Yowie Group — An inflection point after a year of challenges?

Yowie Group — An inflection point after a year of challenges?

After a year of internal and external challenges, we believe Yowie has built a strong and reliable operational base and business plan that will support continued sales growth and a move to profitability by the end of fiscal 2018. With US$1.25/ADR in cash, no debt and modest working investment needs, we see Yowie shares as compelling value for long-term growth investors.

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Yowie Group

An inflection point after a year of challenges?

Business update

Food & beverages

22 September 2017

ADR research

Price*

US$1.60

Market cap

US$34m

*Calculated at ADR/Ord conversion ratio 1:10

US$0.80/A$

Net cash (US$m) at 30 June 2017

26.9

ADRs in issue

21.5m

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

September results

October 2017

December results

January 2018

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 a year of internal and external challenges, we believe Yowie has built a strong and reliable operational base and business plan that will support continued sales growth and a move to profitability by the end of fiscal 2018. With US$1.25/ADR in cash, no debt and modest working investment needs, we see Yowie shares as compelling value for long-term growth investors.

Year end

Revenue (US$m)

PTP*
(US$m)

EPADR
(US$)

DPADR
($)

P/E
(x)

Gross yield
(%)

06/16

13.1

(6.7)

(0.41)

0.0

N/A

N/A

06/17

19.9

(7.9)

(0.35)

0.0

N/A

N/A

06/18e

31.8

(0.9)

(0.04)

0.0

N/A

N/A

06/19e

42.1

1.2

0.05

0.0

32.0

N/A

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

New markets help flattish June quarter sales

June quarterly sales of US$4.2m rose 23% from a year ago, including US$0.8m in sales from Australia. Sales in the US were up a mere 1%, helped by expansion in the convenience and grocery markets. Sales to Walmart were down c 15% due to a delay in the launches of Series 3, and Discovery World, which have begun and will continue through Q2 of FY18.

FY18 will start slow and build

Q1 sales are shaping up to be flattish on a sequential basis. Sales may take a hit from hurricanes Harvey and Irma, which hit the south-east US in late August-early September. In Texas, Harvey forced the closure of at least 134 stores and three distribution centers, however many reopened within a week. In Florida, one Walmart and two Winn-Dixies (a new account) remain shut.

Valuation: DCF US$3.25 on modest assumptions

Yowie’s share price dropped nearly 50% since our update note published on 17 May 2017. Investors appear overly focused on the quarterly sales trajectory, which for start-up companies can be very volatile driven by one-off aberrations such as initial order channel fill, supply/distribution chain disruptions, and inventory management at the customer level. Yowie has grown sales from US$2.4m at the end of FY15 to nearly US$20m in two years, with no brand recognition and limited promotion in the US. The company has healthy gross margins of c 50%, administrative expenses that will benefit from increased economies of scale and US$1.25 cash supporting its US$1.60/ADR price. Our target value of US$3.70/ADR is based on a 10% WACC, a sales CAGR of 36% through FY20, tapering to 2%, and an undemanding EBIT margin of 8%.

Looking ahead to a positive turn in FY18

Call it the “sophomore slump”. As a headline, Yowie has achieved much in a short period of time: rolled out into 4,500 Walmart stores, expanded into drug, grocery, big-box retailers and convenience stores – getting a 0.5% market share according to the Nielsen xAOC plus convenience (eXtended all outlet combined) – and made its initial sales in Australia while finalizing its entry in Canada. In two years, sales have increased nearly tenfold from US$2.4m in FY15 to US$19.9m in FY17. Gross margins are already in line with those of larger confectioners, such as Hershey (HSY), and the company has US$1.25/ADR in cash and no debt. Yet the shares are down 50% in three months and 80% from its price when we initiated coverage in September 2015.

So what has gone wrong? In our view, nothing inconsistent with a start-up: a weather-related supply chain imbalance, longer-than-expected sales cycles for some customers and less-than-optimal merchandising at some accounts. We see much of the decline driven by initial investor enthusiasm, coupled with limited data, leaving investors to extrapolate future results off data that often contains a number of one-time positive (channel filling) or negative (store roll-out delay) factors. Layer these nuances on a largely retail shareholder base, many of whom were likely expecting Yowie confectionary to replicate the rapid success achieved in Australia 20 years ago, and we now have expectations that may have swung too far to the negative.

We are setting our FY18 revenue estimate at US$31.8m (+64%), roughly at the midpoint of Yowie’s guidance of 55-70% growth. Company’s guidance includes additional sales from Walmart, as well as sales from new customers, increased sales in Australia, and expansion into Canada and the UK. At Walmart, sales gains are expected from the introduction of Yowie’s lower-priced Discovery World line, end-cap shelving displays to support holiday promotions, a likely move into the main candy aisle. We have seen a strong improvement in the company’s planning and execution standards as well as a more measured approach to communicating goals to the investor community. We believe these changes will begin to have a measureable impact in both results and investor perception, starting in the second or third fiscal quarters.

Exhibit 1: Yowie Group estimate revisions

Revenues (US$m)

PTP (US$m)

EPADR (US$)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2017

22.1e

19.9

(10.0)

(3.9

(7.9)

NM

(0.18)

(0.35)

NM

2018e

37.1

31.8

(14.2)

5.8

(0.9)

NM

0.27

(0.04)

NM

2019e

51.0

42.1

(17.4)

10.1

1.2

(88.8)

0.48

0.05

(90.0)

2020e

NE

49.9

NM

NE

4.2

NM

NE

0.16

NM

Source: Yowie Group reports, Edison Investment Research estimates FY17 old numbers are estimates, NE = no estimate.

Valuation

Our primary valuation metric for Yowie is 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 have previously used a reverse DCF to gauge valuation; however, with a 50% drop in valuation in the past three months, coupled with a large cash balance, we believe a reverse DCF suggests unsustainably low margins and revenue growth based on current and forecast trends. With US$1.25 net cash for each ADR, we believe Yowie offers significant upside to investors over the next several years.

Our 10-year DCF model builds to sales of approximately US$111m by FY27. 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. Our DCF applies a terminal EBIT margin of 8%, a level that we regard as achievable on the confectionary business alone – where net profit margins for established players can reach the mid-teens. On this basis, we derive an ADR price of US$3.25, double the current price of US$1.60.

If the brand continues to prove itself, we expect the WACC and relative risks to the story will more closely reflect a consumer goods story, albeit one with very high growth. As we saw in FY17, investors have been very sensitive to even slight changes to the implied sales trajectory, making brand acceptance and day-to-day execution key investment sensitivities.

There is a real opportunity for investors should Yowie move significantly beyond confectionery into other products and out-licensing – in essence becoming a “brand” as opposed to a pure confectionary play. Evidence of success here would lead us to adjust our sales and margin forecasts to more accurately reflect the impact of the increased license income. Catalysts would include the planned launch of Yowie children’s books (which are being rewritten to better suit a contemporary American audience), the animated web series (in planning stages) and additional potential projects such as video/web games. It is too early to gauge the impact of these projects on confectionary and licensing income, but management has included an unspecified level of marketing spend in its FY18 estimates to cover brand development.

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.

Profit and loss

Yowie has proven success at the checkout stands at Walmart, but even at checkout, Yowie management sees opportunity for growth with better merchandising. Additionally in FY18, Yowie may finally move to the main candy aisle at Walmart after several iterations of package design. We also expect Yowie to move into Canada and the UK in FY18. 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 and New Zealand on 10 April.

Yowie’s net sales in FY17 rose 51% to US$19.9m, somewhat behind our US$22.1m expectation. The company attributes the delayed roll-out of Series 3, Discovery World and entry into Canada for much of the difference. Gross margins for the year expanded to 55.8%, from 52.2% in FY16. This is 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 in both production and supplies (such as packaging).

Our model calls for revenues of US$31.8m in FY18, climbing to US$49.9m by FY20, including US$0.6m of licensing revenues, a compound average annual increase of 25%. We lowered our licensing forecast from US$2.1m to US$0.6m to reflect management’s focus on the core confectionary products and a more modest timeline for developing the characters so they are well positioned for licensing opportunities.

Our FY18 model keeps gross margins closer to long-term guidance of 50%, down 580bp from FY17. Gross margins in FY17 benefited to some extent from favorable commodity costs and running production of a single product (US-edition Yowies) on a single line for the bulk of the year. In FY18, Yowie will make product for the US, Australia/NZ, Canada and likely the UK. In addition, Yowie will manufacture its new Discovery World product on a separate line at Madelaine. This diversification will add incremental manufacturing costs to set up the production line (changing wrappers and display packaging).

We forecast EBITDA margins to move from -38% in FY17 to 9% by FY20, primarily through better economies of scale in administrative expense. The company has had litigation and product development expenses (related to moving production from Whetstone to Madelaine in January 2016 and the creation and patent of the new capsule), which will continue into FY18, along with professional expenses to set up transfer pricing/intercompany arrangements and ASX filing costs. As a start-up, Yowie is required to file quarterly financials, compared with semi-annually for established companies. We forecast share-based compensation to total c 7% of revenues in FY18, down from 23% in FY17. Senior management is fully staffed, so we do not anticipate large share grants related to new hires.

Our margin forecasts could turn out to be conservative should the company not accelerate its marketing spend to 19% of product sales from our forecast level of 17% in FY18. We anticipate economies of scale in production, sales and distribution and in administrative overhead to largely offset any major step up in marketing expenditures.

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 FY18 and we have made only a modest assumption of US$0.6m for FY19.

Cash flow

At this early stage, Yowie is not operating cash flow positive. The company used US$5.3m in operating and investing cash for FY17, compared with US$3.3m used in FY16. The additional cash used in FY17 went to rebuilding inventories and higher stock compensation expense, partially offset by less investment in plant and equipment.

Balance sheet

Yowie remains debt free, with US$26.9m of cash on the balance sheet at 30 June 2017, somewhat better than our forecasted net cash of US$25.8m. 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 roll-out in the US and newer ventures in publishing and entertainment.

Exhibit 2: Financial summary

US$000s

2015

2016

2017

2018e

2019e

2020e

Year end June

AGAAP

AGAAP

AGAAP

AGAAP

AGAAP

AGAAP

PROFIT & LOSS

Revenue

 

 

2,377

13,063

19,897

31,800

42,112

49,861

Cost of Sales

(1,043)

(6,245)

(8,789)

(15,911)

(21,098)

(24,624)

Gross Profit

1,334

6,818

11,108

15,889

21,014

25,237

EBITDA

 

 

(2,657)

(6,562)

(7,489)

(486)

1,609

4,594

Operating Profit (before amort. and except.)

 

 

(2,727)

(6,674)

(7,878)

(857)

1,210

4,170

Intangible amortization

0

0

0

0

0

0

Exceptionals

(64)

(700)

0

0

0

0

Other

0

0

0

0

0

0

Operating Profit

(2,790)

(7,375)

(7,878)

(857)

1,210

4,170

Net Interest

(1)

(0)

(1)

0

0

0

Pre-Tax Profit (norm)

 

 

(2,727)

(6,674)

(7,879)

(857)

1,210

4,170

Pre-Tax Profit (FRS 3)

 

 

(2,791)

(7,375)

(7,879)

(857)

1,210

4,170

Tax

0

(23)

581

0

(181)

(834)

Profit After Tax (norm)

(2,725)

(6,695)

(7,294)

(853)

1,032

3,340

Profit After Tax (FRS 3)

(2,791)

(7,398)

(7,298)

(857)

1,028

3,336

Average Number of ADRs Outstanding (m)

1.3

16.5

21.5

21.5

21.5

21.5

EPADR - normalized (c)

 

 

(21.6)

(40.5)

(33.9)

(4.0)

4.8

15.5

EPADR - normalized fully diluted (c)

 

 

(21.6)

(40.5)

(32.9)

(3.8)

4.8

15.5

EPADR - (IFRS) (c)

 

 

(22.1)

(44.7)

(33.9)

(4.0)

4.8

15.5

Dividend per share (c)

0.00

0.00

0.00

0.00

0.00

0.00

Gross Margin (%)

56.1

52.2

55.8

50.0

49.9

50.6

EBITDA Margin (%)

-111.8

-50.2

-37.6

-1.5

3.8

9.2

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

-114.7

-51.1

-39.6

-2.7

2.9

8.4

BALANCE SHEET

Fixed Assets

 

 

1,572

3,865

5,695

5,973

6,224

6,450

Intangible Assets

385

783

1,140

1,140

1,140

1,140

Tangible Assets

1,187

3,081

3,513

3,792

4,043

4,268

Investments

0

0

0

0

0

0

Deferred Tax Assets

0

0

1,042

1,042

1,042

1,042

Current Assets

 

 

14,209

35,820

33,293

36,455

40,392

46,130

Stocks

5,197

1,134

3,721

4,933

6,540

7,633

Debtors

319

1,327

1,523

2,433

3,222

3,815

Cash

8,465

31,693

26,878

27,536

28,570

32,278

Other

227

1,666

1,171

1,553

2,059

2,403

Current Liabilities

 

 

(1,516)

(2,708)

(2,794)

(5,092)

(6,751)

(7,880)

Creditors

(1,516)

(2,708)

(2,794)

(5,092)

(6,751)

(7,880)

Short term borrowings

0

0

0

0

0

0

Long Term Liabilities

 

 

0

0

0

0

0

0

Long term borrowings

0

0

0

0

0

0

Other long term liabilities

0

0

0

0

0

0

Net Assets

 

 

14,264

36,977

36,194

37,336

39,865

44,700

CASH FLOW

Operating Cash Flow

 

 

(6,545)

(109)

(5,652)

1,309

1,866

5,192

Net Interest

(1)

(0)

(1)

0

0

0

Tax

0

(23)

581

0

(181)

(834)

Capex

(317)

(3,211)

(1,083)

(650)

(650)

(650)

Acquisitions/disposals

0

0

0

0

0

0

Financing

7,562

26,571

1,339

0

0

0

Dividends

0

0

0

0

0

0

Net Cash Flow

699

23,228

(4,816)

659

1,034

3,708

Opening net debt/(cash)

 

 

(7,767)

(8,465)

(31,693)

(26,878)

(27,536)

(28,570)

HP finance leases initiated

0

0

0

0

0

0

Other

0

0

0

0

(0)

0

Closing net debt/(cash)

 

 

(8,465)

(31,693)

(26,878)

(27,536)

(28,570)

(32,278)

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

DISCLAIMER
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. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Ediso
n’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

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Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

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Sydney +61 (0)2 8249 8342

Level 12, Office 1205

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NSW 2000, Australia

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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Frankfurt +49 (0)69 78 8076 960

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New York +1 646 653 7026

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Sydney +61 (0)2 8249 8342

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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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Windar Photonics — Positive developments during H117

Windar’s H117 results show €1.3m revenues for the six-month period ahead of those achieved in the whole of FY16, while the cost base realignment during H216 resulted in a 71% reduction in EBITDA losses to €0.4m. Our estimates and valuation remain suspended until there is more clarity on test programmes with independent power providers (IPPs) and wind turbine OEMs converting to volume sales.

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