Skellerup (SKL) Fundamentals

[RTM]

Yes

New Director and disclosing he has no shares

Thanks...thought as much. Always learning. I bet he's cursing how high the price is !

[bull....]

this stocks going well since there result , still climbing

[Ggcc]

this stocks going well since there result , still climbing

It seems one of the few beating the trend. I am happy to still be invested

[Waltzing]

Well its a buy on any pull backs in a few weeks. Well i never... we sold out at 2.40 thinking that was a good price for now.... this just demonstrates the power of dividends above 4% ... in this environment..I really should believe my own assessments more often.

[bull....]

new highs again

[Snoopy]

Skellerup is organised into two principal divisions:

1/ Agri: manufactures and distributes milking liners, tubing, filters and feeding teats. It also sells dairy vacuum pumps and other agricultural products, notably rubber footwear. Skellerup is the second largest manufacturer of dairy rubberware in the world. The new dairy rubber-ware manufacturing facility at Wigram is the base for future growth. 60% of Agridivision sales are now outside of NZ. Markets targeted for future growth are Brazil, India, China and Russia as these nations gear up to meet pent up home market demand. Growth prospects come from the ability to customise short runs of products based on Skellerup's intimate knowledge of their rubber raw materials and how it reacts with dairy animals. Given Skellerup make all their production tooling 'in house', there is no better company to design products that are lighter and more ergonomic to use. The Skellerup market presence through 'Argi' is definitely major.

2/ Industrial: manufactures technical polymers for construction, infrastructure, automotive, mining and general industrial applications. This division also sells industrial vacuum pumps. The static revenue performance of the industrial division over recent years does not give an accurate picture of the potential for this division. The near simultaneous collapse in iron ore and oil prices after 2013 hit this division hard with 50% of Industrial Division sales going to iron ore mining companies in Australia and petroleum companies in the USA. Fast forward to FY2017 and the iron ore and oil industries make up just 20% of sales. 50% of sales today are from potable water and waste water projects.

How did this market adaptation take place? In simple overall terms, much of what Skellerup does can be summed up by using rubber compound engineering to to keep liquids either 'in' or 'out'. When put in these simple terms you can see how existing rubber technology can be relatively easily adapted to other industries. Lessons learned in oil and gas transportation were directly applicable to the waste and potable water markets. Fundamental global trends of 'growing populations', 'changing weather patters (flooding more common)' , and 'ageing infrastructure in many developed cities' all produce a tailwind of opportunities that is less susceptible to the vicissitudes of commodity markets. A rubber seal is not the most expensive component of an underground piping system. But it is an absolutely critical components. So saving money on a seal is likely a poor risk strategy when the quality of the competition is unknown. Skellerup works closely with pipe manufacturers and this gives them a competitive 'moat' that potential competitors will find hard to breach.

So is Skellerup's presence in industrial rubber 'major' in a global context? Skellerup supplies critical rubber componentry for other industrial manufacturers. Few would know that Skellerup manufactures all the drive shaft couplings in their Italian factory for the Mercedes Benz E class cars that are made for the Chinese market , for example. Yet no-one would call Mercedes Benz a minor player in the luxury Chinese car market. I think being a manufacturer of world class componentry qualifies Skellerup as 'major players', albeit in their own specialised niche of rubber products.

To summarize,

1/ Strong and deep relationships not just with manufacturing partners but also final end users, AND
2/ Industrial standards and approval processes that provide a barrier to entry for competitors, AND
3/ Adaptability of rubber technology across industries opening up organic growth opportunities

provide solid reasons to expect that Skellerup will continue as a strong player in the niche markets where they choose to operate.

Conclusion: Pass Test

Skellerup are a brand that stands behind the big brands as crucial component suppliers. For governance purposes , Skellerup is split into two divisions: 'Agri' and 'Industrial'.

Agri

As supplier to the share holders of Fonterra, our dairy farmers, Skellerup supplies the milking liner that attaches each cow teat, via a Skellerup supplied silicone hose to the milking machine. The dairy worker keeps their feet dry wearing Skellerup 'Red Band' gumboots. After milking the chances of teat infection is reduced by using the Skellerup supplied "Ambic Jetstream" Teat Sprayer. This is a fully automated device that operates on vacuum power which means no electricity is needed. Skellerup remain the world's second largest supplier of disposables to the dairy industry worldwide, and their target growth market is the United States where sales are catching up to their home market stronghold level in New Zealand.

Industrial

The industrial division is driven by strong and effective partnerships at research and development level, between Skellerup and their customer companies. The focus is on mechanically challenging problems that nevertheless lend themselves to quick solutions by leveraging on the skills and experience of a multi-disciplined Skellerup technology team. Skellerup's strategy is not to patent exclusive technology, but to cleverly apply their materials knowledge to what some might be seen as 'out of the square' applications. Many of these problems involve sealing off one liquid or gas so that it does not mix with another.

Declining markets over FY2020 included oil & gas, an industry into which Skellerup supplies space efficient vacuum pumps for fuel transporter trucks. Furthermore the closure of the Australian car industry and weaker automotive component sales in Italy has meant lower rubber drive coupling sales for Skellerup. However Ultralon U-deck is finding favour as a preferred decking covering for boats, especially in the United States of America. New products and improved sealing applications are driving sales of the Deks roofing product in Australia. Sales relating to the pumping and piping of potable water still make up the largest category of gross industrial division sales for Skellerup. Some projects in this space were deferred due to Covid-19, so Skellerup have high hopes for a sales bounce back in FY2021.

Skellerup is keen to pursue the advantageous properties of silicone to augment their undoubted prowess in conventional rubber componentry. In July 2018 they forked out $US1.1m for a minority stake in 2015 start up 'SimLim' in the United States. Partnering with business founder Michael O'Hara, SimLim's silicone products are very sterile which sets them up for good use in various medical applications and sophisticated consumer products. Then in November 2019, Skellerup purchase 'SilClear' for GBP3.3m. 'Silclear' is the global market leader in making innovative silicone rubber products, in particular food grade tubing diaphragms valves and liners, a good fit for crossover applications into the dairy industry.

Skellerup remain number two globally in the disposable dairy supplies market (second only to DeLavel), and are a well entrenched supplier to various leading industrial brands. At the end of FY2020, 17 of Skellerup's top twenty customers by revenue were also in the top twenty in FY2016 (four years earlier). Customer retention is a measure of enduring relationships not easily usurped.

Q/ Does Skellerup qualify as a key (or top three) supplier in their chosen markets?
A/ Yes, this test is passed.

SNOOPY

discl: holding

[Snoopy]

2014: ($29.202-$0.093-$8.458+$1.6)m/ 192.806m = 11.5cps
2015: ($30.956-$0.558-$9.023)m/ 192.806m = 11.1cps
2016: ($29.099+$0.800+$1.275-$8.429+0.28*$0.145)m /192.806m = 11.8cps
2017: ($31.435-$2.507-$9.300+0.28*$0.025)m /192.806m = 10.2cps
2018: ($37.918-$1.123-$10.641)m /192.806m = 13.7cps

Notes:
a/ Results for all years have had foreign exchange currency gains removed. Foreign currency gains (or losses) are not a measure of operational business performance.
b/ Result for FY2014 adds back a $1.6m long standing warranty dispute adjustment.
c/ Result for FY2016 adds back $800,000 in restructuring costs.
d/ Result for FY2017/FY2016 adjusts for not including a $25,000/$145,000 cost from relocation expenses respectively, by adding back the 'after tax' effect of not having incurred these costs.

Conclusion: Fail test

Earnings Per Share = Normalised Net Profit over Year / No.of fully paid shares on issue at End of Year

2016: ($29.099+$0.800+$0.145m+$1.275-[$8.429+0.28*$0.145])m /192.806m = 11.9cps
2017: ($31.435-$2.507+$0.025m-[$9.300+0.28*$0.025])m /192.806m = 10.2cps
2018: ($37.918-$1.123-$10.641)m /192.806m = 13.6cps
2019: ($40.036+$0.170-$10.973)m/194.753m = 15.0cps
2020: ($39.831-$0.685-$10.767+$0.400+0.72x0.255)m/194.753m = 14.8cps

Notes:

a/ Results for all years have had foreign exchange currency gains removed (FY2017 $2.507m, FY2018 $1.123m, FY2020 $0.685m) and losses added back (FY2016 $1.275m, FY2019 $0.170m). Foreign currency gains (or losses) are not a measure of operational business performance.
b/ Result for FY2016 adds back $800,000 in restructuring costs (AR2016 p7).
c/ Result for FY2017/FY2016 adjusts for removing the one off $25,000/$145,000 earthquake relocation expenses (AR2017 p39) respectively, by adding back the effect of a hypothetical situation where these losses were not incurred. The $9.300/$8.429m tax figures used for FY2017/FY2016 respectively have already incorporated the tax relief on these expenses which did occur. But we are modelling the situation where they did not occur. So we have to:

i/ Add in the extra tax payable when certain expenses did not occur (because profits would be higher than anticipated) .
ii/ Add back the expenses themselves that were not incurred, because expenses not paid amount to profit before tax.

d/ FY2020 result adds back an after tax $0.400m 'before IFRS16' adjustment to allow a like with like comparison of NPAT with previous years.
e/ FY2020 result adjusted for a $0.255m 'vacated lease' payment. ( AR2020 )

Conclusion: I believe the 0.2cps drop in profit shown from FY2019 to FY2020 is within the margin of error of the inputs used to get the two figures. We know that until Covid-19 (a black swan event) the previous year's result would have been beaten. I am therefore declaring this result a 'pass test'.

SNOOPY

[Snoopy]

2014: $22.251m /$144.691m= 15.4%
2015: $21.375m /$159.660m= 13.3%
2016: $22.786m /$155.855m= 14.6%
2017: $19.635m /$159.247m= 12.3%
2018: $26.154m /$172.286m= 15.2%

Conclusion: Fail test

Return on Equity = Net Profit After Tax / Shareholder Funds at End of Financial Year

2016: $22.849m /$155.855m= 14.7%
2017: $19.635m /$159.247m= 12.3%
2018: $26.154m /$172.286m= 15.2%
2019: $29.233m /$178.392m= 16.4%
2020: $28.963m /$184.563m= 15.7%

14.7% rounds up to 15% in whole number terms.

Conclusion: Pass Test

SNOOPY

[Arthur]

15% is a big hurdle when the risk free rate is zero

[Snoopy]

15% is a big hurdle when the risk free rate is zero

There is a point I have not communicated well in this quest for ROE Arthur.

ROE or 'Return on Shareholder Equity' is a company operational and internally generated statistic. If the NZX were closed forever and if interest rates were pinned at zero forever, none of that would make any difference to ROE. You can't compare a 'risk free rate of return' with 15% hurdle that I mention, as an investor would not make 15% per year they bought into Skellerup today. An investor would only be able to make 15% if they were able to buy SKL shares at net tangible asset backing. At balance date NTA was 94.8c, but unfortunately for investors the market price for Skellerup shares is about three times that figure. So investors buying into today will only be getting about a 15%/3 = a 5% return on their investment dollars. But all of this assumes that Skellerup pays all of their earnings out as dividends.

If Skellerup :

1/ Retains some of their earnings, AND
2/ If they can retain that 15% ROE earnings rate on the newly retained shareholders funds

THEN shareholders buying in today will get a 15% return on just that small portion of retained earnings. That may not sound like much as over FY2020, Skellerup paid out 12.5cps as dividends and only retained 2.5cps. But this ignores the compounding effect of such earnings continually being retained and compounding upon themselves over the years. This is where a company generating a high ROE on its retained funds can really surprise. But even then your initial acquisition price has to be cheap enough to make the investment equation work. And it is at this point that 'prevailing interest rates' and the 'risk free rate' start to come into consideration as a 'measuring stick' of what alternative investment returns are available. Stay tuned. All of this is yet to come under the bridge.

SNOOPY

P.S. I should add that Buffett proposed the 15% ROE figure over an extended period of time because he was/is only interested in exceptional investments. These are difficult hurdles to meet. But if Buffett could find just one or two investments like this that satisfied his investment screening criteria per year, then he would be more than satisfied.