My fund recently supported a new IPO called Vitaco Holdings (VIT), which successfully listed on the ASX. My fund has bought more VIT shares on market and today I will explain the investment case behind our decision and why we see VIT as a genuine growth stock when growth is very hard to find.
Chinese prepared to pay for quality
There should be absolutely no doubt the Chinese consumer is paying a premium for “provenance”. By provenance I mean security, quality and reliability of supply. This is particularly relevant to agricultural/food products and health products, with Australia and New Zealand superbly positioned to continue to benefit from this structural growth trend.
You can clearly see the trend already in the performance and earnings upgrades from Blackmores (BKL), Bellamy’s (BAL) and Capilano Honey (CZZ). In fact, owning these three “provenance” plays has been, and will most likely continue to be, rewarding. You can see they basically track each other as a basket and my view is VIT will join this basket over the next few months.
[1]Stories of Chinese tourist buses pulling up outside chemists and supermarkets are rife. What happens is Chinese tourists walk in with large empty suitcases and walk out with them filled with vitamins, baby formula and honey. This isn’t a joke.
Similarly, broker analysts and investors from Asia on Australian road shows have been known to ask where the nearest chemist is to fill requests from relatives for all of the above.
After the numerous scandals in China about baby milk powder and all sorts of substituted products, you can absolutely understand why Chinese visitors pay a premium for Australian and New Zealand sourced product.
According to Citi Research, the growth in demand from China has been rapid and only recent for many Australian and New Zealand health food companies. The trend really only began in 2014, which reflects the expansion of free trade zones. The free trade zones have facilitated cross-border e-commerce.
The new China story
China is transitioning to a consumer-led economy. This is leading to growth in incomes and increasing consumption of “Western” products. Chinese wages growth has averaged 12% over the last five years and Beijing’s income distribution plan aims to double household income in real terms from 2010 to 2020.
There is a strong correlation between Chinese wages growth and retail sales growth. Over the past five years, Chinese retail sales growth has averaged 16%.
Adoption of the Internet and smartphones in China has also driven growth in e-commerce.
However, to truly capture the Chinese consumer opportunity, you need a brand profile. The brand needs to be reliable, well known, and endorsed by friends or celebrities.
Similarly, the product needs to be available. That means you need to have a presence across major e-commerce platforms and a degree of prominence in the brand.
At this moment in time, Chinese consumers have a low consumption per capita of vitamins and supplements. According to Euromonitor, overall consumption is $US12 versus US$86 in Australia and New Zealand. However, products aimed at health and beauty, not simple nutrients, tend to be more popular in China.
The Vitaco story
Vitaco is not simply a vitamins story. The company is also in the Sports Nutrition business. The two key brands are Aussie Bodies and Musashi. The gym junkies reading this note would know those brands well, but clearly sports nutrition products are making their way into mainstream retail via supermarkets and petrol stations.
Sports nutrition products are well-placed, due to an ageing demographic (60 is the new 50) and greater overall sports participation. You could also argue that the proliferation of social media has made the world more vain. The entire world seems to worry about what they look like in a “selfie” nowadays.
Vitaco’s sports nutrition brand is adding new products and gaining shelf space in supermarkets. This could be a source of revenue surprise for VIT in the year ahead.
As I mentioned above, genuine growth is hard to find in Australian equities. Yes, there has been some cost-out growth, but genuine top-line revenue growth is very hard to identify. If anything, analysts are consistently revising down aggregate S&P/ASX 200 EPS forecasts for FY16.
What this leads to is the handful of stocks that offer genuine top line revenue growth trade at significant PE premiums to the broader market. The market is industry agnostic where it allocates that PE premium for growth and I suspect that to continue in a low growth/low inflation environment, where pricing power is hard to find.
This is why I have bought VIT for the AIM Global High Conviction Fund despite the short-term multiples seeming high. In genuine structural growth stocks, the near-term PE multiples are almost always “high”, but so too is the prospective EPS growth.
Price to growth versus price to equity
My preferred approach is price to growth, or PEG ratio analysis. As long as the PE is lower than the forecast EPS growth, i.e. the PEG ratio is less than 1x, I have no issue paying a high forward P/E.
I think this is what a lot of analysts and investors get wrong. Not all PE’s are created equal, just as not all companies are created equal. I’d rather pay up a little for growth than be stuck in a “cheap” stock with no growth prospects. To consistently make money as an investor, you need to be in companies that can grow. Grow earnings and grow dividends. Those few stocks are ALWAYS more “expensive” than growth less value stocks.
If you can find the combination of sustainable revenue growth, margin growth and ROE growth, you will almost certainly also see structural earnings and dividend growth. That is exactly what we see in VIT and why we have bought it on a “high” near-term PE multiple. Below is a table of VIT forecasts for the next three financial years.
[2]The above are all forecasts/estimates that I believe will prove conservative through time. Only time will tell.
VIT has only been listed for a month but it has started very well as a listed company. The stock opened around 20% above its $2.10 IPO price and hasn’t looked back. An IPO performance like this is more than often a good signal of future performance.
VIT is only a small cap stock at $377 million market cap, and has very little broker research coverage. As a newly-listed small cap stock, there are obviously risks and if you buy VIT, you must own it in the right risk-adjusted size for your portfolio.
However, I believe the potential reward significantly outweighs the risks. This is a well-run small company with a strong board and global opportunity.
At this moment in time, on our modelling, we can see value in VIT up to $3.00. That means we wouldn’t buy more above $3.00. However, if VIT follows the Blackmores, Bellamy’s and Capilano script, then the upside multi-year price target would be well ahead of those levels.
Anyhow, if you’re looking for a small cap growth stock in your portfolio that has leverage to the Chinese consumer and a structural growth segment, I recommend you have a look at VIT, at current prices.
Disclaimer: the AIM Global High Conviction Fund owns VIT shares.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.