Growth and income stock idea: Gale Pacific

The appliance manufacturer Breville (BRG:ASX) had almost doubled between the start of the year and early May. Can Gale Pacific (GAP:ASX) do the same? The shade cloth manufacturer looks great value, on a single digit PE and dividend yield of 6.7% after some forced fund manager selling. Under the Radar understands that its big investment in US capacity is paying off as it proceeds to populate the isles of the likes of Lowes, Home Depot, Walmart, Costco and Amazon.

Why we like it

Gale Pacific’s stock has been beaten down recently by some small cap funds exiting out due to lost mandates, which represents a buying opportunity. The company tells Under the Radar that the big investment in capacity in the US is paying off: “the fruit’s at the retail stores and people are buying it.” Its big input cost is resin, where prices are declining according to market reports. A great deal of uncertainty relates to tariffs imposed by the US on Chinese goods, which is where Gale Pacific is stuck in the middle. So far this hasn’t impacted pricing, according to the company.

What's new?

Since early March Gale Pacific’s stock has fallen almost 20% as fund managers have been forced into selling. This comes after a first half result where earnings per share (EPS) was down 27% at 0.5 cents. The result included the maintenance of an interim dividend, 53% sales growth in the US and a prediction of “EPS growth for FY19” which means a significant turnaround in the current half. We think that this is possible due to a weak resin price and growing sales in the US. The current share buy back doesn’t hurt either and gives us some confidence despite the share moves.

Gale Pacific: one-year performance chart

Source: nabtrade

A manufacturer that is under the radar

Gale Pacific is one of the few Australian manufacturers that is thriving, but you wouldn’t know it from the share price, which has fallen almost 20% since its half year result.

A big reason for the selling is the loss of mandates of two small cap fund managers. We believe that this provides a buying opportunity based on the stock’s single digit PE and FY19 forecast dividend yield of 6.7%.

We are optimistic because the Melbourne based manufacturer of screening and shading products has finally hit the world stage and is turning its business around after a series of cost blow-outs. Its products are used for domestic, commercial and industrial applications and it has operations in Australia, New Zealand, the USA, Middle East and China. The company operates two businesses: a commercial brand; and retail brands.

Gale’s strategic focus

The US is the key, where Gale has established a big distribution network and built up inventory and the supply chain to similar success as it has had in Australia through the Bunnings store network. Obviously, if this happens in the US, it will be of a much greater order of magnitude.

A positive sign is the reduction of a build of current inventory created to cater for US sales growth. This has led to an increase in net debt, which stood at $25m on 31 December 2018. From talking with the company Under the Radar understands that sales in the crucial US spring/summer period are proceeding to plan, which means that the inventory levels are reducing. According to CFO Matthew Parker: “Based on point of sale data and what’s moving out of warehouse is positive; customers are purchasing and inventory and cash balances are improving by the day.”

Investing in export led growth

With any manufacturer you need to be confident that it can survive very tough times – exchange rate risk, labour risk, the rise of tariffs, labour costs, input costs, energy costs and distribution relationships to name a few. Despite these risks, we’ve seen that this can be countered with export success. Look no further than kitchen appliance maker Breville’s (BRG) share price, which has almost doubled in the year to date due to a focused US strategy.

Clearly you have to have a product that consumers like, and Gale Pacific’s shades have been tested under the harsh and unrelenting Australian sun for years. What gives us confidence is that its network in the US now includes of the likes of Lowes, Home Depot, Walmart, Costco and Amazon and adds up to a store network of over 1,800 locations, up from less than 400 this time last year.

In order to meet increasing demand the group has invested in a warehouse in the US, which is backed by a new enterprise resource planning IT system implemented globally and into its manufacturing plant in China, which allows it to better coordinate its sales, marketing and distribution capabilities. Gale Pacific has also invested $8m in a new coating line in Melbourne, which has recently been commissioned.

Resin is the key raw material used by Gale Pacific. The company is also benefiting from lower costs than this time last year, as a result of increasing ethylene feedstock as many North American polyethylene makers have added capacity to capitalise on newfound supplies of natural gas in the region (i.e. fracking).

One big cloud over gap

One big cloud that hangs over any exporter from China are the increasing tariffs, which are simply taxes on imports. Thus far US President Donald Trump has announced tariffs of 25% on some US$250bn worth of goods imported from China, while China has retaliated slapping tariffs on US$60bn of American exports. This is in addition to tariffs on steel (25%) and aluminum (10%) imposed by the US on most countries.

Gale Pacific tells Under the Radar that in the past tariffs have not had a material impact on profitability and noted that it is early days, but considers it likely that there will be an impact if the trade war continues.

Certainly, these are concerns, but what is more important is the top line. If that improves as Gale Pacific is indicating, the share price gains could be magnified.

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