Trilogy (TIL)

Tuesday 15th July 2014

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Fat Prophets

Trilogy (TIL)

What’s new?

Given such a challenging trading climate in recent years, it is a testament to any product manufacturers that have been able to successfully grow top line revenues and earnings. It should also bode well for those companies as overall consumer spending tracks back up in line with a wider economic recovery.

A business which stands to do just that in our view is Trilogy International (NZE, TIL) a New Zealand listed company which manufactures and distributes scented candles and skincare products based on natural ingredients. The company recently delivered its first material net profit after tax of NZ$1.1 million on top line revenue growth in the year to 31 March 2014 of 11.6% to NZ$29.8 million.

The company’s Ecoya unit which produces scented candles, delivered a strong performance with sales in Australia and New Zealand up 23% to $8.4 million and 44% to $3.0 million respectively. The company has a strong line of distribution for its core candles products into leading department stores such as David Jones, Myer and Farmers. Management have also remarked that 65% of sales are being provided by ‘independents’ such as gift stores. This is a positive in that the company is not at the mercy of one or two large players.

Bringing product development and design back in house also has boosted sales, as has lowering the average price point on many products. It is also notable that Ecoya has managed to trim operating expenditure from $7.6 to $7.3 million this year on a strong uplift in sales.

Australia and New Zealand are providing the rump of sales but management are also targeting opportunities to expand distribution further offshore. The UK, Sweden and Switzerland are key markets of focus in Europe, while Korea, Taiwan and China are in the cross hairs in Asia.

Meanwhile Trilogy, the company’s natural skincare business, performed impressively across all regions with the exception of Australia. The performance in the latter meant that revenues overall were up only slightly by 1% to $16.2 million. Stripping out Australia, top line growth came in at a more impressive 13%.

Overall sales were down in Australia by 20%, although half of this impact was due to currency movements, with the Australian dollar weakening versus the New Zealand dollar. We do not think that a material improvement in the cross rate is likely (the Australian dollar may even weaken further), therefore this could well remain a headwind for the year ahead.

We do however believe that Australian sales will get a significant boost in the coming 12 months following a new distribution agreement which kicks in on the 1^st of July. Trilogy has signed up with McPherson’s and is consolidating its Australian distribution under a single relationship.

The deal looks like a good one for Trilogy as it simplifies the Australian distribution strategy - up until now it has operated nine distribution points and five independent distribution relationships. The agreement potentially gives Trilogy a full service sales and marketing, and distribution model, along with greater reach into pharmacies as opposed to department stores. It will also increase efficiencies with deliveries direct into store rather than a distribution warehouse. Performance targets are also imbedded in the agreement.

As a result Trilogy will now have physical reach to 5,000 doors in Australia with 49 sales professionals and 300 merchandisers. We therefore believe we will see a much improved performance from Trilogy’s Australian operations in the year ahead.

Meanwhile Trilogy’s kiwi business continues to plough ahead nicely, unabated by any currency headwinds. The brand is now the number one in Pharmacy Self Select and is sold in 850 retail outlets.

We also see a big growth kicker coming from Trilogy’s operations outside of Australasia. The economic recovery in the UK and Ireland are certainly helping, with sales ahead 16% of last year to $2.19 million. Trilogy is establishing a presence in some quality high street chains including the likes of Debenhams and John Lewis. The company is also seeing benefits from moving away from a lower end distributor. We believe that there is further to go in the consumer recovery in both the UK and Ireland which should stand Trilogy in good stead in the year ahead.

Asia also offers up a significant growth market for Trilogy with sales already very meaningful and accounting for the lion’s share of RoW sales which were up 24% to $2.494 million. Here Trilogy has been boosted by getting product placement into 200 Mannings Pharmacy stores in Hong Kong. Management are highly focussed on further growth in the region having recently appointed a full time sales manager on the ground to build upon a presence in Japan (the company’s fourth biggest market), Singapore, Malaysia and Korea. Trilogy is finding there is a clear demand for natural skincare products with the fact they are coming from New Zealand being a particular selling point.

Although currently at a low base of $315,000 in sales for last year, the US also offers up significant long term growth potential for Trilogy. The company is looking to break into the Mid-West after having signed up 41 Whole Foods Market stores. The agreement should provide a platform for further expansion in the region.

Longer term growth will also come from consumers increasingly becoming more discerning between ‘natural’ and ‘non-natural’ skincare products.

Outlook

We believe that the medium term earnings outlook looks excellent for the company following the appointment of a new distributor in Australia, along with robust prospects in the UK and the Asia region, where sales are already growing at a rapid clip. Longer term there is also some blue sky through the company’s penetration into the US market.

The company also has substantial flexibility to invest in core brands and markets. Net Debt at 31 March 2014 stood at $3.4 million, which was down from $5.5 million at 31 March 2013. Interest cover meanwhile is solid at 2.6 times last year.

The company has ample headroom with a total debt facility of $9.5m. Robust operating cash flows ($1.476 million last year) also provide further scope to reduce the current debt load further.

Price

Market sentiment towards the shares has been weak of late on account of concerns over currency headwinds (due to a strong kiwi dollar), and a weaker performance in Australia for the Trilogy product. However we believe that sentiment is showing signs of bottoming out, providing an opportunity for investors.

Worth Buying?

We are encouraged by the recent full year result from Trilogy and expect earnings momentum to grow in the year ahead and beyond. We anticipate an improved performance in Australia as a result of a new distribution agreement there, whilst growth prospects in offshore territories looks immense on the back of improved distribution scope, a growing reputation and improving economic environment.

From a valuation perspective the shares are not cheap, trading on around 28 times trailing 2014 earnings, and with no dividend. We however expect the shares to be re-rated as profit growth ramps up in fiscal 2015, and as investors begin to appreciate the even greater potential outside of core Australasian markets.

Investors should note that the shares are small cap, and should be regarded as a higher risk investment with patience exercised in buying.

Greg Smith is the Head of Research at Fat Prophets.

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