Australia. The assets were divested in the recent IPO Nico Resources (NC1.ASX) and MLX conducted an in-specie distribution of NC1 shares to shareholders. This divestment makes MLX a pure play tin producer, it is often a positive when mining companies sell off non-core projects, it usually means they have something really good they want to focus on pursuing.
Market Cap
Cash
Conv. note receivable +
Debt
EV
EBITDA Run Rate*
EV/EBITDA
$616m
$46m
$31m
$3.5m
$542m
$170m
3.2x
* assumption based on 10,000t p.a. production at current tin prices
Alphamin Resources (AFM.TSXV)
Alphamin Resources is a low cost tin concentrate producer from the Bisie Mine, a high grade deposit in Mpama North. This is on its mining license and it has an additional five exploration licenses covering a total of 1,270sqm in the North Kivu Province of the Democratic Republic of Congo (DRC). Alphamin is currently responsible for producing 4% of the world’s mined tin. They are sitting on a world-class tin reserve of 3.33m tonnes at 4.01% grade for 133,000 tonnes of tin.
Source: Alphamin company filings
DRC is home to some of the highest quality mineral deposits in the world, including the Matunda cobalt mine. The mining sector in Congo was ignited by Israeli businessman Dan Gertler and his partnerships with Glencore but Gertler’s deals were found to involve corrupt practices and saw him take advantage of the Congolese people. Congo has proven to be a tricky jurisdiction for many, however Alphamin have proven they can operate there with few issues.
Alphamin’s current operations at the Bisie Mine are on a run rate of yielding 12,000 tonnes of tin for Alphamin at a AISC of circa US $15,000 p/t. At current tin prices this puts Alphamin on an EBITDA run rate of over US $300m.
Source: Alphamin company filings
Mpama is home to multiple ore bodies that are currently being explored to add to Alphamin’s development pipeline. Their near-term prospect in Mpama South is currently being drilled out to upgrade its resources as part of further feasibility studies. The initial scoping study indicated that Mpama South could be producing over 7,000 tonnes of tin p.a., adding $180m of EBITDA p.a.
Market Cap
Cash
Debt
EV
EBITDA Run Rate*
EV/EBITDA
$1.45bn
$90m
$17m
$1.377bn
$300m
4.59x
* assumption based on production at current tin prices
Closing Remarks
Both MLX and Alphamin are trading at cheap multiples. Both are sitting on strong balance sheets (both in a net cash position). Tin deposits take time to bring to production and given that there are only two “first world” listed tin producers in the world, you would think that Alphamin and MLX might trade at higher multiples due to the sheer lack of quality listed tin companies. Tin prices have more than doubled over the past year and, with EV demand stepping up continuously, it’s easy to see prices soaring higher. Both MLX and Alphamin are bringing in plenty of free cash flow at current prices and have practically paid off all their debt which means they can return capital to shareholders through dividends and/or continue to invest in their development pipelines.
This week we will be talking about founder led businesses and why they tend to outperform. A number of the companies in our portfolios are founder-led; it is a factor we consider when assessing a company. So, we decided to dive deeper into what is driving their outperformance and, in doing so, we will highlight a founder-led chemical manufacture and waste management company that is beating prospectus forecasts, has a strong moat and is growing through an aggressive M&A strategy.
DGL Group (DGL.ASX)
Author: Ron Shamgar
DGL is a well-established, founder-led, end to end chemicals business that manufactures, transports, stores and manages the processing of chemicals and hazardous waste. The company operates a network of sites, both owned and leased, across Australia and New Zealand.
The key operations of the group include:
Formulation and manufacturing of specialty chemicals
Collection, transportation, storage, and logistics
Treatment, recycling and disposal
The company was listed in May of last year, raising $100m.
The Case for Founder-led Businesses
When assessing the merits of a company’s management team it can often be positive if you discover they are a founder-led business. There have been numerous studies about founder led companies and why they tend to outperform. Founders are typically more aligned with shareholders, usually having a significant amount of their own wealth tied up in equity. This alignment makes them more of an owner of the business which deters them from diluting shareholders.
Founders have been found to have a front line obsession. This typically shows up in a love of details and a culture that values those at the front line of the business. Employees at founder led companies typically feel more engaged. Bain & Company’s research found that engaged employees are 3.5x as likely to solve problems themselves and invest personal time in innovation as unengaged workers.
Founders also have more attachment to the company than your typical CEO. After all, the success of the business is essentially their legacy; it’s “their baby”. Founders are typically more prudent with accounting methods and capital allocation; a good example is DGL’s prospectus forecasts (see below). They were extremely conservative and ended up being exceeded by quite a margin. Many of the biggest tech businesses of the last couple of decades have been founder-led; think Apple, Microsoft, Amazon, Facebook, Tesla etc. While they aren’t a tech company, Andrew “Twiggy” Forrest deserves a special mention here in Australia. Given all of the above, we are starting to see a number of venture capital (VC) funds, Andreessen Horowitz for example, voice their preference for investing in companies where the founder is the CEO. DGL’s founder and CEO, Simon Henry, currently holds 53% of the company and recently bought another 500,000 shares for a consideration of $1.43m!
Source: Bain & Company
M&A Strategy
As part of DGL’s ambitious growth plans, they are embarking on an aggressive M&A strategy. During the half, DGL made seven acquisitions and all have been integrated well so far. DGL is looking to acquire companies that will unlock cost synergies for the group as well as broaden their services to create cross-selling opportunities. The more businesses they acquire, the more clients they acquire to cross sell to. A good example is recent acquisition Australian Logistics Management (ALM), which offers safe and reliable transport for dangerous and hazardous materials, focusing on sampling, specialised packing, compliance, and freight service of product samples. This acquisition expands DGL’s service offering while also giving them the opportunity to cross sell this service to existing clients. DGL is also looking to acquire properties to establish their processing facilities, as seen recently with their acquisition in Rocklea, QLD. It isn’t easy to build the infrastructure required for chemical and waste management on leased sites so DGL will continue to acquire properties to facilitate its growth strategy. DGL have typically used a mixture of cash, debt, and scrip to make their acquisitions; they like including scrip to ensure the acquiree remains aligned with DGL.
H1 Results
Source: DGL company filings
DGL reported a strong 1H result with their revenue up +55% to $143m and EBITDA up +59% to $20.6m. They have also been able to navigate supply chain issues well and saw their active customers double in 1H. More than doubling their active customers in the past six months hasn’t just expanded DGL’s business significantly but it has also de-risked their customer concentration. The increase in the number of clients only broadens the massive opportunity to cross sell services as they expand their offering through M&A. Their largest customer now makes up 10% of their revenue, compared to 19% previously.
Source: DGL company filings
Outlook
The advantage of being an incumbent in the chemical waste industry is that there are very high barriers to entry. The CAPEX required to start operations is high, it is expensive and quite difficult to obtain the licences required to operate in the sector. DGL has a broad portfolio of licences, accreditations, and regulatory approvals which are hard to replicate.
DGL has far exceeded its FY22 prospectus forecasts; they released FY22 guidance of $343m revenue and $54m EBITDA compared to the prospectus forecast of $210m revenue and $29m EBITDA. DGL has a huge pipeline of M&A opportunities and will continue to acquire more companies in the half; they still have 25% of their borrowing facility unused and are happy to go to a leverage ratio of 3x (currently at 2x). Most of DGL’s targets to date have been fairly small so a larger acquisition could get a lot more attention from the market.
DGL currently has nine projects under development, some of which have been completed in February with others expected to be completed some time this year. These developments will significantly improve their chemical storage and manufacturing capacity.
Source: DGL company filings
Their environmental solutions segment is seeing significant tailwinds too as the recycling sector receives huge benefits from the government and the shift to a carbon-free economy puts more pressure on businesses to engage in recycling measures. DGL is currently trading at 17x EV/EBITDA. Some might think that’s expensive but we are happy to pay a premium for a quality business with a huge moat that is founder led and growing rapidly, also bolstered by a strategic M&A strategy.
Disclaimer: DGL is currently held in TAMIM portfolios.
More than pleasing results from BHP with EPS of 211cps US (up +77%) and margin of 64%. Most importantly for the yield hunters, an AU $4.55 p/s dividend (estimated). For us, the company has seemingly learnt from its mistakes in terms of balance sheet discipline (many of you may remember the Capex bonanza during the peaks of the China-driven iron ore boom). The company has reduced net debt by 49% to $6.1bn US, though the payout ratio of 78% seems overly aggressive in our view. The market has seemingly rewarded the performance, the share price returning close to 20% since the beginning of the year.
The last time we wrote about this particular company we were at AU $22.26 and were of the correctly of the opinion that the business was too expensive (for those astute investors who then bought the stock close to $14 – well done). But, with the share price having bounced back to similar levels now (AU $21.66 at time of writing), it no longer seems so. What’s changed? For one, we continue to see disciplined management; the number that stands out here? Guidance of 180-185 mt shipments (this will be a new record on top of the one set last year) and 70% realisation of the Platts 62% CFR Index (this bodes well for discounts given historically lower grades). The addition of Iron Bridge, with its average 67% grades, should be beneficial in the long run for margins (i.e. lower grades and higher coking coal costs means higher discounts compared to peers whereas the opposite is true with higher average grades). In the long run, the company’s well touted ESG ambitions should make the business more palatable for bigger valuation premiums. These ambitions include carbon neutrality by 2030 and Net-Zero Scope 3 emissions by 2040 (something which we were concerned about given historic low grades).
Author: Ron Shamgar
