Jenny Ruth: Measuring the bounce at Skellmax

The market hasn't treated Skellmax Industries kindly since it listed in June 2002.

The share price of the vacuum-pumps and rubber-goods manufacturer has at least risen above the $1.15 issue price after struggling in its first year, dipping to 91c.

Yesterday, it was $1.33, but that's only 15 per cent above the issue price and the NZSX50 index is up more than 55 per cent over the same period.

The company's performance, although solid, hasn't been without blemish.

The company slightly bettered its prospectus forecast with a $12.6 million net profit in its first full year as a listed company, although sales were 7 per cent short of the forecast.

But its announcement a year later of an 8.1 per cent drop in net profit to $11.6 million sent the share price plummeting.

And the market showed little enthusiasm earlier this month when the company reported a meagre 1 per cent rise in net profit to $6.25 million for the six months ended December.

The company is forecasting a $12.5 million net profit for the full year.

Looking at that pattern, you might say the market's treatment of the stock has been perfectly justified.

One analyst sums up the prevailing view of the company: "The whole issue with this company is that if you look at the history of earnings, it has excellent returns on capital but there hasn't been a lot of growth. People are looking at a static earnings picture."

What growth the company has managed has been matched by rising costs, particularly in beefing up its head office. "It doesn't appear to me to have organic growth."

Dennis Lee, an analyst at ABN Amro, shares that view. While his discounted cashflow valuation is $1.55 a share, his 12-month price target is only $1.30. In other words, he's expecting the share price to go nowhere over the next year.

Lee says the company may be able to achieve growth in the longer term but, in the shorter term, the company, as an exporter, is being squeezed by the high dollar. About 30 per cent of the company's sales are outside New Zealand.

While it has a natural hedge in that its petroleum-based raw materials are imported, its raw materials costs have been rising even faster. "They're facing a costs squeeze."

It was possible that growth initiatives the company took last year, which included three acquisitions and building a factory in China to lower production costs, would show through in the 2006 earnings, Lee said. "But the market will say, if it's going to be 2006, why buy now?"

But there's another way of looking at Skellmax' recent performance. Managing director Donald Stewart acknowledges the market hasn't bought his growth strategies.

"The proof's in the eating, not in the story. Hopefully, over the next couple of years with what we've already implemented, the fruits of our efforts will be starting to be delivered."

One of the problems is that the company "isn't sexy".

"A good part of our product range is black rubber." However, he says, many of the company's products are critically important to its customers.

Stewart certainly believes the company is growing, organically and as a result of acquisitions.

The big issue last year was that the company's hedging position went from 42USc to 48USc and that added about $3 million in costs.

Even so, earnings before interest, tax, depreciation and amortisation (Ebitda) were down only 1.5 per cent to $22.4 million for the year.

Because of the new acquisitions, the company's depreciation of plant and equipment jumped 54.4 per cent to $2.3 million and the tax bill went up from just under $6 million in 2003 to $6.2 million in 2004. The 2004 result also included about $200,000 in restructuring costs.

The latest first-half result is also much better at the operational line than the bottom line suggests. Ebitda was up 8.4 per cent with higher depreciation charges and a 49.3 per cent in the company's interest bill to $1.14 million, reflecting greater borrowing to pay for last year's initiatives, dragging the bottom line down.

The $12.5 million forecast for this full year might look as if the company is only getting back to 2003 levels. But Stewart points out that this year the company will be without the $1.2 million vendor indemnity at ebit level which its previous owner, the Goldman Sachs-backed Viking Pacific, provided in each of the two years after the float.

The company has taken on extra staff to help grow the business so its cost structure is higher now than it was in 2003.

"As a growth story, we have take three steps forward over the last couple of years, but there's been a couple of steps backwards which we had no control over," Stewart says.

He agrees with the assessment that the full benefits of last year's moves won't be shown until 2006.

Another area of growth has been in attracting a 20 per cent to 25 per cent increase in volumes of work under contract for European companies supplying the dairy industry, he says. The company has contracts with Sweden-based DeLaval International and Germany's Westfalia Landtechnik to supply the Australasian market but Stewart thinks the company can attract more work from these manufacturers.

"We're constantly in discussion with them. They make a significant difference."

The company's target is to increase net profit after tax by 15 per cent a year. Stewart has a personal stake in achieving this as that's precisely the growth required before his 450,000 options, given at the time of the float, are in the money.

Nevertheless, Stewart has been showing his faith in the company by buying shares, accumulating 224,500 by the beginning of November. Other directors have also bought shares.

John Cairns, an analyst at Forsyth Barr, is one of the few who do buy Skellmax' growth story and recommends investors buy the shares. He values them at $1.60.

"They are going forward, they're moving in the right direction. If you're comparing like with like, there is growth there," Cairns says. The company's decision to ramp up the capacity of its Christchurch factory by 30 per cent, which is due to come on stream within the next two months, doesn't suggest a company lacking organic growth, he says.

"Obviously, they're not going to do that if the volumes aren't there."

Cairns believes it is only a matter of time before the market re-rates Skellmax. "In the meantime, you've got a good yield and it's something that's not going to implode on you."

The company's mainstay is supplying consumables such as teat cup liners, gumboots and pumps to the dairy industry, a solid repeat business with high margins last year.

The other leg of the business, various rubber-based industrial operations such as conveyor belts, waste management and mining industry products, managed a margin of only 10.8 per cent.

And while Stewart has his eyes on more acquisitions, "I don't think the risk of him over-paying or buying a lemon is great," Cairns says.

Nuts and bolts

Skellmax Industries HQ: 1-37 Mt Wellington Highway, Mt Wellington, Auckland.

Profile: The company was formed out of Viking Pacific, which held the "good" parts of the former listed Skellerup Group after the Goldman Sachs-backed management buy-out turned sour. It was floated for $115 million in June 2002. It manufactures rubber-based products from gumboots to milking cups, conveyor belts and pumps. Both parts of the business date back to 1910.

Key financial statistics: Net profit fell from $12.6 million in the year ended 2003 to $11.6 million last year. In the six months ended December 2004, net profit rose just 1 per cent to $6.25 million.

Market capitalisation: $132.34 million.

Major shareholders: AMP Capital Investors with 5.4 per cent and Accident Compensation Commission with 4.6 per cent.

Key executives: Managing director Donald Stewart, chief operating officer M McKessar, company secretary Jim Greenwood and chief financial officer Neil Campbell.