Yowie Group — Growing pains, but manageable

Yowie Group — Growing pains, but manageable

After experiencing a drop in sequential sales for the December quarter, Yowie returned to sequential sales growth in the March quarter. However, the company is taking a more modest approach to sales guidance to ensure it can fulfill customer (and investor) expectations. We are maintaining our revenue forecasts, but cutting our profitability estimates for FY17-19 due to higher than expected stock compensation costs in H117. Separately, on 27 February, Wayne Loxton tendered his resignation as executive chairman. With a strong senior team now in place, Loxton had hinted that he would eventually step back from an executive role, however we believed he would wait until FY18 once the publishing and other brand extension businesses had been launched.

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Written by

Yowie Group

Growing pains, but manageable

Business update

Food & beverages

17 May 2017

ADR research

Price

US$3.11

Market cap

US$66m

*Calculated at ADR/Ord conversion ratio 1:10

US$0.74/A$

Net cash (US$m) as of 31 March 2017

29.2

ADRs in issue

21.2m

ADR code

YWRPY

ADR exchange

OTC

Underlying exchange

ASX

Depository

BNY

Business description

Yowie Group, listed in Australia, is engaged in brand development of the Yowie chocolate confectionery product, digital platform and licensed consumer products. Yowie’s brand vision includes distribution in North America, Australia and Canada with further expansion planned.

Next events

Full year results

August 2017

Analysts

Beth Senko, CFA

+1 646 563 7026

Paul Hickman

+44 (0)20 3681 2501

Yowie Group is a research client of Edison Investment Research Limited

After experiencing a drop in sequential sales for the December quarter, Yowie returned to sequential sales growth in the March quarter. However, the company is taking a more modest approach to sales guidance to ensure it can fulfill customer (and investor) expectations. We are maintaining our revenue forecasts, but cutting our profitability estimates for FY17-19 due to higher than expected stock compensation costs in H117. Separately, on 27 February, Wayne Loxton tendered his resignation as executive chairman. With a strong senior team now in place, Loxton had hinted that he would eventually step back from an executive role, however we believed he would wait until FY18 once the publishing and other brand extension businesses had been launched.

Year end

Revenue (US$m)

PTP*
(US$m)

EPADR
(US$)

DPADR
(US$)

P/E
(x)

Gross yield
(%)

06/15

2.4

(2.7)

(0.22)

0.0

N/A

N/A

06/16

13.1

(6.7)

(0.41)

0.0

N/A

N/A

06/17e

22.1

(3.9)

(0.18)

0.0

N/A

N/A

06/18e

37.1

5.8

0.27

0.0

11.5

N/A

Note: *PTP and EPADR are normalized, excluding intangible amortization and exceptional items. Dividend yield excludes withholding tax. Investors should consult their tax advisor regarding the application of any domestic and foreign tax laws. Revenue includes both product sales and licensing income.

Sales growth resumes in the March quarter

On 18 April, Yowie announced record quarterly sales of US$5.9m, up 50% from a year ago, and US$1.5m sequentially from a disappointing December quarter. At the same time, the company moderated its FY17 revenue growth guidance from 85-90% in early March to 70%. The company attributes its more conservative forecast to slightly weak sales to certain Walmart stores that switched to a new distributor and a more staged rollout in Canada. We are maintaining our revenue estimates, which that imply year-on-year growth of 69% in FY17, 68% in FY18 and 37% in FY19.

Profitability pushed out to FY18 at earliest

We are reducing our profitability estimates for FY17-19 to reflect a higher level of administrative expense (primarily from stock compensation); however, with senior staff largely in place, we do not anticipate further negative surprises on the administrative line associated with the company’s expansion plans.

Valuation: Bad news appears largely priced in

At our initiation, Yowie’s shares were discounting a terminal EBIT margin of 22% and sales growth of 70% in FY16-18. Since then, the number of shares has increased 43%, our FY18 revenue estimate has fallen by 16% and the Australian dollar has strengthened by 3%, which may explain a significant portion of the 63% drop in the ADR price since our initiation. A reverse DCF at the current price with a WACC of 10% implies compound average annual top-line growth from FY17 to FY19 of 52%, fading to terminal growth of 2% and an undemanding terminal EBIT margin of 15%. With US$29m in cash, no debt, strong gross margins and growing sales, we believe most of the risks are priced into the shares.

Investment summary: Easing up on the gas pedal to ensure successful execution

On 18 April, Yowie Group released interim financials for the third quarter of FY17, ended 31 March. Results showed that the company has largely recovered from production implementation issues that prevented it from fulfilling several orders in its December quarter. However, the second quarter issues led the company to take a more conservative approach to both its new market rollout and product line extensions in order to avoid customer fulfillment issues in the future.

The company lowered its FY17 revenue growth goal to 70%, from its previous guidance of 85-90% issued in early March. In our update note dated 24 January, we lowered our revenue growth and profitability expectations based on December quarter results; our FY17 revenue estimate of US$22.1m is in line with management’s lowered revenue outlook and we are maintaining our revenue estimate for FY17-19 (see Exhibit 1).

On 24 February, Yowie Group released full financials for the first half of FY17, ended 31 December. The report showed strong gross margins (54% vs 52% in H116) and sales, distribution and marketing expenses well within our estimates; however, administrative expenses nearly doubled to US$6.4m from US$3.4m in the year-earlier period, with the bulk of the increase coming from stock compensation expenses to directors, executives and staff. We have adjusted our FY17 admin expense estimate to more closely reflect the US$3.2m stock compensation expense in the first half of FY17. As a result, we now expect to see profitability at both EBITDA and net profit levels in FY18 instead of FY17. We are also increasing our administrative expenses for FY18-19e to include higher stock compensation expenses.

Exhibit 1: Estimate changes

 

Revenue (US$m)

PTP (US$m)

EPADR (US$)

 

Estimate

New

Chg

Old

New

Chg

Old

New

Chg

FY17e

22.1

22.1

0.0%

2.5

(3.9)

NM

0.12

(0.18)

NM

FY18e

37.1

37.1

0.0%

7.3

5.8

-20.5%

0.35

0.27

-20.0%

FY19e

51.0

51.0

0.0%

11.6

10.1

-12.9%

0.56

0.48

-12.5%

Source: Edison Investment Research estimates, Yowie Group reports. Note: Revenue includes product sales and licensing fees.

We were surprised by Wayne Loxton’s resignation from the position of executive chairman, announced on 27 February. We met with Yowie management on 7 February in New York City and Loxton discussed general plans to pull back from an active operating role in the next year; however, we believed that the timing was an FY18 announcement at the earliest. We have no reason to believe that the timing reflects the board’s opinion of Loxton’s performance as executive chairman. His departure is likely to reduce administrative overhead while leaving operations in the hands of a strong team of confectionary industry veterans.


Valuation

Our primary valuation metric for Yowie is reverse DCF, since the full value of the current opportunity is likely to become apparent over a number of years rather than in near-term results. We believe that if the brand continues to prove itself, the WACC and relative risks to the story will more closely reflect a consumer goods story, albeit one with very high growth. The biggest sensitivity we see with the Yowie story is how customer demand evolves as the product is rolled out broadly to stores in the US and across the globe. While sales have increased nearly tenfold from US$2.4m in FY15 to an estimated US$22.1m in FY17, the trajectory has been somewhat choppy, consistent with the growth trajectory of many start-up companies.

So far, Yowie has proven success at the checkout stands at Walmart, but it is still early in the game. We see Yowie continuing to increase its sales in Walmart by moving to the main candy aisle and expanding into other retail outlets in both the US and other markets.

We expect the US to contribute more than 80% of revenues through FY19; however, there is further opportunity as Yowie renews its existing brand franchise in Australia, New Zealand and Asia, and extends into Europe and the Middle East. Management announced that sales began in Australia on 10 April. We expect sales in Canada to start during first quarter of FY18, slightly behind the company’s original goal of expanding into two new markets in FY17.

We believe that the real margin opportunity will be as Yowie moves beyond confectionery into entertainment (books, gaming, media and out-licensing). Merchandise and other licensing agreements would likely be structured as royalty revenues to the company, with some level of guarantee.

Licensing revenue would likely be highly profitable and drop almost entirely to the operating line, after some level of administrative costs. However, we have not built this into our earnings model for 2017-18 and we have made only a modest assumption of US$2.1m for FY19.

Exhibit 2: Current unit and net sales estimates – US and RoW

Fiscal year ended 30 June

2016

2017e

2018e

2019e

Estimated units sold (000s)

United States

8,600

12,738

21,109

29,065

% growth

48%

66%

38%

RoW

-

2,173

4,346

5,432

% growth

NM

100%

25%

Total units

8,600

14,911

25,455

34,497

% growth

73%

71%

36%

Net effective price/unit (US$)

United States

1.50

1.45

1.40

1.40

% change

NA

-3%

-3%

0%

RoW

NM

1.50

1.50

1.50

% change

NA

0%

0%

Blended net effective price/unit

1.50

1.46

1.42

1.42

% change

-3%

-3%

0%

Product net revenues (US$000)

United States

12,888

18,470

29,553

40,691

% growth

43%

60%

38%

RoW

0

3,259

6,519

8,149

% growth

NM

100%

25%

Total product net revenues

12,888

21,730

36,072

48,840

% growth

69%

66%

35%

Source: Edison Investment Research estimates and Yowie Group. Note: Product net revenues exclude licensing revenues.

As Yowie is still an emerging growth story, we use a reverse DCF model to gauge long-term EBIT margins based on the current share price and our revenue growth expectations. Our 10-year reverse DCF model builds to sales of approximately US$117m by FY26. As noted above, we believe that there is a real opportunity for investors should Yowie move significantly beyond confectionery into other products and out-licensing – in essence becoming a diversified brand as opposed to a pure confectionary play. Evidence of success here would lead us to adjust our forecasts to more accurately reflect the impact of the increased license income.

We assume a terminal growth rate of 2% and use a WACC of 10.0% (reflecting 10% gearing), an equity risk premium of 5.4% and a beta of 1.2. We selected these to reflect what we view as conservative earnings forecasts, a once strong and proven children’s franchise and a business model that is not capital intensive. On this basis, our reverse DCF requires a terminal EBIT margin of 15%, a level that we regard as achievable given our forecast of a modest increase in out-licensing income over the next 10 years, to c 9% of total revenue, albeit still significantly short of management’s aspirations in this area.

Additionally, using our base case forecasts, we have explored alternative scenarios with a range of WACCs of 7-13% and terminal EBIT margins from 7-23%. This indicates the sensitivity to the terminal EBIT margin, which likely corresponds to the rate of development of licensing income over the period. At the same time, overachievement on revenue growth milestones would be associated with a decrease in perceived execution risk and hence in the WACC.

Exhibit 3: ADR value (US$/share) scenario analysis based on terminal EBIT margin & WACC

Terminal EBIT margin

7%

11%

15%

19%

23%

WACC

7.0%

2.83

4.16

5.48

6.81

8.13

8.0%

2.28

3.33

4.37

5.41

6.46

9.0%

1.89

2.74

3.58

4.43

5.28

10.0%

1.60

2.30

3.00

3.70

4.40

11.0%

1.37

1.96

2.55

3.14

3.73

12.0%

1.18

1.69

2.19

2.70

3.20

13.0%

1.04

1.47

1.91

2.34

2.78

Source: Edison Investment Research estimates

Financials

The opportunity for Yowie is significant; however, we are still at the very early stages of what management sees as a global brand across multiple product classes. In addition, apart from Walmart sales performance, we have relatively limited sales data. In our view, there remains a fair amount of uncertainty as to how revenues will trend beyond FY19, especially as confectionary sales to Walmart mature and the company becomes dependent on growth from multiple smaller retailers, new products and new geographies.

March quarter results – production volumes rise, RoW rollout starts

Yowie’s net sales rose 50% y-o-y to US$5.9m in its March quarter. On a sequential basis, net sales rose US$1.5m from US$4.4m in the December quarter. Sales in the US continue to outpace its Nielsen data category growth, rising 0.1 point sequentially to 1.0% in the xAOC (eXtended All Outlet Combined) market. The company shipped US$1.2m worth of product to Australia during the quarter and on its 18 April conference call indicated that a similar size order was set to ship.

Gross margins in the March quarter expanded to 56%, from 54% in the December quarter. This is somewhat above the company’s long-term target of c 50% in the confectionary business and primarily reflects improved commodity costs (the company does not hedge its commodity purchases but does buy forward) and economies of scale both in production and supplies (such as packaging).

Profit and loss

Our model calls for revenues of US$22.1m in FY17, climbing to US$51.0m by FY19, including US$2.1m of licensing revenues, a compound average annual increase of 52%. We forecast EBITDA margins to move from -16.0% in FY17 to 20.6% by FY19. Our margin forecasts could be conservative should the company not plan to accelerate its marketing spend to 19% of product sales, from 16.8% in FY16, a level that is in line with the large confectionery companies. In addition, should the company generate licensing revenues beyond the US$2.1m we have in FY19, margins could expand further as we would expect licensing revenue to largely fall directly to the operating profit line.

Cash flow

At this early stage, Yowie is not operating cash flow positive. The company generated approximately US$3.3m in total operating and investing cash flows in FY16, down from US$6.9m in FY15. Our forecast calls for operating and investing cash use to decrease to approximately US$5.9m in FY17.

Balance sheet

Yowie remains debt free, with US$29.2m of cash on the balance sheet at 31 March 2017. In FY16, Yowie raised US$23m through a private placement of 35.6m shares in addition to US$4.2m from the exercise of options. These proceeds are being used to fund working capital, the continued rollout in the US and newer ventures in publishing and entertainment. We forecast net cash of US$25.8m at 30 June 2017.

Exhibit 4: Financial summary

US$000s

2015

2016

2017e

2018e

2019e

Year end 30 June

AGAAP

AGAAP

AGAAP

AGAAP

AGAAP

PROFIT & LOSS

Revenue

 

 

2,377

13,063

22,057

37,140

50,976

Cost of Sales

(1,043)

(6,245)

(10,867)

(17,813)

(24,283)

Gross Profit

1,334

6,818

11,190

19,327

26,693

EBITDA

 

 

(2,657)

(6,562)

(3,545)

6,119

10,481

Operating Profit (before amort. and except.)

 

 

(2,727)

(6,674)

(3,874)

5,764

10,096

Intangible Amortization

0

0

0

0

0

Exceptionals

(64)

(700)

0

0

0

Other

0

0

0

0

0

Operating Profit

(2,790)

(7,375)

(3,874)

5,764

10,096

Net Interest

(1)

(0)

0

0

0

Profit Before Tax (norm)

 

 

(2,727)

(6,674)

(3,874)

5,764

10,096

Profit Before Tax (FRS 3)

 

 

(2,791)

(7,375)

(3,874)

5,764

10,096

Tax

0

(23)

0

0

0

Profit After Tax (norm)

(2,725)

(6,695)

(3,870)

5,768

10,100

Profit After Tax (FRS 3)

(2,791)

(7,398)

(3,874)

5,764

10,096

Average Number of ADRs Outstanding (m)

1.3

16.5

21.2

21.2

21.2

EPADR - normalised (c)

 

 

(21.6)

(40.5)

(18.3)

27.2

47.7

EPADR - normalised fully diluted (c)

 

 

(21.6)

(40.5)

(17.7)

26.4

47.7

EPADR - (IFRS) (c)

 

 

(22.1)

(44.7)

(18.3)

27.2

47.7

Dividend per share (c)

0.00

0.00

0.00

0.00

0.00

Gross Margin (%)

56.1

52.2

50.7

52.0

52.4

EBITDA Margin (%)

-111.8

-50.2

-16.1

16.5

20.6

Operating Margin (before GW and except.) (%)

-114.7

-51.1

-17.6

15.5

19.8

BALANCE SHEET

Fixed Assets

 

 

1,572

3,865

4,189

4,484

4,749

Intangible Assets

385

783

836

836

836

Tangible Assets

1,187

3,081

3,353

3,648

3,913

Investments

0

0

0

0

0

Current Assets

 

 

14,209

35,820

30,785

37,058

47,859

Stocks

5,197

1,134

2,557

5,522

7,528

Debtors

319

1,327

1,376

743

1,020

Cash

8,465

31,693

25,778

28,475

36,152

Other

227

1,666

1,074

2,318

3,160

Current Liabilities

 

 

(1,516)

(2,708)

(1,869)

(2,672)

(3,642)

Creditors

(1,516)

(2,708)

(1,869)

(2,672)

(3,642)

Short term borrowings

0

0

0

0

0

Long Term Liabilities

 

 

0

0

0

0

0

Long term borrowings

0

0

0

0

0

Other long term liabilities

0

0

0

0

0

Net Assets

 

 

14,264

36,977

33,106

38,869

48,966

CASH FLOW

Operating Cash Flow

 

 

(6,545)

(109)

(5,265)

3,347

8,327

Net Interest

(1)

(0)

0

0

0

Tax

0

(23)

0

0

0

Capex

(317)

(3,211)

(650)

(650)

(650)

Acquisitions/disposals

0

0

0

0

0

Financing

7,562

26,571

0

0

0

Dividends

0

0

0

0

0

Net Cash Flow

699

23,228

(5,915)

2,697

7,677

Opening net debt/(cash)

 

 

(7,767)

(8,465)

(31,693)

(25,778)

(28,475)

HP finance leases initiated

0

0

0

0

0

Other

0

0

0

(0)

0

Closing net debt/(cash)

 

 

(8,465)

(31,693)

(25,778)

(28,475)

(36,152)

Source: Yowie Group reports, Edison Investment Research estimates.

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Yowie Group and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities des
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Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Mologen — SCLC data – subgroup analysis hints at benefit

Top-line data from Mologen’s Phase II small cell lung cancer trial (IMPULSE) have been announced. Positive responses in two subgroups hint at a treatment-related benefit in certain subsets. However, the trial missed its primary endpoint of overall survival in the total study population. Additionally, in line with previous data, an agreeable safety profile was reported. We expect the data to further inform partnership discussions in the near term. The ‘Next Level’ strategy has now been implemented and the pipeline continues to move towards commercialisation. We value Mologen at €252m (€7.33/share).

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