Case Study: McPherson's (MCP)
In this article we go through our experience with McPherson’s (MCP) to highlight why owning stocks is not simply, set and forget. Having taken profits this time last year at $2.50-$3 we upgraded to hold in early December 2020 at $1.20. We are pleased to say that its stock has stabilised and this week we analyse its interim profit result to work out whether the company can resuscitate its fortunes.
This time last year fortune was all investors could think about. The market was very much in love with McPherson’s (MCP) profit growth and its fast talking boss who talked up the business as a Cinderella story, going from a boring wholesaler to a company beautifying the Chinese, one face mask at a time. As we said in our note on 27 Feb 2020 (issue 384):
“McPherson’s is in a joint venture with a Chinese company Access Brand Management, which operates through a ‘daigou’ structure of buying products in Western markets that can be marked up and resold in China. Dr. LeWinn’s sales to export markets increased 272% to just under $14m in 1H20 and in Australia they climbed 49% to $11.2m.”
The stock was benefiting from the double whammy effect of earnings growth from China and the market recognising this and re-rating the stock higher.
I don’t know much about face masks, but fortunately we do know something about value, and we slapped a take profits recommendations at $2.50-$3 over the succeeding months, locking in profits of two to three times on our buy recommendations.
Fast forward to today and the China growth engine has turned into a liability, as have the face masks. ABM has had difficulty placing sales into China, some possibly related to COVID; and in Australia sales are lower, having been impacted by the exodus of Chinese students.
The irony is that its boring Multix brands like cling wrap are holding the company up. Its Dr LeWinn’s beauty product lost $6.6m, 93% of its total $7.1m profit before tax.
What were the red flags that led us to take profits?
Back in February 2020 at its interim result (1H20) the stock traded at $2.80 and we thought it looked very expensive. Then CEO Laurie McAllister spoke words of caution: “1.4m Chinese tourists come to Australia each year, which adds $12bn to the economy; after SARS in 2003 there was a 75% decline in visitors. We need to be realistic.”
Despite his comments and despite the higher weighting of the second half to its profits, the company maintained its FY20 guidance of 10% profit growth, which was ambitious. At the very least we thought dividends would be cut.
McPherson’s (MCP) stock was even higher at $3 at its full year result in September 2020, but our nervousness was confirmed when the company made big asset write-downs. This fact on top of a deteriorating trading environment of Australian products in China, signalled real problems. It seemed that sales of beauty products to Chinese would be subdued, which was not what the market was saying!
For FY20 McPherson (MCP) had a decent “underlying” profit before tax of $22.8m, but its statutory profit was only $13.3m because of write-downs of $10.6m. Some of that was COVID-19 related, but it was clear that the majority of it was related to the growing beauty products business being marketed to the Chinese.
When we said, “Caution is required because of the Australia/China relationship,” we were looking at the pain being experienced by other Chinese exporters like Treasury Wines (TWE) and the infant formula marketers to name a few.
There was so much optimism in the stock that most investors ignored the warning signs. Being Under the Radar means taking advantage of our hard won experience on the valuation front. This is where the real money is made.