Clover Corp (ASX: CLV) is a small, profitable Australian company that has encapsulation technology used to turn stinky products like fish oil into tasteless, colourless, odorless powder used as a food supplement. Their main customers are infant formula makers who have long been forced to include omega-3 in their formulations.
Note to supporters: ’tis the season for me to catch up on small-cap mailbag requests. If you already emailed me a request, and I haven’t done it yet, please feel free to remind me. Otherwise, I’m just going to meander through my backlog in a purely random order.
Clover has been listed for a very long time and I first wrote about the stock back in 2013. A perusal of the dusty corners of my Sharesight account reveals I’ve made a negligible profit trading the stock in years gone by. My view for most of the period has been that it is not a particularly high quality company, but not a bad quality company either.
To this day, I believe Clover has a sustainable business. The main problems are that it is capital-intensive, has inconsistent profit margins, requires investment in factories and inventories, and relies on distribution networks to transport goods all over the world. All of these moving parts mean you would hardly expect profit to grow consistently.
Clover reports on a July financial year-end, and below I show the half-yearly net profit before tax over the last decade.
Next, I draw your attention to the share price over the last decade.
Now, I don’t for a moment suggest that revenue multiples are a useful tool for valuing Clover Corp in an absolute sense, given profit margins are far from stable. However, the chart showing the enterprise value to revenue multiple does show how the inconsistent profit margins have impacted the market’s view of how profitable and sustainable the revenue is.
From this graph, we can see that the sentiment is currently low, despite the fact that profit has actually picked up. As a result, the trailing P/E ratio is about 19, and the dividend yield is about 2.2%, fully franked.
More recently, the company has launched a new product, CholineXcel. Choline is intended to be added to infant formula to ensure the Omega-3 is absorbed, and Clover has figured out how to turn this sticky substance into a “white flowable powder that has the same bulk density as milk powder.” Obviously, they are hoping to sell this to their existing Omega-3 customers.
However, before they reach that lofty goal, they need to scale up production. At the AGM the CEO said: “We are talking to a variety of different providers that we could go into a toll manufacturing arrangement, a joint venture, or an outright purchase of a facility to recur production.” It is therefore quite likely that capital expenditure will be required well before profits come from the new product.
When it comes to the balance sheet, the company does have a net cash position, but it also has debt, which is indicative of the need for significant liquidity, for example, when it buys bulk fish oil. I don’t think it has excess cash, and I would prefer to see a business of this nature have a very significant net cash balance to buffer any temporary shocks to production, demand, or distribution. It only takes one hiccup, and suddenly debt would increase and interest payments will start taking a chunk out of profit.
For example, a big part of the reason sentiment has improved is that the company has begun operating its new fish oil processing company out of Manta, Ecuador. (Edit Friday 12 December: changed the word ‘profit’ to ‘sentiment’). However, to quote the CEO:
“Ecuador isn’t without its challenges. We certainly have practices and processes in place to ensure that our shipments and production are protected. Our facility is actually behind the 12-foot wall, it is held on guard. All of our shipments are conducted by a third party who videotapes the entire process with security. All containers are loaded under secure mechanisms. The trucks that take the product are all escorted trucks that take it from our facility through the actual port when it goes in behind locked gates in the board.”
That’s one way to put it.
Another way to put it would be that they are sensibly scared about security, operating as they do from a town described by El Pais, last year, as “the epicenter of drug trafficking organizations that ship globally.”
Sure, the small-cap gambler in me is attracted to this stock; as long as everything remains stable in the, ahem, epicenter of drug trafficking, things should be fine.
On the other hand, I might have moved past the stage in my investing career when I want to set up Google alerts about gang violence in Manta, Ecuador, just so I can find out quickly and sell Clover shares, if things go to hell. I’d prefer to chill out with my friends, water the garden; or keep searching for those rare high-quality compounders I call fluffy dog stocks.
As an aside, I’ve noticed “high quality stock” is now so overused it has become basically meaningless, so I might revert to the more specific (because only I use it) descriptor of fluffy dog stock.
At these prices, I consider Clover shares to be an intelligent speculation on a decent quality stock currently facing low sentiment. Now, the sociological and business momentum is probably in favour of a higher Clover Corporation share price. Nonetheless, if I were to buy, I’d have a very clear plan of when I intended to sell, because Clover is far from a fluffy dog stock.
Disclosure: The author of this article does not own shares in CLV and will not trade CLV shares for at least 48 hours following the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Ethical Investment Advisers Pty Ltd (ABN 26108175819) (AFSL 276544).
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