Is There Money in Capilano Honey (ASX: CZZ)? [Part 1]

Note: This article is first published on my blog on 14 Jan 2018.

Executive summary

Capilano Honey (ASX: CZZ) is Australia’s largest honey packer that sells honey products (both normal honey and premium Manuka honey) in both Australia and overseas markets, with a market capitalisation (in January 2018) of around AUD 175m. It was listed on ASX in July 2012, and thereafter from FY2013 (ending June 2013) to FY2017, it has almost doubled its revenue (AUD 73m to AUD 133m), tripled its net profits (AUD 3.4m to AUD 10.3m), while increasing its honey sales volume by more than 40% (from 9,800 tonnes in FY2013 to 14,000 tonnes in FY2016) and expanding its number of outstanding shares by 11% only. In my opinion, Capilano is a strong company with strong (and growing) moats with high returns on capital, and it’s worth looking at for the following reasons:

1. Capilano’s honey packing business has good business economics, reflected by its strong financials.
2. Capilano has very strong access to one of the most important ingredient to be successful in this business, i.e. good honey supply.
3. Capilano has been investing and consolidating its businesses in the past few years, investing in additional resources, repairing its inventory and strengthening its balance sheet, and is ready to reap the rewards, with an improving honey production season to come after its worst few years in history;
4. Capilano’s stronghold in Australian market (of >70% market share) provides it with strong and sustainable cash flows, which are partly returned to shareholders as dividends and partly reinvested for future growth in markets with high growth potential (e.g. China).
5. Last but probably most importantly, I see Capilano as being able to grow and deepen its strong moat as time passes and has long runways for growth opportunities (from new markets, new products, greater sales volumes and potentially more M&A activities to expand its asset base).

This will be a long post and therefore I am splitting it into three parts:

1. Introduction to Capilano Honey;
2. Why I think Capilano is worth looking at; and
3. What are the risks, and how much is Capilano worth?

Introduction to Capilano Honey

Capilano Honey was founded in 1953 as the co-operative Honey Corporation of Australia to help protect the interests of beekeepers, by purchasing honey from them and helping them to be price-setters instead of price-takers.

It was initially listed on the Bendigo Stock Exchange in 2004 following legislative changes that deemed Capilano ineligible to operate an internal market for trading shares between beekeepers in the co-operative (the beekeepers have to hold a certain number of shares per hive owned). It was subsequently forced to move to ASX in 2012, because BSX was changing the nature of its exchange to make it a clean energy exchange.

It currently sells mainly (about 95%) honey products (both normal honey and premium Manuka honey (Manuka honey is produced from the Leptospermum species of plants that are native to Australia and New Zealand, and this honey is recognised for its scarcity and unique clinically proven antibacterial qualities and consequential premium price) and some (about 5%) non-honey products (apple cider vinegar and beeswax). It is a very popular brand in Australia with a market share of more than 70%. The Australian market contributes to 83% of its revenue in FY2016, with the remainder coming from more than 30 countries (as of 2016) in Asia, Middle East, America, Europe and other countries.

The video below provides a good introduction into Capilano Honey and the beekeeping and honey packing businesses.

In terms of operations:

• its head office and main packing plant are in Brisbane, with two other packing plants in Perth and Maryborough;
• it has just over 120 employees who oversee the honey packing process in its head office;
• it carries a few honey brands that target different market segments, i.e. Capilano Honey, Allowrie, Barnes Natural Brand, Wescobee and Beevital Manuka honey;
• it has a honey market share of >70% in Australia, and Manuka honey market share of around 11% worldwide;
• it sources its honey mainly from more than 600 beekeepers in Australia, and has also gone upstream into its beekeeping businesses since mid-2015. In terms of Capilano’s honey suppliers, they vary greatly in size, including “hobbyist/amateur” beekeepers with 100 hives, medium producers with 600–700 hives, and large producers with more than 5,000 hives, where the big commercial guys would produce 100 tonnes of honey a season for Capilano;
• it purchases, subject to the amount of available supply, around 10k-11k tonnes of honey from beekeepers annually (in FY2016 and FY2017), and imports honey from other countries (e.g. Argentina) to make up the shortfall;
• it packs more than 1,200 tonnes of honey per month (with a total of 15k tonnes packed in FY2017);
• it sold about 14k tonnes of honey in FY2016 (no data on FY2017); and
• it had a honey stock of around 6k tonnes at the end of FY2017 (Jun 2017).

As seen in the figure below, Capilano sources its honey from various areas in Australia, with some of them being more premium honey.

Capilano’s competitors include other honey brands in Australia, New Zealand and other countries. In terms of Manuka honey, which is produced only in Australia and New Zealand, Capilano faces competition mainly from the popular New Zealand brands, which include Comvita, Watson & Son, Nature’s Way, Pure Honey New Zealand, Ora Honey, Streamland, and Arataki Honey.

In terms of financials, let’s have a look at its revenue and profitability over the past few years. As seen in the tables below, from FY2013 to FY2017:

• revenue has been growing at (0.4)% to 40.5% per year, with a CAGR of 16.5%. These growths are mainly driven by mainly increase in average selling price (ASP), followed by sales volume (CAGR of 12.6% from FY2013–16); and
• gross profit has been growing at a CAGR of 13.9%, driven mainly by revenue growth, offset by a decline in GPM from 46% to 42%. The decline in GPM was due to increasing costs of raw honey supply due to lack of honey supply (with Capilano passing on some of these costs hike to the consumers, but not fully), offset to an extent by Capilano’s switch to higher-margin products to help improve GPM, although the end result was still a decline in GPM; and
• net profit has been growing significantly at a CAGR of 31.6%, driven mainly by revenue growth and improvements in operating margins as the business scales up in size (with NPM increasing from 4.8% to 7.8%). The increase in NPM was driven mainly by declining marketing expenses (from 16.0% to 11.5%), declining depreciation expenses (from 2.5% to 1.2%) and declining interest expense (from 1.5% to 0.3%).

In the next post, I will talk about why I think Capilano Honey is worth looking at for a value investor. Do subscribe to my blog to make sure that you receive the updates.