Just how similar are the Ingham’s and Dick Smith IPOs? Both are (or in Dick Smith’s case, were) iconic Australian businesses. Private equity firms bought both businesses from trade owners. They then floated them for healthy gains (Ingham’s lists this coming Monday). And in both cases, private equity sold a truckload of assets prior to listing, leaving incoming shareholders with hollow balance sheets.
But as far as one can tell based on the Ingham’s prospectus, that’s where the similarities end. Dick Smith’s main undoing was booking stock purchase rebates as revenue at time of purchase instead of at time of sale. No signs of that from Ingham’s.
So does that make Ingham’s a solid addition to your portfolio?
The first thing I did when I downloaded the prospectus was search for the word ‘Woolworths’. This took me straight to page 35. And there it was, powerful supermarket customers such as Woolworths, Coles, IGA and their Kiwi counterparts Countdown and PAK’nSAVE comprise over half of Ingham’s revenue. Throw in fast food giants like KFC and that total moves to 70%.
And therein lies a problem. The big risk for Ingham’s is not that it turns out to be another Dick Smith but rather another Goodman Fielder, Asaleo Care or Patties Foods. Or any other supplier to the supermarket channel, even Pacific Brands. When you have a commoditised product, dealing with powerful customers is not a recipe for earnings growth. It’s a recipe for wealth destruction.
Perhaps some investors will disagree with me because Ingham’s is an Australian icon. Tell that to the Woolworths and Coles buying departments. Make no mistake, iconic or well-known brands do not equal brand equity. Helgas, MeadowLea, Sorbent, Libra, Four’N Twenty and Bonds weren’t able to steer the fortunes of the above-mentioned companies towards growth. Pricing power is everything in domestic wholesaling and unless a product has true brand equity such as Coca-Cola, the supermarkets will dominate price negotiations.
Sure, maybe things will go ok for a year or two, while prices are locked in for the short-term and the vendor’s remaining shares are in escrow. But let’s look at what happened to the above-mentioned supermarket suppliers in the years following their IPOs.
After two or three years, their share prices started falling off a cliff. Why? They were dressed up for IPO as dependable staple goods manufacturers, paying a steady dividend stream from their stable profits. After a few years the reality set in. These companies would struggle to maintain profitability in the face of gruelling price negotiations with their powerful customers. Earnings were far more volatile than the inelastic demand for their products.
It’s hard not to see the same thing happening to Ingham’s. The business is expected to generate a return on equity of 76% in the 2017 financial year. How long will Woolies let that go on for?
And don’t get me started on valuation. The private equity vendors bought the business in 2013 for $869 million, sold $540 million of property in 2015 and are now floating it for an enterprise value of $1.6 billion. This implies a price to earnings multiple of 12 times based on forecast 2017 earnings, which are a whopping 91% higher than what the business earned two years earlier. For mine, this looks fairly valued at best, with little margin of safety given the risks.
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You are so right, after reading this article any one buying this stock should not complain. The only problem is that fund manager who looks after lay people monies would get into this either for a short term gain or because of mates with private equity firm.
Thank you for the clear explanation of “come in sucker”
Can you provide companies that are price makers not price takers
most of whom seem to be being taken for a ride
Very helpful Daniel.
These private equity firms really do ‘take the cake’ when looking at the money makers in these deals.
And what about the professional gatekeepers?
They don’t seem to be much better.
Do you think the auditors, or the ‘objective’ accountants report, or the legal advisers, or the other IPO rentseekers will be mentioning these matters?
I think not – they all are getting a big slice of the action (read money).
Do you think any of the above parties will be mentioning what you have said in your brief article Daniel?
Of course not – they will leave that ‘for the market’ to ascertain.
They just presume the silly mum and dad investors will be sucked in by all the above advisers.
Why is anyone surprised at the notion that this will destroy ( transfer ) wealth. That is what private equity firms do! It appears that they bought for 330M (after asset sales ) and are selling for 5 times that. I think the more interesting question is;
Who bought the land and improvements (assets ) that were offloaded.
That would be a better company to invest in
Good article -when will the poor old retail investor learn. Never buy shares from Private Equity firms. They are NOT your friends. You will find that if it’s a ‘good’ IPO you somehow get scaled way back anyway and if it’s a dog you will get a full allocation. Funny that!
Nice clickbait headline!
I agree with much of the sentiment in this post but just for fun what do you think of these counterpoints:
The return on equity figure is meaningless due to the amount of equity sucked out by TPG. You’re surely not suggesting that they are getting 75% return on incremental equity? That being the case it won’t make any difference to price negotiations. They would have already faced years of price pressure with Woolies and Coles who have been placing suppliers under maximum pressure in recent years.
With introduction of Asda, Costco, maybe Lidl and now, we hear, Amazon doing fresh produce, there will be greater numbers of customers fed by a near duopoly in producers. There will be increasing price pressure on retailers sure, but also pressure on ensure supply of a key ingredient at least with fresh chicken.
They are different from the other firms you name due to their size in the wholesale industry and lack of alternates for their customers. Unlike Pacific Brands, Asaleo and even Patties most of their products can’t just be substituted with overseas imports and no one apart from Baiada can compete with them on scale and production costs. If Inghams refuse to supply to Woolies or Coles where are they going to get their fresh chicken? Baiada can’t suddenly double production, it takes years and huge capital cost and, as a near duopoly wouldn’t be in their interest to compete irrationally on price anyway. The retailers can’t import or even threaten to import alternatives like they can for clothes, frozen pies or toilet paper. You can’t set up a massive fresh chicken supply chain as readily you can a large bakery in the case of GF. No one else can step in with the necessary supply. That gives them some power that is missing in all your other examples.
Sure TPG are horrible but at least some of their windfall has come from the huge tightening in cap rates and the property market fetish for ‘quality’ tenants which meant the property was worth way more by now than the Ingham family obviously thought in 2013. No point spiting yourself over someone else’s fortune. This only accounts for maybe $200M of the money they sucked out to be fair.
Anyway, at 12x earnings I don’t think it is too badly priced (certainly at 15x it would have been too expensive).
Hmm. You seriously don’t think that a Chinese supplier of “fresh” chook can’t be found?
Of course they can be found, they supply everything else you can think of, including lots of the stuff in Patties food products (which I won’t touch with a barge pole).
$ count in the end.
You are simply not allowed to import fresh chicken into Australia and no sign of these rules being changed (for any country other than NZ which has subspace production.)
Methinks that the Peter doth protest too much.
A cynic might suspect that he works for TPG or their PR firm.
I’m a cynic.
….says the person who won’t even use their full name and, from posts below, sounds like a PETA stooge.
Yeah really ‘protesting’ by agreeing with the majority of the original post in my first line. The company is very very ordinary ok, and i’ve made it clear i am mainly raising matters for discussion, but the straight comparisons to the likes of Myer and Pacific Brands are ridiculous and simplistic.
There is no way i’ll be holding this stock longer term and sure everyone’s noses are in the trough – if you can’t deal with that you might as well move on from any stock in the top 300. All i’m saying is there might be enough quality there for it to trade on 12.5-13.5x earnings at some point in the first month or so and, from my perspective to take a quick 5-10% profit. If not so be it – i’m wrong at least 35% of the time in any event and this could well be one of those. If Trump wins on Wednesday then everything will implode anyway.
These are all good reasons why Ingham’s would be a very interesting company to take a look at once the stock price is in the doldrums, and it has been recapitalised by more gullible shareholders than I.
The retail supermarket duopoly is in the early stages being disrupted, the recent Woolworths results compared to Coles tell us a lot. http://tinyurl.com/zkfg5hx
Understanding the way the supermarket business model http://tinyurl.com/hn3ydld works, and the competing strategic forces at work is fundamental to making a bet on the IPO of Inghams.
It is true that the history of returns post IPO for supermarket suppliers is very poor, but it is also true as noted by Peter that chicken supply is almost as much a duopoly as is the retail side, and neither of the suppliers would benefit from a major disruption.
However, the retail side of the equation is changing as consumers change behaviour and new distribution modes evolve.
The whole supermarket supply chain will undergo substantial evolution over the next 10 years, and the comfortable duopolies on both side of the business model will start to ‘leak’ badly.
Agree with the article and the comments re PE modus of operandi.
Who is buying all these private equity exits? Me thinks these are the same people that happily bought AAA rated subprime bonds due to a slightly higher yield. PE exit IPOs are usually a bit cheaper than comparable firms on the important metrics (PE, PCF etc), yet due to their hollowed out balance sheets, are still no bargain.
I think I have seen a study somewhere that PE exits actually had better stock performance than the market. First, because obviously they are highly leveraged, which (on average) had been a good thing in the stock market boom of the last 30 years.
And second, perversely, in an environment of falling interest rates that most countries have had been in in the last 30 years, a lot of debt is a source for earnings growth. You can refi those loans every two years or so at steadily lower interest rates.
First of all, let it be known that I am not a fan of private equity floats AT ALL. However Inghams does interest me at the IPO price for a number of reasons. It is a market leader with high barriers to entry (time and cost to replicate national scale) in a duopoly market that is protected by import restrictions. This gives it a higher degree of negotiating power with the big supermarkets. It is about who has the chickens and the supermarkets have few alternative suppliers to deliver them their $8 chickens because of the industry dynamics mentioned above. I would not put Inghams in the same universe as Dick Smith, and I would be more positive on Inghams than consumer products companies you mention (Asaleo etc) which are akin to commodity producers.
Brett no doubt the snouts are in the trough but you are double counting a bit. The large increase to $177m includes all the one off costs related to the float you already mentioned earlier. Proforma increase is only $1.
Just stating the obvious Peter.
$50 million increase from 2016 to 2017 certainly indicates quite a few little piglets doing some fattening on the float. I did a rough and quick count of $30 million to the above-mentioned ‘gatekeepers’, so somehow even in the float year they have managed to squeeze out another $20 million over and above this.
However I hardly think the 25% increase from 2015 to 2016 relates to the float. That’s another tidy little $20 million.
Certainly the new owners did not spare any expense in dressing it up.
And all of that just relates to expenses. Let’s not talk about the big piggy gains by TPG.
Whew this is some trough.
I’d like to imagine some of the advisers took a closer look at the prospectus, and advised accordingly.
What I think is most concerning with this and similar floats is the purportedly objective third party professional experts who get rewarded handsomely only if the float is successful.
Gee I wonder what they will say!
Most will fall back on their reputational integrity as professionals but in reality the conflicts of interest muddies the waters considerably so that one wonders just who are they acting for.
When will their be some review by ASIC of the integrity of the process where the investment banks and brokers are advising their clients to invest with a considerable bias toward their own benefit and not the clients. Silly question I know. ASIC not called the corporate plod for nothing.
By my reckoning the company is skating on relatively thin ice when it comes to their debt covenants even on pro-forma FY17 numbers. In the event of any deterioration to their gross margins (WOW and WES ending cheap roast chicken promotions for e.g..), or any increase in their working capital requirements, or any of the other listed asterisks around their pro-forma debt levels (there are many) – and they will be in breach of covenant. Aside from that the dividend payment policy of 65-70% of NPAT appears unsustainable, as their profit bears little relationship with free cash flow – from which dividends are ultimately paid – as the cost of keeping the lights on and replacing capital items is large at Inghams. Free cash flow generation (under any normal industry metrics) for this business is woeful, and by my reckoning will necessitate either a dividend cut or an increase in debt (not likely given covenants) within the next few years at most.
I wouldn’t go near it.
Hear Hear Toby.
Balance Sheet at 30/6/16 (refer page 68 of prospectus)
Assets $946.3 million
Liabilities $947.5 million
That’s a negative equity position of $1.2 million.
Of course they then show what it would be like if the IPO had occurred at that date (which it hadn’t) to get to a not much better positive equity position of $130.7 million.
i.e Assets $926.4 million
Liabilities $795.7 million
That in itself is no small concern.
But when you consider that they are trying to say the market capitalisation is between $1.3billion to $1.5 billion (yes, that’s billion with a b), or the enterprise value is between $1.75billion and $1.95 billion. (page 4 of prospectus)
That some difference between book and market value.
Lets hope the fund managers have a good explanation for this if they invest their clients money in this IPO.
Whew!
The following numbers come from the Inghams Prospectus Page 11 and from the Offer Summary from Commsec
Ingham’s revenue has been flat over the four years 2014 – 2017 averaging 2.08% change per year over the four years.
You would expect such results from such a business.
But who’s been doing what to the financial statements? In those same four years there have been huge fluctuations in the profits. And there have been variances between EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), EBIT (Earnings Before Interest and Tax) and NPAT (Net Profit after Tax). Just why the accounting profession condones the use of anything other than NPAT I’m not sure. EBITDA is, in my opinion (Chartered Accountant), almost useless as a measurement because it can be so easily manipulated by strategic financial decisions such as owning vs leasing, capital vs debt etc.
Anyway, have a look at the wildly fluctuating EBITDA figures in the prospectus. In the 2015 year EBITDA dropped 28% from the previous year. But the next year (2016) it bounced back increasing by 46%. And in 2017 it is expected to increase by another 14%. All this while revenue has hardly moved a whisker! Could there be some creative accounting taking place to generate financial statements ready for the IPO?
And to make my point about EBITDA being meaningless have a look at the difference between EBITDA and NPAT. I trust NPAT (Net Profit After Tax) because it is the figure least vulnerable to manipulation and creative accounting and the ATO make the rules.
In 2014 EBITDA was 149% higher than NPAT. (that’s correct – nearly 2 1/2 times)
In 2015 EBITDA was 122% higher than NPAT.
In 2016 EBITDA was 102% higher than NPAT.
In 2017 EBITDA will be 92% higher than NPAT.
And guess which figures are highlighted in the IPO IM? Of course it’s the higher EBITDA. To find the “real” tax figures you need to go deep into the fine print of the prospectus.
But even NPAT reflects some “housekeeping”!
In 2015 NPAT went down by 9%. But the next year, 2016 it went up by 61% – and of course 2016 is the last completed financial year before the float.
So if the Company cant get any consistency in it’s financial statements even though it’s business remains steady how can we trust the projections?
I’ll pass thanks!
The more I see these things happen the more I appreciate Warren Buffett imparting his knowledge.
Warren Buffett: “It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).”
Incidentally, the chooks in the stock photo are plainly not Ingham’s chooks, green grass and freedom of movement aren’t the sort of things that you’ll see very much of at an Ingam’s “farm”.
The strength of Ingham’s business resides in its ability to squeeze suppliers, most notably the 225 contracted broiler farms and then keep most of those excess gains from the other competitive forces.
A chook farmer told me the going rate for a bird is 2 cents (they want 9 cents) and there hasn’t been a rise in prices in 18 months. Suppliers can only be squeezed so far and it sounds like PE may have squeezed every last cent out of their growers to boost current profits. It wouldn’t surprise me if Ingham’s COGS increased in the near future to secure their supply and the new owners bore this cost. That sounds like a typical PE trick to me.