Feltex Carpets Ltd: Sam Magill
By Jenny Ruth
Carpet manufacturer Feltex listed in May following a $243 million public share offer. Although it has since beat its profit forecast by $1.1 million, reporting an $11.2 million net result for the year ended June, the shares have fallen from the $1.70 issue price to $1.55 at the end of last week. The result was almost double last year's $6.8 million profit and the company is expecting to more than double the latest result next year.
ShareChat: Why have you been buying Feltex shares?
Feltex managing director Sam Magill: Obviously I wouldn't be buying them if I didn't see value in them. I think they're undervalued. That's my personal opinion. The company has been meeting its targets to date. I will continue to buy them as long as I see value in the shares. The issue is, even the more conservative brokers like Macquarie still value the shares at $1.70. Forsyth Barr have them at $2.10. At $1.58 or $1.57, it's pretty good value.
SC: Why do you think the shares dropped so sharply when the results were announced?
SM: There are a number of things. This is the first public company I've been CEO of. The indications to me are once you announce your results, immediately you're marked down by dividends per share. I can't really say. I think the shares are undervalued. The outlook for the company is really strong and robust as I've always said. The business is in the best shape of any merger I've been through in the last 20 years. I think it's partly because of a lack of understanding by the market of the currency effects on our business. The market's concerned we won't meet our targets. We think we will. That's what keeps coming up: we're not so sure you will meet all your projections. We're still getting continuing improvements in the business. We were above our EBITDA (earnings before interest, tax, depreciation and amortisation) projections in the first quarter. We had a price increase on 1 July and we have another one on 1 December. Who knows what's going to happen in the next six months. The currency could reverse out and those concerns about the currency could dissipate. We're still confident of meeting our projections in terms of EBITDA and the bottom line. Sales may be a bit lower but improvements in our margins will cover any misses in that regard.
SC: Was the float price set too high?
SM: I don't think so. The process of determining the price was market driven. The process did involve four of the leading brokers. There's no doubt it was a big issue and there were a number of other floats announced. Two of the brokers are still valuing our shares at $1.70 to $2.10 with buy signals.
SC: Should the company have waited longer before floating?
SM: I don't think so. I think it was the right time. At the end of the day, that's a question for the vendors. They made the call. We've got a very strong and robust business and the outlook for the company is very positive. From the vendor's point of view, it may prove to have been a bit early, but they're the ones who decided to go - they actually wanted to go a bit earlier than we ended up going to the market.
SC: Why have you moved to quarterly reporting?
SM: We had discussions with the board about this issue. We think part of the problem with our business is that probably in connection with our trading record in comparison with a good company like Cavalier which has had a very consistent trading performance against a stable ownership platform. The directors felt if we went to quarterly reporting it would give the market a much more transparent view of our business. It's a much different business from the old business. It will give analysts and journalists a better understanding with more frequent reporting.
SC: What do you see as the differences between Cavalier and Feltex?
SM: We're manufacturers in both Australia and New Zealand but we've got a much bigger business than Cavalier. If you back out wool trading, their carpet sales are sitting at $128 million. Our sales are in excess of $300 million. We're a much bigger business than wool with much more of the price points than Cavalier. I put them in a niche part of the market. They're basically a wool niche carpet manufacturer whereas we have elements of their business within our business. Looking at their business and backing out the wool trading, (I'm making an assumption because I can't get to some of the numbers), their EBITDA is probably 20% (of sales). That's not really available everywhere. I believe we can build the $128 million within our $300 million to 18% plus EBITDA. Last year, we ended up with 14.3% EBITDA. In the last quarter, it improved to about 15.4% and that was our total business, that wasn't stacking up Cavalier's product profile with ours. There's been a significant improvement due to a very focused marketing strategy and moving up the value chain. That also came through in the first quarter. Even if the strengthening of the New Zealand currency and the translation effect on our business means a slightly lower sales position, we were significantly above where we were last year. EBITDA accelerated as we went through the second quarter last year. We're on track to be at our annual forecast, even with the currency. We have the currency covered right through to January next year. My strategy's always been to try and pre-empt price increases. The relationships we've got with all our suppliers we always signals that price increases are coming in. in most cases we have time before the price increases hit the business.
SC: Can Feltex ever achieve the same profit margins that Cavalier does?
SM: Only in the same segments that they're in. I can build within the Feltex profile $128 million of sales that will deliver the same margins.
SC: Are you at that level yet?
SM: I haven't done the numbers yet, but I've probably got another $30 million of sales to go to reach the same number of sales they've got within their segments. The rest of the business, roughly $200 million of the business would be lower. They're in synthetic, poly propolene etc. The overall mix of our business in the last quarter through to June this year we were running at 15.4% EBITDA to sales. Our forecast was only 14.9% for 2005.
SC: Why is the company spending more, sooner on new tufting equipment?
SM: In the carpet market, the thing that will make you more money than anything else is product differentiation vis a vis your competition. We made a decision on the back of an anticipated softening of the residential market - although if we look at the recent statistics they've actually shot up again - to invest in new technology in tufting and to try and get the technology exclusively for a period of time. That equipment was up and running in 2003. Within six months by December the first machine was completely utilised. We went back to the board for a second machine. It was allowing us to increase our market share at better margins. The second machine will be up and running within the next two weeks. The commercial machine will come in November. There was a decision by Cavalier to purchase another machine recently which is not the equipment we've purchased. We decided to negate that strategy by Cavalier and we purchased the same machine as Cavalier. Australia's allocated $A700 million for the restructuring of the textile industry. We get a 40% subsidy from the Australian government that Cavalier doesn't get. We took the view if we got the same machine, the technological advantage is negated. Secondly, with the government subsidy, we're getting a better return on investment than Cavalier. We asked the government whether we could put the same technology into New Zealand but got a negative response from the government. That's why most of our capital spend is going into Australia rather than New Zealand. That will allow us to further I improve our margins. We're starting to see a shift in market share because no one else has got the product at the moment.
SC: Were the prospectus forecasts overly conservative?
SM: I don't think so. If you break down the increases in EBITDA above the forecast, $700,000 was increases in product charges. It wasn't just management who agreed (to the forecasts). Obviously the vendors and the board were involved.
SC: How exposed is Feltex to the reduction in demand for its products arising from the coming downturn in the residential building activity and consumer spending in New Zealand ?
SM: We made capital investments on the back of seeing some downturn in the residential market. It appears housing starts in Australia, which is the bigger market, have actually kicked back in the last couple of months. We believe the growth in the commercial market will more than offset any drop. We believe, with the capital investment, we've also got the capacity to increase our market share of the residential market. Although the market could reverse, I believe we will see an increased share. Whether we can grab enough share to counter any down turn that may come, time will tell.
SC: What other markets/market conditions are Feltex exposed to ?
SM: Our export business, relative to our total business, isn't that sizeable. Although we are in overseas markets, it's only about 3% of our overall business.
SC: What percentage of carpet sales to the residential market are replacements and what percentage are to new homes?
SM: That's very subjective. We believe the split in terms of value is 70% residential and 30% commercial. If you break the residential down, we believe about 40% is residential renovation and refurbishment and 30% to new homes. We've refocused our business more on renovation and refurbishment and reduced our effort to the new housing segments.
SC: Can you give me a comparison of Feltex's sales in these categories now with, say, three years ago?
SM: I prefer not to. I don't want our competitors to realise how much they've lost in those segments.
SC: What plant rationalisation opportunities has Feltex got?
SM: There's none at the moment. We always try and position ourselves for future opportunities. That was one of the reasons behind the purchase of the Foxton plant. From a productivity perspective, it needs to be reorganised. There may be opportunities in the future to centralise more of our activities on the Foxton site. It's a very sizeable property which has been under-utilised. We found it very difficult to persuade the land lord to improve it. Progressively, we will re-organise and re-develop that site.
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