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Managing Director's Address
In addressing you today, I shall cover the following topics:
Ontera Modular Carpets
Our wool businesses
Outlook for the current year
Microbial Technologies
Our 02/03 financial results
Shareholders will remember that in the year 2000, we closed down the Lichtenstein wool trading operation and completely restructured our involvement in the wool industry. As a result of those changes, we were able to return $25m of surplus capital to shareholders, and this we did in July 2001. The changes produced a dramatic improvement in the companys return on funds employed, and that in turn led to a dramatic up-rating of the companys stock by financial markets.
2002/03 was the second full year of operation of the re-configured Cavalier Corporation following these changes. It was a year in which we saw strong growth in earnings and a further dramatic improvement in return on capital. Two main factors contributed to these improvements: -
- Strong earnings growth from the Cavalier Bremworth broadloom carpet business. Cavalier Bremworth has been enjoying ongoing market share growth as well as very buoyant markets on both sides of the Tasman..
- A maiden profit contribution from Ontera Modular, the Sydney-based carpet tile business that we acquired in July of last year. Ontera was acquired at a price that was low relative to its earnings potential, and so was able to add shareholder value from the outset.
Here, in brief, is the earnings result set against those of recent years: -
|
Cavalier Corporation |
| |
|
|
|
|
| $ Millions |
2003 |
2002 |
2001 |
2000 |
| |
|
|
|
|
| Operatng surplus after tax |
$18.26 |
$13.15 |
$10.25 |
$13.10 |
The 2003 profit result of $18.26 million was a big 40% improvement on the $13 million odd that we achieved in 2002 and 2000, and that we would have achieved in 2001, but for the restructuring costs. Last year, I remarked that we seemed to be stuck on the $13 million number, but now we have managed a break-out.
We have also managed a further substantial improvement in our return on funds employed. First, let me remind you of the level of funds we are employing in the business today and how that has changed in recent years: -
|
Cavalier Corporation |
|
$ Millions |
2003 |
2002 |
2001 |
2000 |
1999 |
| Funds employed: |
|
|
|
|
|
|
Shareholders' equity
Amount owing to shareholders
Net interest-bearing debt |
63.2
0
30.0 |
57.7
0
32.6 |
55.2
25.2
13.8 |
80.1
0
30.4 |
77.1
0
56.9 |
| Total funds employed |
93.2 |
90.3 |
94.2 |
110.5 |
134.0 |
This table shows us the big reduction in funds employed since our last full year of wool trading in 1999, and it reminds us of the $25 million capital repayment. It tells us that we have about $93 million of capital employed today.
The next table looks at the return on those funds employed: -
| |
Cavalier Corporation |
|
$ Millions |
|
2003 |
2002 |
2001 |
2000 |
1999 |
|
Total funds employed
Operating surplus after tax
Return on shareholders equity
NOPAT |
|
93.2
18.9
31%
20.2 |
90.3
13.57
24%
14.8 |
94.2
11.0
14%
11.6 |
110.5
13.1
17%
14.7 |
134.01
10.6
14%
12.7 |
| |
|
|
|
|
|
|
| NOPAT: Total funds employed |
|
22% |
16% |
12% |
13% |
9% |
It shows the big improvement in earnings that we achieved last year in the context of earlier years. Most importantly, it shows that by whatever measure you use, the return on funds employed has been more than doubled over the five-year period. Return on equity has gone from 14% to 31%. The ratio of NOPAT to total funds employed has gone from 9% to 22%.
The company has gone from being an average performer, producing an adequate return on funds, to being a stellar performer producing an outstanding return on capital. This, of course, has been reflected in the share price, and shareholders have benefited accordingly.
Naturally, the higher the returns achieved are, the more difficult it is to improve on them. That is the challenge for management, but it is one that we relish. To those that say you cant possibly do better than that, I say wait and see!
Now, let me turn to the operating businesses. In discussing progress and performance, you will hear me frequently make mention of the level of return on funds being achieved. I make no apology for that since it is the level of earnings relative to the amount of capital employed in the business that determines shareholder value. Our rough rule of thumb is that if a business is contributing more than 15% pre-tax on total funds employed, it is creating wealth. If it contributes less than 15% pre-tax, it is destroying wealth.
Cavalier Bremworth
Cavalier Bremworth, of course, is our long established broadloom carpet business and the main contributor to the companys earnings. It had a very good year. It had the benefit of very strong market conditions occasioned by low interest rates and the property booms on both sides of the Tasman. It also continued to grow market share, especially here in New Zealand. Sales were up by 11% on 2002, which was in itself a record year, and could have been higher except that we simply didnt have the production capacity to meet market demand.
This table summarises the results for 2003 and compares them with those of the previous two years: -
|
Cavalier Bremworth Operations |
| |
|
|
|
|
$ Millions |
2003 |
2002 |
2001 |
|
Operating revenue |
$120.6 |
$108.9 |
$97.0 |
|
EBIT |
$25.4 |
$19.9 |
$19.8 |
|
EBIT/Operating revenue |
21.1% |
18.3% |
20.4% |
|
Total assets employed |
$84.1 |
$84.5 |
$82.4 |
|
EBIT/Total assets employed |
30.2% |
23.9% |
25.6% |
So, we see another outstanding result from Cavalier Bremworth, with the earnings contribution up by 28% to $25.4 million and the pre-tax return on funds employed over 30%!
In the annual report, I noted some of the highlights for this business in the 2003 year: -
-
We achieved an 80% sales increase for the Kimberley brand in Australia, despite being hampered by stock shortages for much of the year.
-
We grew market share in New Zealand yet again, this time by another 8%. We have now increased our share of the New Zealand market by 80% since 1997.
-
We doubled our sales volume in the UK, as our reputation for quality and reliable service begins to take hold.
-
We enjoyed an excellent sales year in S E Asia, where contracts won included two new major hotels - the President in Jakarta and the Bali Hilton.
-
We manufactured yarn and carpet in new record quantities yet again. This was the sixth year in a row that we surpassed the previous record for quantity produced.
On the negative side, we had quite a tough year in America, where the economy has been very sluggish, and in China and Hong Kong, where business was badly affected by the SARS epidemic in the latter part of the year.
However, this is a very strong business that has achieved extraordinary growth over the past six years. In that time, production and sales volumes have been increased by more than two-thirds, and the additional yarn-making capacity that we commissioned less than three years ago has already been exhausted. As a result, we spent much of last year managing demand in certain markets to stay within capacity limits.
We have been reluctant to invest in a further round of additional capacity until we find a way to do so economically. However, I am pleased to announce today that we have now found that opportunity and are extending our Wanganui Yarn plant to house a 3 metre semi-worsted card set that we have acquired in the UK.This will give us up to 25% more capacity in a very cost effective way and pay for itself in a very short time. We expect to commission that equipment in the first half of the next financial year.
Meantime, business continues to be strong. Up to the end of October, after 4 months of the year, sales were up by 10% on last year, and profit was up by 16%. That is pretty much in line with our budget.
Ontera Modular Carpets
We acquired this business with effect from July 1st 2002. Then, on April 1st this year, we sold a 10.5% stake back to Ontera management under terms and conditions agreed to at the time of acquisition, so that Cavalier now owns 89.5%.
For its maiden year as a Cavalier subsidiary, Ontera performed quite well, generating a significant positive contribution, compared with a loss in the previous year. Earnings before corporate costs, interest and tax were $2.7 million on turnover of$28.3 million. Turnover was more or less in line with our initial expectations, but earnings were ahead. The improvement can be partially attributed to the appreciating Australian dollar, since Ontera purchases much of its raw material in US dollars, and it has been a significant beneficiary of the decline in that currency. The declared result also includes a one-time benefit of$0.6 million pre-tax associated with the purchase. Thus, the benchmark contribution for this year, against which we will measure future performance, was $2.1 million before corporate costs, interest and tax.
This table summarises Onteras financial performance for the year: -
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Ontera Modular Carpets |
| |
|
|
| $ Millions |
|
2003 |
| Operating revenue |
|
$28.3 |
| EBIT |
|
$2.7 |
| Normalised EBIT |
|
$2.1 |
| Normalised EVIT/Operating Revenue |
|
7.4% |
| Total assets employed |
|
$10.6 |
| Normalised EBIT/Total assets employed |
|
19.8% |
Onteras performance represents a good return on funds employed — in part because we acquired it quite cheaply. But more importantly, we believe that there is considerable potential to grow this business. It had been starved of capital for some years and unable to fulfil its potential. Our medium term goal is to raise volume and profits through expansion of the product and brand portfolio, while investing in a modernisation program to reduce manufactured costs. The modernisation program has begun, and we will spend about $1 million on plant and equipment in the current year.
After the first quarter, the EBIT contribution from Ontera was up around 15% on last year. The forward outlook appears quite positive, and we are hopeful of improving substantially on last years performance in the current year.
Our wool businesses
Our ongoing wool operation comprises the businesses of Elco Direct and our 76% owned Hawkes Bay Woolscourers. Each is a service provider for the wool trade, and each has Cavaliers carpet operation as a major customer.
Elco Direct is a private wool buyer, established several years ago 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. For the year under review, Cavalier had a 76% share in the venture. However, we acquired a further 16.5% from our joint-venture partner on July 1st 2003, so that our stake in the business going forward is 92.5%.
It was again quite a difficult year for the wool trading and exporting industries that form the customer base for our wool operations. It was a year that saw a major strengthening of the NZ dollar — especially against the US dollar and the pound. This meant that the price of wool rose by some 15% in international currency terms. That, in turn, led to a big gap in price expectations between overseas buyers and local sellers. This difficult trading environment saw several major and long-established merchants close down their operations during the year, leaving the business to a shrinking number of players. Thus, customers of our wool operations are becoming fewer in number, but larger in size. The volume of wool scoured on the North Island was level with the previous year, but still well down on volumes in 2001 and earlier.
In this challenging environment, our wool operations contributed $3.8 million before corporate costs, interest and tax, and before allowing for minority interest. This table summarises the results of operations over the last three years: -
|
Wool Operations |
| |
|
|
|
|
$ Millions |
2003 |
2002 |
2001 |
|
Operating revenue |
$54.3 |
$60.7 |
$58.6 |
|
EBIT |
$3.8 |
$3.7 |
$3.8 |
|
EBIT/Operating revenue |
7.0% |
6.0% |
6.5% |
|
Total assets employed |
$15.9 |
$16.0 |
$14.3 |
|
EBIT/Total assets employed |
23.9% |
22.9% |
26.6% |
Note that profit contribution has been a steady $3.8 million or so for the past three years. Whilst this is a relatively modest contribution compared to that of the carpet business, you can see that it does represent an excellent return on funds employed. In addition, of course, these operations provide an important service to the carpet business in the procurement, blending and scouring of wool. They also provide the vital connection from farm gate to fabulous wool carpets that is part of the Cavalier Bremworth story.
We dont think we have yet seen their full earnings potential. If we achieve our budgets this year, our wool operations will do about $0.7 million better than last years $3.8 million. After the first quarter, we are a little behind last year after a rather slow start to the season. However, the vast bulk of turnover has yet to come, and we are quite optimistic about the prospects.
The outlook for the current year
If we are able to achieve our budgets for the current year, we should produce an EBIT of $33.4 million, which would be a 10% improvement on last year. I am pleased to be able to say that for the first four months into the year, it seems we are going to be right on budget, year to date. Going forward, one factor we appear to have in our favour is exchange rates.The NZ dollar is weaker against the Australian dollar than we had budgeted for, and both the NZ and the Australian dollars are stronger against the US dollar than we had budgeted for. Both of these factors are in our favour.
Provided there is not a substantial downturn in the carpet business, either here or in Australia, before the end of the year, we see no reason why we cant deliver that full year EBIT of $33.4 million.
Microbial Technologies
This project has made considerable progress during the last year. Initial trials of a scab mite remedy for the UK market yielded very promising results, and four full-registration field trials on the lice remedy are currently underway in Australia. In addition, our active ingredient has received draft approval from the Australian Therapeutic Goods Administration, with the suggestion that no residue limits or withholding periods will be required. Whilst this is as we had always expected, it is, nevertheless, an important milestone passed.
After a careful review of various potential commercialisation alternatives, we have entered into discussions with a number of potential interested parties from the veterinary medicines industry. The scope of this project appears to be worldwide, and it will benefit from the involvement of a company with a worldwide presence in the field on animal health.
We will inform shareholders of the outcome of these discussions in due course.
Closing remarks
Ladies and gentlemen, that concludes the formal part of my address to you today. As many of you will know by now, this will be the last time that I stand before you as Managing Director of the company. It is 10 years since I first stood before you and said what an immense privilege it was for me to be taking over from Tony Timpson as Chief Executive.Now I can say what an immense privilege it will be for me to take over from Tony as Chairman in April of next year.
I know you will all miss Tonys presence on this platform. He has graced it for more than twenty years, capturing meetings with his irreverent style, razor sharp wit and immaculate sense of timing. I will not be able to replace that, and I dont think there is anybody that could. As all who know him can attest, behind Tonys congenial exterior lays an intellect of great breadth and a brilliant business mind. Those that have been shareholders from the outset can attest to that. $10,000 invested in the Cavalier float 20 years ago would be worth some $132,000 today and would have returned almost $50,000 in dividends over that period. Few, if any, listed companies can match that record.
We are fortunate in that we will not lose Tonys wise counsel, as he will remain a director and continue to give the Board the benefit of his immense experience and wisdom. However, today will be the last on which he stands before you as Chairman. Therefore, I would like you to be upstanding and show your appreciation of the contribution he has made.
Ladies and gentlemen, Mr Tony Timpson!
For myself, I am proud of what has been achieved over the last ten years. When I joined the company, it had a market capitalisation of $120 million, and today, that stands at $340 million — with again, many tens of millions of dollars of dividend payments on top of that. I want to record my thanks to the loyal and dedicated staff of Cavalier that have made such achievements possible, and I want to assure shareholders that I remain committed to the company and to the task of maintaining and growing shareholder value.
Thank you for your attention.
A M James
5 November 2003
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