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Why the Wattle Health (ASX: WHA) Share Price is a Potential Buy

This article was originally published at MF & Co. Asset Management.

Wattle Health Australia Limited (ASX WHA) founded in 2011, is a vertically integrated milk powder and infant formula provider based in Melbourne Australia and also one of the largest milk formula export companies across Asia (China, Macao and India). At the time of writing, the Wattle Health share price is a high-risk play with strong potential upside.

However, in 2017, Wattle Health did not achieve their targeted profit expectations and distance remains between Wattle and its competitors in terms of financial performance.

About Wattle Health Australia Limited (ASX WHA)

Wattle Health Australia Limited is an infant formula and baby food company that is listed on the Australian share market with a market capitalisation of about $140 million.

Established in 2011, Wattle Health has obtained two key distribution channels in Australia, Australian Pharmaceutical Industries (API) and Metcash Trading (MTL). In the global market, the business has sealed a number of deals with Asian countries where the demands for baby products are significant. In one example, Wattle Health became the first company to sign an order with Vasudevan and Sons Exim Private Limited distributors in India.

With one founder having a long history in dairy farming, Wattle Health uses locally grown ingredients to provide high quality, 100% Australian made healthy and organic products and creates formulations with leading scientific and nutritional benefits that comply with strict international standards.

The development of Wattle Heath in Asian markets

Wattle Health exports internationally to countries including China, India and other Asian markets in an effort to improve profitability and boost distribution networks.

At the beginning of 2018, Wattle Health obtained China Food and Drug Administration (CFDA) accreditation for its goat infant formula and became one of the few Australian companies to gain this accreditation.

In particular, goat infant formula diversifies the product profile for Wattle Health in China, which is the largest nutritional dairy market in the world. The projected Chinese sales of goat infant formula in 2018 is expected to be around A$ 1.9m, a 43% increase on 2017.

Significantly, three months later, International Supplies and Distribution Company (ISDC) signed with Wattle Health and guaranteed a minimum purchase of 1.5 million units for the first 2.5 years and 2.2 million units 12 months thereafter.

Meanwhile, in January 2018, Wattle Health made its first foray into India, selling a range of Wattle Health baby food products. In addition, Wattle Health secured its first order for its nutritional dairy range in Macau in February 2018, and sales in January reached $329,000, representing 35% of sales in FY2017. The market of Macau has a population of approximately 650,000 and more importantly, it has 36,000,000 tourists visit annually.

Overall, in 2018 it is expected Wattle Health will see significant growth in sales and brand equity along with the WHA share price. The large tourism market constitutes an advantage for Wattle Health shares to increase sales and improve brand awareness.

Opportunities and threats from acquisition for Wattle Health

There are two acquisitions that happened in 2018 for Wattle Health.

On 8th February, to diversify product range and enlarge distribution network, Wattle Health acquired 80% of Little Innoscents company who was recognised as a brand with 100% natural, organic and effective baby skin care products.

In recent months Wattle Health formed a joint venture called Corio Bay Dairy Group Pty Ltd (CBDG) with Organic Dairy Farmers of Australia (ODFA), the largest fresh milk supplier in Australia, and Niche Dairy Pty Ltd (Niche).

Based on this new agreement, Wattle Health owns 45% of CBDG and was obliged to provide $63m in funding for the construction of new spray drying facilities for the venture. This strategy helped Wattle Health to become a wholly vertically integrated company while being reliant on raising external capital. The breakdown of the funding from Wattle includes $20m from a loan facility, $37.9m from an entitlement offer and $20m from institutional placement.

This capital raising has caused some strong downward pressure on the Wattle Health share price as the placements were done at a significant discount.

In recent times Wattle Health has suffered from serious financial difficulties. Up until the end of March 2018, the company generated negative cash flow of $2.54m and net losses of $13.08m during the half-year ending on the 31 December 2017. This has been reflected in the Wattle Health share price which has fallen significantly since March 2018.

This has put pressure on the Wattle Health share price and could see more capital raisings to shore up the balance sheet.

Wattle Health has -447.09 profit margin

Wattle Health Share Price (ASX WHA)

For the purpose of a competitor analysis, Bellamy’s Australia Limited (ASX: BAL) and Bubs Australia Limited (ASX: BUB) are chosen to compare with WHA shares.

Bellamy is the market leader while Bubs Australia and Wattle Health follow close behind in the Australian infant formula industry comparing the WHA share price with its competitors.

From the price line chart above, it is easy to find that these three companies have similar growth trends from 2017 to 2018. The prices continue to climb from the start of 2017 to today and show volatile changes during the end of 2017.

Even though the price gaps are quite significant between BAL and the other two competitors, they all receive high expectations from investors and the industry has immense potential.

Some of the key ratios between the companies are in the table below:

WHA BAL BUB
Current Ratio 8.75 3.06 5.99
Days Receivables 4.63 59.26 83.61
Days Payables 215.64 55.66 101.78
Inventory turnover 1.53 7.31 4.01
Inventory/Trading Rev. (%) 147.36 13.69 24.97
EPS -5.7 1.94 -2.49
Profit margin -447.09 8.29 -84.57
ROE -89.2 21.23 -44.34

(Source: WHA 2017 Annual Report, 2017)

Wattle Health has a positive current ratio, however, the funds received are much quicker than payment with 4.63 days receivables while 215.64 days for payment, meaning cash operations are not well managed and in the long run, suppliers may not be satisfied and may choose other partners.

Bellamy and Bubs don’t have such problems and Bellamy operates well with an average of two-month receivables and payables with suppliers and distributors. When viewing the inventory turnover, Wattle Health has the lowest rate, which implies weak sales, and when we check the inventory/trading revenue ratio, it is 147.36 and Bellamy and Bubs each has only 13 and 24 roughly, indicating that Wattle has an inventory management problem.

From the EPS, profit margin, and ROE ratio, Wattle Health has negative profit and revenue cannot cover the operating costs in the past year. While competitors, except for the market leader did not reach their expectations as well.

In the medium term, we should expect pressure on the Wattle Health share price as they are still running at a pretty significant loss.

WHA shares are a high-risk high return play

While keeping in mind the current contracts with China, India and Macau signed recently that could ensure 3-year of continuous cooperation, Wattle Health should have relatively strong sales in the next three years which should see the WHA share price growth with it.

The joint venture that is now in place will improve the capacity for increasing the demand of milk products and will ensure quality control from raw material to final products, which will satisfy the demands of both domestic and international customers.

The risks from competition in both domestic and international markets are quite intense with market leader Bellamy obtaining strong customer loyalty and brand awareness and many new entrants entering into the same market as Wattle Health.

Wattle Health has to secure its current customers and improve its competitiveness in all aspects including brand equity and product differentiation to achieve solid results in the future.

However, if Wattle Health can deliver on their promises and the agreements in Asia take off, we could see very strong upside for the Wattle Health share price in the medium term.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.



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