Swiss Water
Filing
May. 31, 2017
Q1 2017
Current Price: $6.00
1.Basic Information
(1) History
The company was a spin-off from Kraft at the year 2000 to private equity fund. It IPO'd at 2002 as income fund at $10/unit and totally around 5.5m shares. At 2001, the company's sale is around $20m and EBITDA is around $8m. Gross margin is 50%. It grew revenue to $36m at 2010 but the margin was down to 17%. Since 2011, its revenue grew faster but margin drop to below 10% and then gradually back to 15% and now revenue is over $80m.
At the beginning, the company only has one facility. At 2006 it added second production line which cost around $18.6m. At 2016, it planed 2 more production lines at a new facility and started to construct it at May 2017. It should be completed by the end of 2018. The cost is expected to be $35m.
(2) Business-related:
The company's major business is decaffeinating coffee beans using Swiss water process which is a chemical free and generally better taste than older method. The process is more expensive and the caffeine is burned away during the process. However, because the coffee tastes better, it seems well received.
The company has two types of orders. The first one is called "toll" business which its customer provided the beans for it to process and the company charge only the processing cost. This is a very high margin business. The second one is that the customer order processed beans from them directly. Obviously, this is a lower margin in accounting. The trend is that more customers tend to use the second one. That explains why the company's gross margin decreased quite a lot.
In accounting, the company account all processing revenue in one and all pass through green bean cost in another. It also has transportation revenue which is quite small compared to first two.
The processing rate charged was fluctuated because of currencies. When CAD is high, seems bad for the rate, when CAD goes low, the rate tends to go up.
(3) Management.
Frank Dennis is the key person in the company. Before 2000, he worked for 11 at Kraft on coffee product.
(4) Debt and Credit Facility.
It has 15m debt and it is convertible to common shares.
(5) Insider holding, options, Insider trading info, share buyback.
Derrick Rowe: Executive Chairman, 14.5m shares, 14%.
(6) Employee numbers
Not much
(7) Industry comparison.
There are some other companies in Mexico using the chemical method. On Swiss Water Processing side, it seems the company is the only recognized one. There is also a europian company uses the CO2 decaf that recently shut down its facility. Don't know who is the producer.
(8) Major events
2016: It issued $15m convertible debt at 6.85% to Mill Road Capital. The debt is convertible into common shares at $8.25/share. The company has the option to pay down the principle and pay the difference in stock in case a conversion happens.
2017: The company's first release of the annual report was mistakenly added gains in derivatives to operating cash flow instead of subtracting it. This inflated the operating cash flow before working capital changes by over $3m. Later it corrected it and changed its auditor.
2. Financial data.
3. Valuation
(1) In my view, the real revenue is its processing revenue. The green bean sale is just a pass-through cost. Can't make too much on that. The processing volume dropped a lot at 2009 and since recovered and grew quite well at 2013 to 2015. Although 2016 it has some drop, I believe in long-term the volume still can grow.
(2) The hedge makes it much harder to understand its numbers. In the past ten years, the hedge only generated $0.5m in total which kind of neutral in a long term.
(3) From 2010 to 2016, the book value changed very little if remove the dividend payment. The dividend for these 7 years totally is $13m. If only counting that, it is probably just $2m/year. On the cash side, its depreciation generally is $1m more than maintenance CapX which kind of added $1m in cash.
(4) Using $20m processing revenue, using 55% margin after hedge. Using $7m SG&A. It should generate $4m pre-tax income. Using 25% tax, it generates $3m net income. Adding back the $1m cash in cash flow, it is able to generate $4m in real income. Current $55m market Cap is around 13 times P/E.
(5) Assuming in by 2019, it generates $25m in processing revenue, $25m*55%=$13.75m in gross profit. $8m SG&A. 25% tax, it generates $5.75*0.75=$4.3m. Added back the $1m cash flow difference, it generates $5.3m in income.
(5) Currently, it pays 24c/share annual dividend which equals 4% in current price.
4. Risk
(1) The mistake in 2016 cash flow statement is really bothering me. I was wondering how that happened. To get the cash flow balanced it subtracted 2 times of the amount in working capital changes. CFO Sherry Tryssenaar is a certified accountant and has been that position since 2009. It is hard to believe they made this kind of low-level mistakes. Also, I found its statement format often not very consistent from year to year.
(2) The hedging activity in my view is not really that useful. It does create quite some complexity.
5. Conclusion
Overall the company seems managed quite well and with some growth opportunity. Current price is not really cheap. However, if the new production line works and it grows as expected, then this might be a good one.
6.Links
