Is Bega Cheese too tasty?

Co-founder of the Switzer Report
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Don’t be in any doubt – the initial public offering (IPO) for Bega Cheese Limited will be over-subscribed and will probably close early. But while short-term speculators may snare a bit of ‘stag profit’, the real question for SMSF investors is where will the stock be trading in 12 months?

Firstly, let’s look at the company. The Bega Cheese Group operates five dairy manufacturing sites across NSW and Victoria, value adding about 186,000 tonnes of dairy products. The Group’s business can be categorised into three segments: core dairy product manufacturing of cheddar, milk powders, butter and cream (59% of revenue); cheese packaging and processing of consumer goods, including products marketed under the Bega brand (32% of revenue); and nutritional products (9% of revenue). Total revenue in 2010/11 is forecast to be $943 million, of which 34% comes from export markets.

Only 14.4% of the company is being offered in the IPO, with the balance of 85.6% held by existing shareholders, primarily farmer suppliers. The float will raise $35 million, which will largely be used to repay debt. When the ‘preferential offer’ to eligible farmers, existing shareholders and others is excluded, the amount available to the investing public is $24.5 million or 9.6% of the company. Details of the float are as follows:

 

 

With the full weight of the CommSec and Commonwealth Bank machines behind this brand-name float, this relatively tiny issue will be paced quickly. Don’t expect too much more than the minimum application of $2,000 – there is bound to be some sort of scale-back, so leaving large sums of cash with the company only to be reimbursed some weeks later (without interest) may not be the best strategy.

Coming back to my earlier question, what will happen to Bega’s share price after the euphoria of the listing? On a prospective price-to-earnings ratio of 16.9 for fiscal 2011 (based on the application price of $2), Bega Cheese is not exactly cheap.

Unfortunately, the forecast information provided in the product disclosure statement relates to the year ending 30 June 2011, which although past, has not yet ended in an accounting sense. This means the statement gives no hint of any forecast for the next 12 months. So, investors have nothing to go by and it’s difficult to see just how much real growth potential there is for this company.

Nor is there a forecast around dividend payments. The product disclosure statement makes the comment that it’s the board’s current intention to pay a dividend of approximately 50% of net profits for fiscal 2012, which they expect to fully frank. If earnings in 2012 are the same as those forecast for 2011, this would equate to a dividend of 6c per share – or a yield of 3%. If earnings increase by 50% to 18c per share, this would translate to a fully franked dividend yield of 4.5% – which is interesting, but not stellar.

There are also some challenges in the corporate governance stakes because Bega has been granted an exemption to maintain a board where the majority of directors are ‘farmer suppliers’. Moreover, shareholder caps will apply; for the first two years, no shareholder will be allowed to own more than 5% of the company, and then for the next three years, this limit will be increased to 10%.

The importance of these issues relates to whether there will be a liquid market and ongoing buying support for Bega shares after the hype of the float wanes. Bega has ‘snubbed’ the institutional brokers by appointing Commonwealth Bank as the lead manager of the float, with a possible consequence that it’s unlikely to attract much ongoing analyst coverage. This, together with the shareholder caps, lack of a majority independent board and small market capitalisation means that Bega’s unlikely to get on the radar of many institutional fund managers – it’s too small for the ASX200 and it won’t be on any index manager’s brief.

The bottom line: Bega Cheese is a solid company and if you’re interested in short-term speculation, its IPO is probably worth a small stag investment. However, there are many other stocks in the market offering better value for SMSF investors and they come with more certainty over the medium term.

Also in Thursday’s Switzer Super Report:

Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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