The company in question is Alternative Investment Market (Aim)-traded confectionary and snack food producer Zetar. (www.zetarplc.com). The shares have been on my radar for some time, but I was previously put off by the level of the company's debt and funding issues. The shares were lowly rated, but with good reason.
Others clearly felt the same; the shares have practically gone nowhere since last autumn and, priced on a bid-offer spread of 218-223p (AIM: ZTR), they are trading well below the company's net asset value of 350p. However, I believe there are sound reasons to believe that an imminent re-rating is on the cards and one that could see the shares trade back around their net asset value to provide us with well over 50 per cent upside on our investment.
Zetar back on track
Zetar's financial results for the 12 months to end April offered clear signs that the business is back on track, with revenues and cash profits edging up a couple of points to £135m and £9.8m, respectively, to produce underlying pre-tax profits 6 per cent higher at £6.7m and adjusted EPS of 38.5p (2010: 35.4p). But it was the board's decision to propose a maiden dividend of 2.25p a share to be paid in November that really got me interested.
The company can certainly afford to reward its shareholders in this way because, with net debt of £14.9m and net assets of £46.3m, gearing is now only 32 per cent and, importantly, is set to fall sharply thanks to strong cash generation. Analysts at Edison Research expect net borrowings to decline to £9m by April 2012, which would imply gearing of under 20 per cent. And if the company is not paying interest on debt it has paid off, then there is scope to recycle the cash back to shareholders by progressively raising the dividend. This is exactly what analysts expect as Paul Coffrey of Liberum Capital is pencilling a 11 per cent hike in the payout to 2.5p a share in the current financial year, a forecast that Edison is also making.
However, I think this looks conservative especially as Liberum is forecasting that Zetar's net debt will fall to £7.1m by April 2013. It's worth pointing out that the company has aggregate credit facilities of £44.2m, which run until September 2014, and the interest bill was covered a comfortable seven times over last financial year, so with funding no longer an issue, the risk to the dividend looks firmly to the upside.
Tasty prospects
Strategically, management under the leadership of chief executive Ian Blackburn, a food industry stalwart with over 20 years experience, is making the right moves by targeting brand sales, which rose a couple of points to account for a third of the product mix, and private-label customers which account for half of sales. According to market research group Kantar, UK shoppers purchased 11 per cent more premium private label products in 2010 from supermarkets in what was a flat market. There should be more growth to come as private label, accounting for 40 per cent of UK food sales, still remains under represented in the confectionary segment.
Zetar's confectionary division also has a broad portfolio of licensing agreements, including ones with multi-nationals Fox, Mattel and Disney. The company's Kinnerton brand is well established as the UK's leading children's novelty chocolate brand and, following the success with Hello Kitty and Toy Story 3 last year, the business has a strong line up of food products for the coming year having signed licensing deals with Peppa Pig and new teenage hit Victorious. Adding branded products to its portfolio also moves the business up the value chain and Zetar has been doing deals with the likes of beverage giant Diageo for adult-orientated confectionery lines. Baileys and Famous Grouse branded flavoured chocolates are two of its lines.
The long-term aim is to increase the contribution from brands to 45 per cent of the sales mix by 2015, which will not only broaden Zetar's appeal to a wider customer group, but will also enhance margins. Liberum expect Zetar's operating margins to rise by almost one percentage point to around 6.4 per cent by 2014 driven by the confectionary business, which currently accounts for almost two thirds of Zetar's sales and 75 per cent of operating profits.
Admittedly, the company's snacks business, principally dried fruit and nuts, disappointed last year, and this division is more exposed to commodity price pressures and is lower value added. However, Zetar is moving towards higher-margin lines and did report a sharp recovery in margins in the second half to end April. And as the confectionery business grows, the snacks business will be making a diminishing contribution to the sales mix, as will third-party manufacturing, although some contract work will be retained to balance seasonal productivity activity.
So with the higher margin confectionery business growing strongly, analysts at Edison expect revenues to rise to £137m in the 12 months to April 2012 to produce pre-tax profits of £7.1m and EPS of 40.7p. Trading on 5.5 times earnings forecasts, yielding over 1 per cent and priced 36 per cent below net asset value, Zetar shares look primed for a major re-rating and I have set a six-month price target of 350p.
