Skellerup (SKL) Fundamentals

[Muse]

Here are some quotes from the annual report p6

"Skellerup has focussed on identifying markets that offer us the best potential for growth, and on putting in place the people and the structures to capitalise on that potential in a cost-effective and strategic way."

"Identifying where to allocate our resources in order to achieve the best results for the business and for our shareholders involves continually reviewing our operations across both our Industrial and Agri divisions and assessing individual markets to see where the best margins and most sustainable growth prospects can be found. We do that by working closely with our existing customers so that we understand their businesses and how they work and also through very capable people who are focussed on seeking out new opportunities and gaps in the market we can fill."

"Over recent years we have invested a great deal of time and energy in developing capability in the US and in executing a growth strategy in our Masport, Gulf Rubber, Deks and Ultralon businesses. Also we have proven our strategy is working , an example of this being selected as Partner of the Year to Moen, the number one tapware brand in North America and one of the most demanding customers."

"Our facility in Christchurch remains very important to us. It is where key people involved in our research manufacturing and sales teams for our Agni-business are housed. Having these key people on one site provides us with our most effective competitive advantage. We can react swiftly to changes in customer requirements , thereby ensuring customer product development is customer driven. While we emphasis innovation and quality, we also devote considerable time and attention both to continuous process improvement and careful investment in capital equipment."

This is all very positive stuff, showing Skellerup's changing face from the "contract manufacturer" of old to "wrapping its business model around blue chip OEMs with long term macros driving their own growth." - except - all of those quotes are from the FY2015 annual report six years ago!

Basically I am calling BS on your claim (or maybe your parroted cut and paste from the Jarden report) that Skellerup has really transformed themselves over the last five or six years. They are good today and they were good back then, through executing the a/, b/ c/ strategy that I have previously described, (but which you labelled as 'factually incorrect').



As Winner has calculated, the most important element of shareholder returns (69%) over the last couple of years was hype (a re-rated PE ratio). Business execution has been good, but that is not where the bulk of the return for shareholders has come from. Thus I am very wary of the 'this time it is different' transformation thesis for investing in Skellerup.

SNOOPY

Mate this is getting exhausting & I'm one of the central participants I can't imagine how others following the thread are feeling. NO ONE is making a "this time is different transformation thesis for investing into Skellerup" at these levels - you are creating a boogeyman to argue with. I'm pretty sure I've said it looks expensive and potentially overvalued, noted the tailwinds from the run up in milk prices, and a need to be mindful of the maintainability of recent developments (echoing some but not all of your sentiment).

I talked to the business being transformed over both the last 10 years and again over the last 5. The strategy to pivot from being more or less a contract manufacturer to a provider of bespoke OEM components did occur over the previous 5-10 year period but what I highlighted was the financial flow through of that pivot has taken time, and you can literally see it occur over the last 5 years where the company improved in nearly all its financial metrics in every consecutive year. It takes time to phase out legacy lower margin products, which has occurred over the last 5 years, new products get in the door, incrementally higher margin secondary products and services (which both require less capital and upfront investment than the initial sales) take time to take hold after that, so the financial profitability and ROIC naturally lifts in the many years post the strategic pivot. It doesn't occur immediately and sort of waterfalls down after that. So my point was I just dont see it as appropriate to just take an average as you had advocated and challenged the piousness & superiority you had claimed it warranted given it was a "mathematical model" representing "the buffetology workbook" .

Finally yes multiples have changed. Skellerup historically warranted quite a low multiple given its past. The horrendous historic leveraged buyout and subsequent receivership, the low margin boring manufacturing operation they had. It wasn't particularly well regarded, treated as a dividend trap, and was priced as such. I think the business fundamentally changed over time, which resulted in stronger dividends being paid & increasing the yield - suddenly interest rates keep dropping so people got quite interested in high yielding stocks bidding up price. But then as their margins and returns on capital and cashflow lifted investors realised this was actually quite a strong business and priced it up even more. Its my view reratings (lifting PE, EV/EBITDA, whatever) can occur for a number of reasons: interest rates dropping, bit of fomo, but also the financial profile of a business improving. A business that grows faster while requiring less capital than before ought to trade on a higher multiple than before. You can test that in a DCF by running two similar sets of numbers holding everything else constant and the DCF implied EV/EBITDA or PE will be quite different between the two. So while I think there is some scope for SKL multiple comes down as interest rates rise and the dividend yield attraction wanes I certainly don't see it reverting to long term averages. I also looked at what other comparable OEM manufacturers trade at and noted the correlation between their EBIT multiple and ROIC and Skellerup fit within the line of best fit, which is comforting to me as a holder.

Apologies if you have taken offense at me calling out your repeated used of the "Buffetology Workbook Mathematical Model" - which I regard as written by a hack trading off her divorced husbands name and has the same credibility of Trump University - but I only did so after trying to find middle ground and debate the points until you displayed an awful lot of superiority because you were operating "a mathematical model" and others weren't, that it was more pure, and repeated name dropping buffet to shut down the debate - which all seemed very ironic to me. Talk down to other members and telling people their recent purchases were going to cost them x dollars (which lacked a lot of awareness), that the share price would be worth a fraction of its current price in 10 years, etc. Hence I called it out and argued my corner that I think you do have to evaluate why things changed before just dumping on the business like you did, and even still I dont know why try to point out the common ground despite philosophical differences, which you reject out of apparent desire to impress everyone with how much you know about "mathematical models"

Sorry everyone else will be my last post on this particular subject.

[Snoopy]

The following is an evaluation (post 216 on this thread) that I did on Skellerup using the 'Buffettology Workbook' method nearly seven years ago. This analysis was what convinced me to join the share register around that time.

For this model I am using an ROE of 17.8% (the actual average of the last 9 years) and a dividend payout ratio of 62% (the actual dividend payout of the last 9 years).

	SOFY
FY	Asset Backing	Earnings	Dividend	Retained Earnings
2013	0.63	0.094	0.080	0.014
2014	0.65	0.115	0.085	0.030
2015	0.75	0.134	0.083	0.051
2016	0.80	0.143	0.088	0.054
2017	0.85	0.152	0.094	0.058
2018	0.91	0.162	0.101	0.062
2019	0.97	0.173	0.108	0.066
2020	1.04	0.185	0.115	0.070
2021	1.11	0.198	0.123	0.075
2022	1.19	0.211	0.131	0.080
2023	1.27	0.225	0.140	0.086
2024	1.35	0.241	0.149	0.091
2025	1.44	0.257
Total			1.13

With a 2025 year earnings of 25.7cps and using a PE of 12.6 (actual average over the last 9 years) the expected share price for Skellerup in ten years time is:

12.6 x 0.257 = $3.24

The dividend return over that time is $1.13 (as per above table)

Using a market share price today of $1.39, the expected compounding annual return 'i' can be calculated from the following equation.

$1.39(1+i)^10 = (3.24 +1.13) => i=12.1%

This return is a net return, before imputation credits. I haven't seen anywhere else on the NZX I can get a return so strong for so long. So for me investment in SKL at under $1.39 is a no brainer.

SNOOPY

PS The reason I like this method of analysis is that all the data used to generate it comes from Skellerup itself. I haven't assumed a return on equity rate, nor have a assumed the market value multiple of Skellerup will be anything to different to how 'Mr Market' has valued Skellerup in the past.

This evaluation was predicting a share price of $3.24 in 2024. Bah, humbug you might say. We are already at a level almost double that. But wait a minute. A key factor in that prediction was a PE ratio of 12.6. A PE ratio cannot be controlled by a company. Only a market can determine that. So what happens if I put in today's market PE ratio of 29.1 into the share price valuation equation?

29.1 x 0.257 = $7.48

O.K. we have three years to go. But if current earning trends continue, and the PE remains at what I consider an 'elevated' level of 29.1, I think that share price prediction from 2014 is tracking pretty well.

The prediction for FY2021 earnings was 19.8cps. Actual result 20.5cps. Not far away is it, for a forecast from seven years ago.

Apologies if you have taken offense at me calling out your repeated used of the "Buffetology Workbook Mathematical Model" - which I regard as written by a hack trading off her divorced husbands name and has the same credibility of Trump University - but I only did so after trying to find middle ground and debate the points until you displayed an awful lot of superiority because you were operating "a mathematical model" and others weren't, that it was more pure, and repeated name dropping buffet to shut down the debate.

Your remarks seem to me shaped by the conclusion you want to find, reinterpreting what others wrote according to what you think they said.

You call Mary Buffett a 'hack' trading off her divorced husband's name. Yet it appears the methods of this 'hack' can be used a forecast earnings and a share price 7-10 years down the track. Could any of the alternative forecasting methods have done that?

The 'name dropping' you refer to is because the method I was referring to was drawn up by Mary Buffett, along the lines of how father in law Warren thought through his investments. The method was drawn up by one Buffett, on the methods of another Buffett from a book on Buffettology. The 'name dropping' is simply an accurate description of where the information comes from.

I described the Buffettology evaluation method as a 'mathematical model' because that is what it is. Whether it is superior or not is for every individual to decide. But I never claimed any superiority because it was mathematical, as you claim I did. In fact, I pointed out the limitations of the mathematical model

When Biscuit wrote
"As I used to tell my students: there is no answer that you want, there is just the answer."

then I wrote in reply

On the contrary, that may be how it works in pure mathematics, but it isn't how things work in business analysis. Give me the answer you want, and I will adjust the input information to provide it!

If you start modelling things by changing inputs, because you believe there has been an underlying step change, then what you are doing is changing the inputs to get the result you want to see. And if you start feeding your mathematical model information like that, you will soon find that you can 'prove' any future business scenario that you care to dream up.

You then re-edited the above two posts into the contracted quote below

The Buffettology workbook method instead uses historical constants in the modelling mechanics....Not in the sense of making the Buffetology methodology irrelevant.....if you start feeding your mathematical model information like that, you will soon find that you can 'prove' any future business scenario that you care to dream up....What that Buffettology modelling is telling me is ....that may be how it works in pure mathematics

to make it look like I was saying that pure mathematics was the key to Buffettology modelling. In fact if you go over the original material that you cut down, you will see what I actually said was the exact opposite. Namely, It was the following of the pure mathematical rules that, in the FY2021 Buffettology calculation, derailed the answer.

SNOOPY

[Biscuit]

.......

Worked out from your statistical sample of one year you mean? The ROE jump from around 15-16% of the previous three years, to 20%? I don't know whether that improvement is 'business cycle related' or 'underlying change'. But I do know you should model it as a business cycle effect. Because if you start modelling things by changing inputs, because you believe there has been an underlying step change, then what you are doing is changing the inputs to get the result you want to see. And if you start feeding your mathematical model information like that, you will soon find that you can 'prove' any future business scenario that you care to dream up....

SNOOPY

Being naturally lazy, I used the ROE data you provided for the last 6 years and compared the latter three years with the first three using a (possibly inappropriate) t-test. The p value, from memory, was about 0.05 so close enough to statistical significance to allow the conclusion that there may be a significant change in ROE for the business. If (as is possible) the change (if there is one) in ROE is just due to the business cycle, then we should quietly put down the wine and leave the table.

[Rawz]

This thread has been a good read of late. Thanks to all posters!

[Snoopy]

I used the ROE data you provided for the last 6 years and compared the latter three years with the first three using a (possibly inappropriate) t-test. The p value, from memory, was about 0.05 so close enough to statistical significance to allow the conclusion that there may be a significant change in ROE for the business. If (as is possible) the change (if there is one) in ROE is just due to the business cycle, then we should quietly put down the wine and leave the table.

Interesting, although I don't think there is any disagreement that the ROE of the present is higher than the ROE of the recent past. The real question is 'why is this so?' ('significant change in business' or 'business cycle effect' as you allude to). A numerical statistical test doesn't answer that question.

SNOOPY

P.S. I don't think the t-test is appropriate in this situation (as you hinted might be the case), because the two sets of data you are comparing are so small, the t curves in your tables are not representative. I think you would need to reformulate the problem as a binomial test

https://www.statisticshowto.com/binomial-test/

[Biscuit]

Interesting, although I don't think there is any disagreement that the ROE of the present is higher than the ROE of the recent past. The real question is 'why is this so?' ('significant change in business' or 'business cycle effect' as you allude to). A numerical statistical test doesn't answer that question.

SNOOPY

P.S. I don't think the t-test is appropriate in this situation (as you hinted might be the case), because the two sets of data you are comparing are so small, the t curves in your tables are not representative. I think you would need to reformulate the problem as a binomial test

https://www.statisticshowto.com/binomial-test/

Also, as you point out in previous posts, the ROE has historically not been inconsistent with what it has been recently. You've actually done a reasonably good job of convincing me to reduce my holding!

[Snoopy]

I don't think there is any disagreement that the ROE of the present is higher than the ROE of the recent past. The real question is 'why is this so?' ('significant change in business' or 'business cycle effect').

In an attempt to throw more light on this question (I had been leaning towards the 'business cycle effect' camp), I have re-read my SKL annual report collection since 'Our Liz' took over the chair, and selected a few quotes:

AR2017 p2 "(Our) success has been somewhat masked in prior years by navigating through international market conditions, especially in the dairy, mining and oil and gas sectors."

AR2017 p39
Snoopy Comment: I make the observation that $2.507m in foreign currency gains, compared to a $1.275m foreign currency loss in the previous year, boosted headline profit year on year by an unrepresentative: 0.72($2.547m - -$1.275m) = $2.737m year on year, or 12.4%

The above figures are of note, because it shows underlying profitability to be lower in FY2017, which makes the compounding growth rate for the four years to FY2021 higher (i.e. true underlying earnings have almost doubled).

AR2018 p10 (In the context of Gulf Rubber) "New product development typically takes anywhere from 18 months to 3 years from concept to market ready production."

AR2019 p21 (In context of Masport Vacuum Pumps) "Since the launch of the range of vacuum pump systems in 2016, sales have grown every year. We now have a strong foundation to enable us to become the supplier of choice for vacuum systems in the US."

Snoopy Comment:

FY2017 Revenue from Exploration & Mining: 0.06 x $131.2m = $7.9m,
FY2021 Revenue from Exploration & Mining: 0.08 x $177.4m = $14.2m ( +$6.3m)

Drilling operations require water on site, and Masport vacuum pumps are used in the supply of this. I note that Skellerup's 'Exploration & Mining' business unit includes Flexiflo chutes, which are used to enhance mine productivity. But the pre-2017 collapse in the iron ore price means Flexiflo is not currently a growth focus for Skellerup. Growth since FY2017 in Exploration & Mining products, I believe, has likely largely come from Masport Vacuum Pump products.

HYR2020 p3 (on the Covid-19 effect) "External factors can impact our ability to deliver and this was the case for the first half of 2020. Industrial division earnings were lower due to impacts of trade tariffs and slower demand for products we sell within the water infrastructure oil and gas industries."

AR2020 p7 (Agri division performance) "Growth in sales of essential dairy rubber-ware products into the USA, and a strong contribution from Silclear (the silicon rubber business) acquired on 01-11-2019 were the key contributions."

Snoopy Comment:

	FY2017	FY2018	FY2019	FY2020	FY2021
Agri-Division Revenue Trend	$79.233m	$89.033m	$88.750m	$93.609m	$102.201m
North American Revenue Trend	$58.229m	$68.364m	$78.278m	$81.111m	$81.514m

The growth in the North American market, ties in with the growth of 'essential dairy rubber' sales (Agri division growth) and ''Masport Vacuum Pumps' that I have also commented on. The North American growth looks far from cyclical, which is shifting me towards the 'significant change' side of the argument. But over the last three years North American revenue looks to have stalled. This could be because the easy gains in the NA market are over, and we have reached a 'new sales plateau'.

AR2020 p25 (Retention of Customers) "At the end of FY2020, 17 of our top 20 customers when measured by revenue were also in our top 20 in FY2016."

HY2021 p2 (Coping with Covid-19) "Despite some project timelines extending because of Covid-19, we have successfully moved into production with new products and customers across the world, contributing to revenue growth of 11%"

HY2021 p5 "Extended shipping times and increased freight costs due to congestion and availability will have some impact in the near term. We have also seen some increases in raw materials and will be impacted by the recent strengthening of the $NZ"

Snoopy Comment: On p69 of AR2021 under "Financial Risk Management Objectives and Policies" we learn:

"The group seeks to cover up to 100% of the net foreign currency cashflow forecast for the next 12 month period, with foreign currency contracts."

I find it difficult to reconcile that statement above with the previously stated effect of being 'impacted by the recent strengthening New Zealand Dollar'.

AR2021 p14 "We are focussed on growing the business, we are also disciplined in eliminating business that generates marginal returns and requires disproportionate resource to do so. During FY2021 we discontinued a small range of products used on roofing applications in the US. We managed to exit well and continue to work with the customer on new product developments."

Fuel for both sides of the debate in those excerpts I think.

I talked to the business being transformed over both the last 10 years and again over the last 5. The strategy to pivot from being more or less a contract manufacturer to a provider of bespoke OEM components did occur over the previous 5-10 year period but what I highlighted was the financial flow through of that pivot has taken time, and you can literally see it occur over the last 5 years where the company improved in nearly all its financial metrics in every consecutive year. It takes time to phase out legacy lower margin products, which has occurred over the last 5 years, new products get in the door, incrementally higher margin secondary products and services (which both require less capital and upfront investment than the initial sales) take time to take hold after that, so the financial profitability and ROIC naturally lifts in the many years post the strategic pivot. It doesn't occur immediately and sort of waterfalls down after that.

There is evidence of a step change in business operations. But 'Waterfalls down' sounds like a continuous process. I wonder how much 'water' is left at the top of the 'Skellerup falls' feeder lake?

SNOOPY

[BlackPeter]

...

Good post and research ...

One other thing to consider might be their move into the new factory. They used to produce in a pretty filthy and rundown building - and sort of have been lucky to get the building earthquake damaged and various payments from the insurance.

I heard from people who have seen the previous (somewhat) underwhelming factory but understand that their new factory is top notch. Not quite sure when they moved exactly, but it must be something like 5 years ago.

A good factory makes a difference, but not sure I would expect their margins to grow every year ... i.e. I assume we have seen the step function - and from now it will be cyclical again (just on a higher level). Obviously - this is unless they change something else.

[Snoopy]

Good post and research ...

One other thing to consider might be their move into the new factory. They used to produce in a pretty filthy and rundown building - and sort of have been lucky to get the building earthquake damaged and various payments from the insurance.

I heard from people who have seen the previous (somewhat) underwhelming factory but understand that their new factory is top notch. Not quite sure when they moved exactly, but it must be something like 5 years ago.

You are exactly right. First year operating out of the Wigram factory was FY2017

A good factory makes a difference, but not sure I would expect their margins to grow every year ... i.e. I assume we have seen the step function - and from now it will be cyclical again (just on a higher level). Obviously - this is unless they change something else.

Yes, that is why I feel it is appropriate to focus on the 'new' Skellerup from FY2017. Since then there have been add ons both locally and from overseas as well.

a/ 35% of Slimlim (USA) (FY2018) (Liquid silicon rubber products, 35% stake acquired for $US1.1,)
b/ Nexus Foams (NZ) (FY2019) (High tech design solutions using the latest foam compound technology, particularly in the healthcare and electronics sectors, acquired for $NZ6.5m)
c/ Silclear (UK) (FY2020) (makes food grade Silicon rubber products, acquired for GBP3.3m)
d/ Talbot Technologies (NZ) (FY2022) (makes plastic products for health and electronics OEM manufacturers, acquired for $10m)

For a business with a market capitalisation of around $NZ1.2billion, none of these acquisitions are truly game changing. But they are an example of the measured growth that is typical of Skellerup.

SNOOPY

[forest]

I wonder how much 'water' is left at the top of the 'Skellerup falls' feeder lake?

SNOOPY

Great lot of post on SKL Snoopy, I find the detail very impressive.

The world is a big place therefore I think the feeder lake is likely to rise as long as SKL keeps making high quality products for a reasonable price.
Present CEO David Mair I think is a great manager of SKL, who has very clear ideas of how to monetize SKL products.
He often talks about improving margins and that shows in the results.