Skellerup (SKL) Fundamentals

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Originally Posted by Snoopy

One way to 'cheat' at the Buffett tests is to leverage up your business to such an extent that your ROE looks fantastic, but the debt taken on puts your business at unacceptable risk. How do we know if debts at a business are out of control? One way is to look at the 'Minimum Debt Repayment Time' or MDRT.

'MDRT' is the answer to the question:

"If all profits for the year were put towards paying off the company's debts, how long would that take?"

My rule of thumb for the answer in years is:

years < 2: Company has low debt
2< years <5: Company has medium debt
5< years <10: Company has high debt
years >10: Company debt is cause for concern

	FY2018	FY2019	FY2020	FY2021	FY2022
Bolt on Acquisitions		Nexus Foams (NZ) & 35% of SimLim (USA)	Silclear (UK)	Projects Vanilla & Tika IT upgrades	Talbot Technologies Ltd (NZ)
Cash & Cash Equivalents: {A}	$9.681m	$9.639m	$13.617m	$15.673m	$14.796m
Non Current Borrowings:	$40.400m	$46.215m	$41.300m	$24.000m	$40.000m
add Current Borrowings:	$0.0m	$0.0m	$0.830m	$0.409m	$0.0m
equals Total Borrowings: {B}	$40.400m	$46.215m	$42.130m	$24.409m	$40.000m
Total Net Borrowings: {B} - {A}	$30.719m	$36.576m	$28.513m	$8.734m	$25.204m
Net profit declared {C}	$27.277m	$29.063m	$29.064m	$40.175m	$47.813m
MDRT ({B} - {A}) / (C}	1.1 years	1.3 years	1.0 years	0.22 years	0.53 years

In the case of MDRT it is really only the latest figure that matters. But historical figures do give a feel for how conservatively (or not) the business has been run in recent years. Skellerup are in the second most conservative position they have been in for five years. Yet over the period Skellerup has made serious capital investment and bought some useful bolt on acquisitions along the way. Growth is being pursued while debt has almost disappeared. There is a lot to like in this picture. I have no qualms about giving Skellerup a 'pass' on the MDRT front.

Now having reassured ourselves that the Buffett growth model is relevant to apply in this case. let's see what happens when we apply it.

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One way to 'cheat' at the Buffett tests is to leverage up your business to such an extent that your ROE looks fantastic, but the debt taken on puts your business at unacceptable risk. How do we know if debts at a business are out of control? One way is to look at the 'Minimum Debt Repayment Time' or MDRT.

'MDRT' is the answer to the question:

"If all profits for the year were put towards paying off the company's debts, how long would that take?"

My rule of thumb for the answer in years is:

years < 2: Company has low debt
2< years <5: Company has medium debt
5< years <10: Company has high debt
years >10: Company debt is cause for concern

	FY2019	FY2020	FY2021	FY2022	FY2023
Bolt on Acquisitions	Nexus Foams (NZ) & 35% of SimLim (USA)	Silclear (UK)	Projects Vanilla & Tika IT upgrades	Talbot Technologies Ltd (NZ)	Sim Lim (USA) (majority ownership)
Cash & Cash Equivalents: {A}	$9.639m	$13.617m	$15.673m	$14.796m	$17.094m
Non Current Borrowings:	$46.215m	$41.300m	$24.000m	$40.000m	$42.300m
add Current Borrowings:	$0.0m	$0.830m	$0.409m	$0.0m	$1.624m
equals Total Borrowings: {B}	$46.215m	$42.130m	$24.409m	$40.000m	$43.924m
Total Net Borrowings: {B} - {A}	$36.576m	$28.513m	$8.734m	$25.204m	$26.830m
Net profit declared {C}	$29.063m	$29.064m	$40.175m	$47.813m	$50.941m
MDRT ({B} - {A}) / (C}	1.3 years	1.0 years	0.22 years	0.53 years	0.53 years

In the case of MDRT it is really only the latest figure that matters. But historical figures do give a feel for how conservatively (or not) the business has been run in recent years. Skellerup are in the second (equal) most conservative position they have been in for five years. Yet over the period Skellerup has made serious capital investment and bought some useful bolt on acquisitions along the way. Growth is being pursued while debt has almost disappeared. There is a lot to like in this picture. I have no qualms about giving Skellerup a 'pass' on the MDRT front.

Now having reassured ourselves that the Buffett growth model is relevant to apply in this case. let's see what happens when we apply it.

SNOOPY

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Originally Posted by Snoopy

I wasn't very happy with the numbers that came out of my Buffett analysis (Iteration A). Tending to it day to day on my share farm, my SKL shares are akin to a 'healthy growing porker'. But take it to market and it looks like I am sitting on an overpriced SKL pig.

For the FY2022 edition 'second iteration' of the Buffett growth model, I will change my assumptions to assume that the last five years of company results represent the 'new paradigm' in which SKL operates I have recalculated our three essential parameters as below:

	FY2018	FY2019	FY2020	FY2021	FY2022	Average
Return on Shareholder Equity	15.2%	16.4%	15.7%	20.5%	22.4%	18.0%
Dividend Payout Ratio	71%	83%	87%	68%	75%	77%
PE Ratio at 30th September	15.7	15.2	19.9	29.1	22.3	20.4

The dividend payout ratio is based on the dividends actually paid out in the financial year under question - normally the final dividend for the previous year and the interim dividend for the current year, (not the dividends declared relating to the results of that year).

The number of previous years that I use to generate my data is a judgement call. The more years of data that you use, the better longer term picture you get. But over time a business evolves. So the longer series of data may be less representative of the business today, and going forwards. This iteration B uses just the last five years of results.

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For the FY2023 edition of the Buffett growth model, I will assume that the last five years of company results represent the 'new paradigm' in which SKL operates I have recalculated our three essential parameters as below at my 30th September reference dates:

	FY2019	FY2020	FY2021	FY2022	FY2023	Average
Return on Shareholder Equity	16.4%	15.7%	20.5%	22.4%	23.7%	19.7%
Dividend Payout Ratio	83%	87%	68%	75%	77%	78%
PE Ratio at 30th September	15.2	19.9	29.1	22.3	17.0	20.7

The dividend payout ratio is based on the dividends actually paid out in the financial year under question - normally the final dividend for the previous year and the interim dividend for the current year, (not the dividends declared relating to the results of that year).

The number of previous years that I use to generate my data is a judgement call. The more years of data that you use, the better longer term picture you get. But over time a business evolves. So the longer series of data may be less representative of the business today, and going forwards. This exercise uses just the last five years of results.

SNOOPY

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Originally Posted by Snoopy

A excellent company can still be a lousy investment if the price you pay for access is too high. So is the price for Skellerup today on the market too high? My first iteration A says 'yes'. But I have changed my input parameters to reflect a more 'forward looking view' of the company.

What will happen when I put the revised inputs (below) into the Buffett style ten year growth model?

Key Model Inputs	Average over Five Years
Return on Shareholder Equity	18.0%
Dividend Payout Ratio	77%
PE Ratio at 30th September	20.4

I have noted that the dividend going forwards is likely to be no more than 50% imputed. The reason why the Skellerup dividend is only 50% imputed today is that around 50% of profits (and 75% of revenues) are now generated overseas. This tax matter has no real bearing on the operational performance of Skellerup. But from an investor perspective, this means extra tax (at a rate of 28%) must be deducted from half of all future dividends (compared to if an equivalent fully imputed dividend was to be paid). I have adjusted for this in my calculation table by including an extra 'unimputed dividend tax' deduction column (assuming all dividends going forwards are 50% imputed, 50% non-imputed).

	SOFY
FY	Asset Backing	Operations Earnings	adjust OCI (1)	less Dividend	equals Retained Earnings	Unimputed Dividend Tax
2020 (historical)	0.916	0.150	0.011	(0.130)	0.031	(0.018)
2021 (historical)	0.942	0.206	(0.010)	(0.140)	0.056	(0.020)
2022 (historical)	1.00	0.245	0.010	(0.180)	0.075	(0.025)
2023	1.08	0.194		(0.149)	0.045	(0.021)
2024	1.125	0.203		(0.156)	0.047	(0.022)
2025	1.172	0.211		(0.162)	0.049	(0.023)
2026	1.221	0.220		(0.169)	0.051	(0.024)
2027	1.272	0.230		(0.177)	0.053	(0.025)
2028	1.325	0.239		(0.184)	0.055	(0.026)
2029	1.380	0.248		(0.191)	0.057	(0.027)
2030	1.437	0.259		(0.199)	0.060	(0.028)
2031	1.497	0.269		(0.207)	0.062	(0.029)
2032	1.559	0.281		(0.216)	0.065	(0.030)
2033	1.624	0.292
Ten Year Total				(1.810)		(0.255)

Notes

(1) OCI = 'Other Comprehensive Income' (hedging and foreign currency adjustments)

(2) Sample forecast calculations for FY2023:

Operations Earnings = $1.08 x 0.18 = $0.194
Dividend = 0.194 x 0.77 = $0.149
Retained earnings = $0.194 - $0.149 = $0.045
50% Unimputed Dividend Tax @28% (shareholder perspective only) = $0.149 x 0.5 x 0.28 = $0.021
Asset backing (subsequent year): $1.08 + $0.045 = $1.125

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With FY2033 projected earnings of 29.2cps, and using a PE ratio of 20.4 (actual average over the last 5 years), the modelled share price for Skellerup in ten years time is:

20.4 x 0.292 = $5.96

The net dividend return for shareholders over that time is $1.810 - $0.255 = $1.555 (refer above table)

Using a market share price today of $5.65, the expected compounding annual return 'i' over 10 years can be calculated from the following equation:

$5.65(1+i)^10 = ($5.96 +$1.56) => i= 1.0290

This represents a projected return of 2.90% per year, for the next ten years.

To understand this result, you have to realise that this is a mathematical model that will faithfully spit out a result from the data you feed it. So how good is the data the model is being fed? Notice that the projected earnings for FY2033 are 29.2cps, verses actual earnings for FY2022 of 24.5cps. This is modelling earnings to increase by 19.1% over 10 years or: (1+i)^10 = 1.191 => i=1.8% compounding per year. That doesn't sound too demanding.

But wait. We are coming off a $28.969m (14.8cps) to $47.205m (24.1cps) -or 62%- profit lift over just two years to EOFY2022. So if we assess 'eps' share growth over 12 years from FY2020 to FY2033, we get: 14.8(1+i)^12=29.2 => i=5.83% compounding (after tax). That is a good growth rate over 12 years from a company that isn't making substantial acquisitions. Would it be realistic to expect a 'boring rubber and foam component company' to make any more progress? And, even better, most of that growth is already 'baked in' (from EOFY2020 to EOFY2022). We know that much of the success of Skellerup over the last two years has come from buoyant dairy prices (Wigram factory NZ) and oil prices (via Masport USA). If profit margins on these commodities stall 'some time this decade', then some of the last two years of stellar growth could unwind. It is easy to imagine that boom times will continue when you are in a boom. But I don't think my 'Buffett Modelling', in iteration B form, is too far removed from what shareholders might expect, taking a realistic expectation of SKL's development.

On the issue of 'Price earnings ratio' thinking that today's PER of 22.3, will reduce to a PE ratio of 20.4 in 2032 is not unreasonable, particularly if growth rates slow over the next ten years .

With those changed 'Iteration B' parameters, what Skellerup share price (P) would Warren need to buy Skellerup at to get his much touted 15% compounding return per year over the coming decade?

P(1+0.15)^10 = ($5.96 +$1.56) => P= $1.86c

Skellerup is currently my largest NZX holding and have surprised on the upside in the recent past. But given the Buffett modelling calculations as I have laid them out, I would now seriously consider reducing that holding on any significant share price appreciation.

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A excellent company can still be a lousy investment if the price you pay for access is too high. So is the price for Skellerup today on the market too high? Let's see.

What will happen when I put the revised inputs (below) into the Buffett style ten year growth model?

Key Model Inputs	Average over Five Years
Return on Shareholder Equity	19.7%
Dividend Payout Ratio	78%
PE Ratio at 30th September	20.7

I have noted that the dividend going forwards is likely to be no more than 50% imputed. The reason why the Skellerup dividend is only 50% imputed today is that around 50% of profits (and 75% of revenues) are now generated overseas. This tax matter has no real bearing on the operational performance of Skellerup. But from an investor perspective, this means extra tax (at a rate of 28%) must be deducted from half of all future dividends (compared to if an equivalent fully imputed dividend was to be paid). I have adjusted for this in my calculation table by including an extra 'unimputed dividend tax' deduction column (assuming all dividends going forwards are 50% imputed, 50% non-imputed).

	SOFY
FY	Asset Backing	Operations Earnings	adjust OCI (1)	less Dividend	equals Retained Earnings	Unimputed Dividend Tax
2020 (historical)	0.916	0.150	0.011	(0.130)	0.031	(0.018)
2021 (historical)	0.942	0.206	(0.010)	(0.140)	0.056	(0.020)
2022 (historical)	1.00	0.245	0.010	(0.180)	0.075	(0.025)
2023 (historical)	1.08	0.260	0.019	(0.209)	0.070	(0.029)
2024	1.15	0.227		(0.177)	0.05	(0.025)
2025	1.20	0.236		(0.184)	0.052	(0.026)
2026	1.252	0.247		(0.192)	0.055	(0.027)
2027	1.307	0.257		(0.201)	0.056	(0.028)
2028	1.363	0.269		(0.209)	0.06	(0.029)
2029	1.423	0.280		(0.219)	0.057	(0.031)
2030	1.480	0.292		(0.227)	0.065	(0.032)
2031	1.545	0.304		(0.237)	0.062	(0.033)
2032	1.607	0.317		(0.247)	0.065	(0.035)
2033	1.672	0.329		(0.257)	0.072	(0.036)
2034	1.744	0.344
Ten Year Total				(2.150)		(0.302)

Notes

(1) OCI = 'Other Comprehensive Income' (hedging and foreign currency adjustments)

(2) Sample forecast calculations for FY2024:

Operations Earnings = $1.15 x 0.197 = $0.227
Dividend = 0.227 x 0.78 = $0.177
Retained earnings = $0.227 - $0.177 = $0.05
50% Unimputed Dividend Tax @28% (shareholder perspective only) = $0.177 x 0.5 x 0.28 = $0.025
Asset backing (subsequent year): $1.15 + $0.05 = $1.20


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With FY2034 projected earnings of 34.4cps, and using a PE ratio of 20.7 (actual average over the last 5 years), the modelled share price for Skellerup in ten years time is:

20.7 x 0.344 = $7.12

The net dividend return for shareholders over that time is $2.150 - $0.302 = $1.848 (refer above table)

Using a market share price today of $4.96, the expected compounding annual return 'i' over 10 years can be calculated from the following equation:

$4.96(1+i)^10 = ($7.12 +$1.85) => (1+i)=(8.97/4.96)^0.1 => i= 0.0610

This represents a projected compounding after tax return of 6.10% per year, for the next ten years.

To understand this result, you have to realise that this is a mathematical model that will faithfully spit out a result from the data you feed it. So how good is the data the model is being fed? Notice that the projected earnings for FY2034 are 34.4cps, verses actual earnings for FY2023 of 26.0cps. This is modelling earnings to increase by 32.3% over 10 years or: (1+i)^10 = 1.191 => i=2.8% compounding per year. That doesn't sound too demanding.

But wait. Using my adjusted profits (see post 1238, 1239), we are coming off a $28.969m (14.8cps) to $53.501m (27.3cps) -or 85%- profit lift over just three years to EOFY2023. So if we assess 'eps' share growth over 13 years from FY2020 to FY2034, we get: 14.8(1+i)^13=34.4 => i=6.70% compounding (after tax). That would be a good growth rate over 13 years from a company that isn't making substantial acquisitions. Would it be realistic to expect a 'boring rubber and foam component company' to make any more progress? Even better, most of that growth is already 'baked in' (over the period EOFY2020 to EOFY2023). I say the growth is 'built in' because, in the tabulated model, I am not forecasting an eps increase until 2028. We know that much of the success of Skellerup over the last three years has come from buoyant dairy prices (Wigram factory NZ) and oil prices (via Masport USA). If profit margins on these commodities stall 'some time this decade', then some of the last three years of stellar growth could unwind. It is easy to deceive yourself and imagine that boom times will continue when you are in a boom. That means I don't think my 'Buffett Modelling' today is too far removed from what shareholders might expect, taking a detached and realistic expectation of SKL's development.

On the issue of 'Price earnings ratio' thinking that today's 'depressed market' PER of 17.0, will increase to a PE ratio of 20.7 in 2033 is not unreasonable, particularly if the growth rates of the last two years is more indicative of growth over the next ten years .

As a theoretical exercise, what Skellerup share price (P) would Warren need to buy Skellerup at to get his much touted 15% compounding return per year over the coming decade?

P(1+0.15)^10 = ($7.12 +$1.85) => P= $2.22c

I think that means we won't see Warren on the SKL share register any time soon.

Skellerup is currently my largest NZX holding and managment have surprised on the upside in the recent past. But given the Buffett modelling calculations as I have laid them out, I think Mr Market is pricing this share very close to fair value. A 6.1% total return after tax is a 'good' but not a 'great' return per year. I would class SKL as a HOLD at $4.96, and that is what I intend to do with my own shareholding in this company.

SNOOPY

Thank so much Snoopy for sharing!

Another consistent and solid result from Skellerup

Mair stepping down as CEO though but I’m sure he’s taught his successor the tricks of the trade

http://nzx-prod-s7fsd7f98s.s3-websit...206/412572.pdf

Last year FY23 profit $50.9m

They say Skellerup expects FY24 NPAT to be similar to prior year

But they did say a few months ago it would be between $50m and $55m

Hope market doesn’t see latest outlook as a profit downgrade

Wow, very impressed by Mair in this podcast interview. Interesting comments on succession. Thinks there's up to five youngsters 34-39 years old that are good enough to run the business today.

https://omny.fm/shows/shared-lunch/s...ing-and-legacy

What a legend and so glad he is staying on the board. Would love to have a beer with him

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Originally Posted by Goob

Wow, very impressed by Mair in this podcast interview. Interesting comments on succession. Thinks there's up to five youngsters 34-39 years old that are good enough to run the business today.

https://omny.fm/shows/shared-lunch/s...ing-and-legacy

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superb interview. fantastic company. and in the low $4 dollars / share, increasingly attractive value.