Rising damper

By Nikki Mandow and Mark Story

Friday 1st February 2002

Five years ago, things weren't going so well for New Zealand tow-truck driver turned youthful entrepreneur extraordinaire Graeme Hart. His $310 million foray into Australia's historic food, insurance and shipping conglomerate Burns Philp & Co was rapidly turning to custard as the company neared collapse. The Australian media and broking community were sniggering behind their hands at the Kiwi battler out of his depth.

Maybe they should have stuck their hands in their pockets and bought some shares instead. Hart looks close to achieving a remarkable turnaround in the embattled company, and brokers are picking the September 11 terrorist attacks didn't do the company any harm, either.

Burns Philp makes yeast and baking products. At least it did, before the previous owners embarked on an unrestrained buying spree that saw them move into everything from herbs and spices to antibiotics to property and automotive. In the 1996–97 year, Burns Philp became the second-largest corporate collapse in Australian history, losing 90% of its market capitalisation and seeing profits fall 600% - a bit like what happened with Brierleys in New Zealand, only worse.

Five years on and Burns Philp recently turned a first-quarter net profit of $A19.2 million, a respectable 19% increase on the year before. Sales rose 7% to $A367.9 million and chief executive Tom Degnan forecast the company would meet its full-year profit projections of $A120.4 million. In the 13 weeks to November 30, as world markets crumbled, Burns Philp's share price increased more than 25%. It was at $A0.57 in January as Unlimited went to press. It's still a far cry from the $A4.80 the company traded at in 1994 (or the $A2.50 Hart first paid) but it's a whole lot better than the low point of 4.6 Australian cents a share. Some brokers are forecasting the price could go to $A0.65–0.70 this year - maybe even $A1 if Hart finds a buyer.

"The business is in good shape, and I believe it's undervalued," says Paul McCarthy, director of Sydney-based broker Wilson HTM. "It's still in a transitional phase and some of the big brokers are worried about its levels of debt. But it's got modest headline growth and fantastic margins. It's achieving mid-teen margins in yeast in mature markets like North America and Europe, at a time when Goodman Fielder struggles to make 6%."

What's changed? Management. Hart, who could hardly have picked a worse moment to buy his first portion of shares, refused to give up. He bought more shares at the new, discounted price (he now owns 54%), imported the extremely capable American Tom Degnan (a man well versed in the yeast and food business) and set about selling non-core assets, restructuring and cutting costs. He sweet-talked the banks into a refinancing package, and quietly watched the company - and himself - start to make money again. Degnan says the company is now generating a lot of cash and is on the acquisition trail again, only this time in core bakery areas.

Luck? Unlikely. Hart hasn't achieved a turnaround as spectacular as this before, but it is the second multimillion-dollar business he's built up virtually from scratch in less than two decades. Hart, now 46, started his business career driving taxis and tow-trucks, painting cars and pumping gas before founding a printing company in 1974. He sold that and established the Rank Group in the mid-1980s, building up a printing and stationery empire which eventually included the Government Printing Office, Whitcoulls, Croxley and Collins (CCO) and Wiljef. He eventually sold out to US Office Products in 1996, for $320 million.

"Graeme Hart is key to the success of the [Burns Philp] turnaround," Degnan says. "He stepped in at the darkest hour and raised more capital for the company. And he's smart. Once you've worked with him for a while you recognise he has deep and long experience of many of the business issues you are dealing with. He has involvement in everything we do. I talk to him all the time and I meet with him all the time."

DF Mainland chief executive of securities John White believes part of Burns Philp's renaissance has do with the capital market finally realising the defensive nature of its underlying earnings. Not even suicide bombers can stop the world eating bread, and yeast is a pretty critical ingredient. So wouldn't it make a whole lot of sense, asks White, to invest in a company that has a 16% global market share of the pungent yellow stuff?

Burns Philp is also the largest industrial supplier of vinegar in the US, with a 50% market share. Yeast, yeast extracts and bakery ingredients (including fats and oils) accounted for 68% of Burns Philp's $A88.5 million revenues for the 2000–2001 year. (Herbs, spices, and terminal and bulk storage facilities made up the rest.) White expects productivity improvements, business expansion and increased prices in the US (where Burns Philp makes 63% of sales and 55% of profit) to add to the company's improving fortunes. On the downside are assets in Argentina, where the economy is on the verge of collapse after three years of recession.

Based on Burns Philp's comparatively low price-to-earnings (P/E) ratio, White thinks the current share price makes for an attractive entry point, especially considering its potential for growth. Recent Wright's Investor Service analysis compares Burns Philp with three other Australasian food companies: S & B Foods, Warabeya Nichiyo and Fuji Foods. Burns Philp does well on a number of fronts: better gross profit margin (50.8% of sales compared with between 15.8% and 44.6% for the others); higher sales growth; better share price growth (the others saw declines of between 1.7% and 20.4%); and cheaper P/E (Burns Philp was trading at 4.2 times earnings late last year, compared with between 7.5 and 16.6 times for the others).

So, why isn't the stock worth more? Partly because after slumping from Australia's 48th-largest company in 1996 to number 500 in 1997, and losing significant numbers of shareholders significant amounts of money, institutional investors have largely kept away. When Degnan went to the market last year to raise new equity, he was amazed to find investors still wary. "I knew Burns Philp was running pretty well and I had figured everyone understood the company. But when I met with fund managers and institutions I was surprised to hear much of the Burns Philp baggage coming back up again."

Meanwhile, there's the question of if and when Hart cashes up. Past history indicates that it is likely he'll be looking to exit the company at some stage, and food companies traditionally change hands at above market value. Hart, who is almost fanatically opposed to the press and speaks to them only on rare occasions, has said that he isn't looking to sell yet, and when he does it will be all or nothing. In the short term, the September 11 terrorist attacks and difficult US economic conditions may make finding a buyer difficult. But in the meantime, Hart must be more than satisfied with progress so far. Even without counting his nearly one billion options (which convert to ordinary shares at $A0.20), Hart's shares are worth $A382 million at present levels. At $A0.75 they would be worth $A480 million, giving Hart a very acceptable 55% return on his original investment.

And if he's fed up with the regular commute from his luxury Auckland home to Burns Philp's head office in Sydney, there are plenty of New Zealand corporates that could use the Hart touch. Could we recommend Air New Zealand, perhaps?

Nikki Mandow
nikki@unlimited.net.nz

Mark Story

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