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 MARKET REPORTS |
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Analyst report - shares
"Stock of the week": TFS Corporation
October 29, 2007
Tim Morris, wise-owl.com analyst
Stock: TFS Corporation
Recommendation: BUY
Code: TFC 
Ethical investing does not always have to come at the cost of earnings and capital growth, proven we have found a stock in the Managed Investment Schemes (MIS) sector that ticks all the right investment criteria, which also attracts the investor with a green thumb.
Most companies involved in MIS have been on the nose over the few years following the government’s decision to tinker with tax laws governing the tax deductibility of products sold by MIS focused companies.
In the past, companies involved in MIS schemes have generally made money by growing an agricultural or forestry type product, and selling units of their plantations, or crops to investors. Investors primarily buy into these MIS products because of their tax deductible nature; however they also get to share in the proceeds generated when the products are harvested and then sold, which is usually a number of years after the initial investment.
The risk of investing in MIS products is that the proceeds generated after harvest are occasionally not enough to recover the initial investment, meaning that they can be a case of losing a dollar to save 40 cents, which just doesn’t make sense.
However, the stock we are profiling today, TFS Corporation (TFC), offers an MIS product that has the potential to provide very strong capital gains in addition to tax savings. Without dwelling on tax issues too much, the recent law changes have removed the tax deductibility for non-forestry MIS products, which affects those companies pushing MIS schemes focused on anything not to do with trees and forestry plantations.
TFC operates a forestry classified MIS scheme, their products, remain unaffected by the legislative changes, therefore retaining their tax deductibility, and appeal amongst investors.
TFC are in the business of growing and harvesting Sandalwood. Although the really big dollars are set to be made in 2012, when their plantations are first harvested and sold, the company has been growing earnings in the mean time by selling lots in their plantations to investors as part of an MIS scheme.
Sales of their Sandalwood MIS products have been growing strongly because of the attractive fundamentals backing the market for Sandalwood, which is classed as a high growth industry experiencing severe supply side constraints and rising demand.
The fragrance industry is one of the major sources of Sandalwood demand, as the oil derived from the Sandalwood tree is a key ingredient in some of the world’s leading perfumes, such as Chanel No 5. Sandalwood oil is also widely used in skin-care lotions, soap, candles and incense sticks.
Currently 90% of the world’s Sandalwood supply comes from India, however after years of exploitation and deforesting, the Sandalwood tree has become an endangered species in its own native land. These supply constraints and unrelenting demand from the fragrance industry have made Indian Sandalwood is the world’s most expensive tropical hardwood, commanding a current price tag of $US105,000 per tonne, after rising at an average annual compound rate of 22% for the last 15 years.
TFC are well poised to fill this gaping hole in the supply side of the market, as they own and manage the largest Indian Sandalwood plantations in the world from their base in Kununurra, in northern Western Australia. Given that barriers to entry for those wanting to also grow Sandalwood are strong, there is likely to be little competition for TFC in the future. In addition to the tropical climate, large land bank, and water supply needed, the most significant barriers to entry include the multi year time lag from planting to harvest, and the high level of agricultural expertise required for the plantations to prosper.
Where TFC’s plantations are located, in the Ord River region, land and water is abundant, as nearby Lake Argyle is 30 times the size of Sydney Harbour. TFC have also developed significant intellectual property in field of Sandalwood cultivation, which takes a lot more than simply planting a seed in the ground. The process is a mixture of art and science, as the species requires another ‘host’ plant from which to grow.
TFC's potential to be a key provider in a tightened supply environment has seen the company strike a collaboration agreement with French company Albert Vieille, a leading supplier of raw material inputs to the French fragrance industry.
Given these strong fundamentals backing the industry, and TFC’s premier position as a provider of supply relief, sales of their Sandalwood MIS products have been gaining momentum from investors seeking tax relief and the prospect of strong capital growth.
The most recent financial year saw the volume of Sandalwood MIS product sold increase 71.8% to 558.5 hectares, underpinning a 60.6% rise in revenues to $45m, a 59.9% increase in net profit to $19.1m, and a 58.5% rise in EPS to 12.04c. The bulk of revenues (77%) came from new product sales, as TFC generates ongoing management fees from taking care of investor plantation lots until harvest in 10-15 years. This growth is set to provide a solid reoccurring income stream for the future. These recurring fees increased by 46% to $2.3m, and can only rise further as sales maintain momentum.
Even if sales were to slow, this revenue stream provides an important buffer for the company to rely upon. This year's growth was a product of broader market penetration. Last year, investors in the company’s home state, Western Australia, were the dominant buyers of TFC’s MIS product, accounting for 83% of total sales. This year, sales were more evenly shared between the states, with strong growth seen in NSW, Victoria and QLD. This is a very positive development and indicates that investor appetite for their products is strong around the nation.
Over the next few years earnings growth should remain supported by continued momentum in MIS sales, made possible by ongoing expansions of their land bank. However if all goes to plan, this growth pales in comparison to the company’s potential once harvesting begins around 2012.
The risks facing the company and investors in the stock include pests and disease, or a natural disaster wiping out their plantation. It is also possible that demand for natural Sandalwood oil could falter if synthetic alternatives were to gain traction, however the global trend is very much weighed towards natural ingredients. From a valuation perspective the stock appears incredibly cheap, with a PE of 8 times current earnings. Although this is partly due to the market failing to appreciate the company’s prospects, it should be noted that the whole MIS sector trades at a discount to the market.
DISCLOSURE OF INTEREST: The author of this article owns shares in TFC.
Tim Morris is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
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Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
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