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Managing Director's Address - 13 Nov 2002
In addressing you today, I shall cover the following topics:
Our 01/02 financial results
This was our first full year of operation after the restructuring of our wool business and the capital repayment we made to shareholders in July of last year. The restructuring allowed a big reduction in the level of funds employed in the business, and that, in turn, gave scope for the capital repayment. Of course, the one-off costs of the restructuring also affected the profit we were able to report last year.
In this year's results, we can see for the first time, the full benefits of the restructuring exercise and the exit from wool trading activities. As I will show you, the benefits come not so much from growth in earnings (which at this stage are not that much changed), but from the much-reduced capital base and the consequent improvement in return on funds employed.
So here, in brief, is the earnings result:
|
$ Millions |
2002 |
2001 |
2000
|
|
Operating surplus after tax and minority interest |
$13.15 |
$10.25 |
$13.10 |
The 2002 profit result of $13.15 million represented a 28% improvement on the $10.25 million that we reported last year. However, last year's number was affected by the closure costs, and in fact, the contribution from our ongoing businesses has been much the same for each of the past three years. That is not to say that $13 million odd doesn't represent a good result; we think it does. It's just to say that it hasn't changed very much in the last three years.
To see whether or not $13 million odd represents a good result, we need to look at it against the level of funds employed and the return on funds being generated:
|
$ Millions |
2002 |
2001 |
2000 |
1999 |
|
Funds employed:
Shareholders' equity
Amount owing to shareholders
Net interest-bearing debt |
57.7
0
32.6 |
55.2
25.2
13.8 |
80.1
0
30.4 |
77.1
0
56.9
|
| Total funds employed |
90.3 |
94.2 |
110.5 |
134.0 |
|
|
|
|
|
|
|
Operating surplus after tax and minority interest |
13.2 |
10.2 |
13.1 |
10.6 |
|
Return on average shareholders' equity |
24% |
14% |
17% |
14% |
|
|
|
|
|
|
|
NOPAT |
14.8 |
11.6 |
14.7 |
12.7 |
|
NOPAT : Total funds employed |
16% |
12% |
13% |
9% |
This table supplies quite a lot of information. It shows that the present level of funds employed is about $90 million. It also shows the progressive reduction in funds employed totalling $44 million since the 1999 year, and it reminds us of the $25 million capital repayment. Finally, it shows what our operating surplus represents in terms of a return on funds employed and how that has changed over the period. It shows, for example, that return on the book value of average shareholders' equity has grown from 14 to 24%. It shows that the ratio of NOPAT to book value of total funds employed has similarly grown from 9 to 16%.
These current rates of return on capital are amongst the best to be seen on the New Zealand Stock Exchange, and of course, it is that that has given rise to a total re-rating of the company's share price.
The challenge for management is to maintain, or even improve, on these excellent rates of return.
Now let me turn to the operating businesses.
The carpet business
At last year's Annual Meeting, I had to report that the carpet business had been very slow, but was showing signs of improvement. I said that we were hoping to get within about 10% of the previous year's record result even though we were down by 25% at that stage.
Fortunately, we were wrong, and we had the strongest second half to the year ever - by far. In that second half, business was up on the previous year by over 30%! This allowed us to record sales revenue growth of 12% on the previous year, which in itself had been a record year. Profit was on a par and that, whilst 10% better than we had expected, was a little disappointing given the level of sales growth. The comparison with last year can be summarised as follows:
|
$ Millions |
2002 |
2001
|
|
Operating revenue |
$108.9 |
$97.0 |
|
EBIT |
$19.9 |
$19.8 |
|
EBIT/Operating revenue |
18.3% |
20.4% |
|
Total assets employed |
$84.5 |
$82.4 |
|
EBIT/Average total assets employed |
23.9% |
25.6% |
Thus, the 2002 result was an excellent one, with outstanding sales growth and a very strong 24% pre-tax return on average funds employed. However, it was not quite as good as the previous year in terms of return on funds, because of the slight erosion in profit margin. We understand the factors behind the margin erosion, and we don't expect them to happen again in the current year.
Our carpet business is very strong and has seen extraordinary growth over the past few years. Only last year I was reporting to shareholders that we had completed the commissioning of new yarn-making equipment that would increase capacity by 30% to cope with the increased business volume. Now I have to report that sales demand has already exhausted that capacity increase, and we are having to manage demand in certain markets to stay within capacity limits. We have grown sales volume by between 60 and 70% over the last five years, and the business is still growing.
Some highlights from the year were the following:
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We successfully established Kimberley as a retail brand in Australia. Like Knightsbridge in New Zealand, Kimberley offers carpets produced to a lower specification than Cavalier Bremworth, but with the same attention to manufactured quality. It marks the real beginning of our market segmentation strategy in Australia and has the potential to deliver substantial sales growth going forward.
-
We again generated substantial market share growth on both sides of the Tasman. In New Zealand, we grew market share by another 8% and have increased share by more than 60% over the last five years. In Australia, assisted by the retail launch of Kimberley, we increased share by more than 10% over the year. We believe the potential exists to grow share further in both markets, but especially in Australia.
-
We saw consolidation of our relatively recently established market position in North Asia and the UK. In North Asia, our commitment to the region through the Hong Kong office that we established in 2000 is starting to bear fruit. In the UK, after a somewhat prolonged gestation period, sales turnover is starting to build.
-
We manufactured yarn and carpet in new record quantities yet again. This was the fifth year in a row that we surpassed the previous record for quantity produced. Production volume for 2001/2002 exceeded that of 1996/1997 by over 60%!
-
We won the Woolmark Company's Golden Thread award at Designex in Sydney in May with one of our new textured loops, Raffia. Raffia is the Company's fifth Golden Thread award winner in as many years, and that helps to reinforce our position as the style leaders in the Australasian marketplace.
Ontera Modular Carpets
At last year's Annual Meeting, I spoke about the challenge of growing the business. I said that I felt we were doing a very good job of growing the business organically, but that viable acquisition opportunities in the carpet business were few and far between. We had looked at a number of opportunities over the years - some of them quite high profile - but found none that could provide an adequate return on the investment required.
Now I am pleased to report that we have found, and invested in, a business that meets all of our criteria, and that is Ontera Modular Carpets. Ontera, based in Sydney, is Australasia's leading manufacturer and marketer of carpet tiles. It enjoys about 40% of that market and has a turnover of approximately A$25 million and total assets employed of A$10 million. Formerly known as Feltex Modular, the business was the subject of a management buy-out in 1998 and has struggled latterly through lack of capital.
We have invested a total of A$2 million to acquire the equity and put the business on a sound financial footing, but will be offering management an ongoing 10 - 12% stake in the business.
We believe that Cavalier's existing carpet business and Ontera should complement one another because they service different markets, but with a similar operating culture. They each dominate the better end of their markets with high quality products and a high commitment to service. However, the Ontera business is mainly synthetic fibre and exclusively contract business, whilst Cavalier is mainly wool with an emphasis on residential. Thus, there is relatively little overlap between the two. Nevertheless, there are a number of important areas of synergy, and we believe the two businesses will add value to one another.
We regard the Ontera purchase more as a strategic investment than as a takeover or merger. Ontera will continue to operate as an autonomous business, run by committed management shareholders. It should add about $2 million to Cavalier's EBIT in the current year and offers the potential to make a greater contribution in future years.
The wool businesses
Today, our wool operation comprises the businesses of Elco Direct, and our 76% shareholding in Hawkes Bay Woolscourers. Elco Direct is the private woolbuyer established in 1996 to source wool for the now discontinued E. Lichtenstein and Co. wool trading operation. It has now successfully made the transition to one of industry service provider and has a broad client base amongst wool merchants and exporters.
Hawkes Bay Woolscourers was established in November 2000 to acquire and operate an existing commission wool scouring business in Napier. It is one of only two specialist commission wool scours in the North Island servicing the requirements of wool exporters. Each of these two businesses has Cavalier as a major customer, and each springboards off that to provide a service to the wool trade at large.
For the year under review, these businesses, which have a combined turnover of about $60m, contributed $3.7 million before interest and tax and before allowing for minority interest. The equivalent number for last year was $3.8 million, even though last year's result included only an eight-month contribution from Hawkes Bay Woolscourers. The table here shows the relevant comparatives:
|
$ Millions |
2002 |
2001
|
|
Operating revenue |
$60.7 |
$58.6 |
|
EBIT |
$3.7 |
$3.8 |
|
EBIT/Operating revenue |
6.0% |
6.5% |
|
Total assets employed |
$16.0 |
$14.3 |
|
EBIT/Total assets employed |
22.9% |
26.6% |
The current year's result, although satisfactory, was down on our expectations. It was not an easy year in the wool industry because normal activity patterns were affected by extremely wet weather in both spring and autumn in the North Island. Partly as a result of this, the volume of wool that was available for scouring was down by more than 10% on the previous year, and Hawkes Bay Woolscourers was unable to reach its volume targets.
Whilst the profit contribution of $3.7 million was a little below our expectations, you will note that it still represents an excellent return on funds employed.
These businesses have developed well, and we expect to do even better in the current year.
Outlook for the current year
If we are able to achieve our budgets for the current year, we should produce an EBIT of $27.8 million. That would be an exciting 24% increase on last year, made up of a 15% increase in contribution from our existing businesses, plus a $2 million maiden contribution from Ontera. Those numbers, in turn, would translate into an operating surplus after tax and minority interest of around about $16 million, or $0.51 per share, compared with last year's $13.1 million, or $0.42 per share.
So, how are we doing so far?
Well, I am delighted to be able to report that after the first four months, we are tracking ahead of that budget. Our best estimate for the half-year is a tax-paid surplus of $9 million, which would be 12.5% ahead of the aforementioned budget. It would also be a massive 56% increase on last year's first half!
Nobody should expect us to carry that level of increase through for the full year! However, I believe the $16 million to be very achievable provided there is no dramatic change in the business environment.
One vulnerability that we do have is to the cross rate with the Australian dollar. Our forward cover is almost exhausted, and if the New Zealand dollar were to strengthen much beyond the current A$0.88 level, then a $16 million year-end result could come under some pressure. Conversely, should the New Zealand dollar weaken against its Australian counterpart, there could be some upside to the year-end result.
We will update shareholders on the outlook at the half-year.
Microbial Technologies
This project has made significant progress over the past 12 months.
Two full-scale and registration-compliant blowfly field trials were completed successfully in Australia, and we are continuing to make progress in the registration preliminaries. Further field trials are now underway, and the results of these will accumulate over the next three months. The trials cover both the prevention of flystrike and the eradication of lice infestation in Australia, and the eradication of scab mite in the UK.
A final decision about commercialisation will almost certainly follow the results of these trials.
Share capital structure
The growing earnings of Cavalier, together with the cancellation of one share in eight that we effected as part of the capital repayment last year, mean that the per-share numbers on the stock are beginning to look quite high. Share price is over $6, and the prospective earnings per share is getting up towards $0.50, etc. In addition, and perhaps partly because of the high unit price, the stock is very thinly traded. Your Directors have therefore decided that it would be appropriate to effect a 2:1 share split, thereby doubling the number of shares on issue and in the hands of each shareholder.
We propose to do this after the payment of the first interim dividend, and once we have done so, there will be a fraction under 63 million shares on issue. We hope this may have some positive effect on the liquidity of the stock. Of course, the share price is likely to halve, but that is of no consequence because each and every one of you will own twice as many shares.
The Chairman will speak further on this topic when he covers the subject of dividends.
That concludes my address. Thank you for your attention.
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