Probiotec (ASX: PBP) delivered a 1H23 result that beat market expectations. Probiotec is part of our Top 10 Stock Picks for 2023; our earlier coverage can be viewed by clicking here. During the half year, PBP experienced a significant increase in demand, particularly regarding pharmaceutical manufacturing services. This saw revenue grow by 25% on the prior corresponding period.
Highlights of the result were:
- Record first-half revenue of $106.8m, +25% on HY22, above $100m – $105m guidance
- Underlying EBITDA of $17.2m, +16% on HY22, above $15.5m – $16.5m guidance
- Fully franked interim dividend of 3 cents per share, up 50% on HY22
The robust results were driven by strong organic growth and a full return of cold & flu product sales that were suppressed during the pandemic. As expected, margin pressures existed in the first half. The heightened level of price inflation globally and labour shortages have resulted in some compression of gross margins. Price rises have been enacted during the half year across most of the Group’s customer base. These price increases are expected to progressively reverse this gross margin compression during the second half of the 2023 financial year.
PBP has a strong outlook for the future with several growth opportunities, onshoring and industry tailwinds continuing.
Despite margins pressures and managing supply chain disruptions, PBP generated $10.9 million in underlying cash flows from operations. The company holds additional inventory to buffer disruptions and support increasing demand, which is expected to partially unwind by 30 June.
From the Balance Sheet perspective, PBP remains healthy. It has significant undrawn credit facilities and cash reserves available for inorganic growth opportunities. During the period, PBP also paid down $3 million of debt. This has decreased the firm’s leverage (Net Debt/EBITDA) from 0.80x in June 2022 to 0.75x as of December 2022. This puts the company in a healthier state. We expect PBP to continue paying off its debt and lower its leverage as the company is forecasted to benefit from rising revenues and earnings.
Site Consolidation to Boost Bottom Line
Late last year, PBP announced that it had agreed to terms with a major Australian developer for a circa 30,000 sqm facility in Kemps Creek, NSW. Once operational, this site will house most of Probiotec’s current NSW pharmaceutical and FMCG packing businesses and deliver material financial and operational benefits to the company.
Since the start of FY18, Probiotec has completed five acquisitions in NSW. Following this acquisitive period, Probiotec has been undertaking an extensive process to identify a new large-scale facility in NSW to consolidate its footprint in the state. The Board and senior management team see this as a highly accretive opportunity via this consolidation of its NSW footprint.
The NSW site is large, allowing for growth and substantial improvement in the efficiency, compliance, look and feel of PBP’s operations versus its current footprint. The site will be cutting-edge and provide an incredible platform for Probiotec to attract pharma clients and maintain and grow with its existing business relationships.
The project is expected to deliver cost savings of $3m to $5m annually from 1 January 2025. It also has low project cost, with the developer responsible for the build and the majority of specialised fit-out. The entire investment has a low Payback of circa 2 years from the commencement of facility operation.
The benefits the site consolidation is expected to bring are:
- Significantly reduce overhead expenses,
- Remove duplication of products,
- Simplify logistics to deliver shorter turnaround times for customers,
- Improve coordination & efficiency of consolidated IT systems,
- Support the opportunity to cross-sell services across the enlarged platform,
- Increase capacity to meet increasing customer demands & any future acquisitions,
PBP is expected to deliver strong revenue growth in FY23, which is expected to continue into FY24 as the momentum in the business and new products are fully onboarded.
Despite the uncertain operating environment, the Board expects to deliver Sales of $205m to $215m with EBITDA of $34.5m to $36.0m for FY23. These numbers mean PBP will deliver record revenues and earnings for FY23.
PBP has a significant volume of orders on hand (particularly at its Laverton North manufacturing site) to drive growth in the 2nd half. Cold and flu sales are expected to reset above historical levels for the foreseeable future – boosting revenues.
Significant new business wins are being integrated into the Laverton manufacturing facility. All of which are contracted long-term (3-5 years +) revenue streams. Labour shortages and supply chain disruptions continue to impact operational output and efficiency; however, it is expected to ease by mid-2023. This will lift the pressure off the bottom line, and PBP’s earnings should increase, resulting in higher dividends.
In the medium to long term, onshoring tailwinds continue to gather momentum along with a push by major multinationals to move production operations locally. PBP has said that significant new business opportunities are being developed and implemented from an extensive, high-quality client base. The full impact of the pipeline of new business opportunities continues to be realised in FY23 and beyond.
Organic growth in PBP is, therefore, very robust. The company is also paying down its debt and has facilities in place to help the form grow via M&As. PBP’s Board mentioned that they would look at opportunities in the market.
The $215 million in revenues and $36 million in EBITDA for FY23 have been priced into the share price. Looking forward, the market expectation is for PBP to continue growing top-line revenues by about 5% annually through to FY25. EBITDA is forecasted to hit $45 million by FY25. This means PBP’s margins will expand from 13% in FY22 to 16% in FY23 to 19% in FY25 – the market expects a full recovery from cost pressures.
We think PBP is being mispriced in the top line. We think the market is understating the organic growth that PBP has to offer. A margin recovery will ensure this organic growth also makes its way into the bottom line. As such, we think that PBP’s forward FY25 P/E of 10x and EV/EBITDA of 5x is very modest, particularly because PBP also pays a healthy dividend.
Probiotec reported a record result for 1H23. Manufacturing capacity, supply chains, and labour availability are the biggest requirements for PBP. As we emerge from the pandemic, the latter two factors are easing, and PBP is increasing its manufacturing capacity to capture the rise in demand for cold & flu medicines. PBP is, therefore, well positioned for recovery. The outlook for 2023 and beyond is robust, and we maintain our ‘Buy‘ recommendation.
Probiotech’s share price has spent most of the last two years trading in a range of $2.00 to $2.50. As the business’s financial performance continues to improve, its share price gets closer to the top of the range (the green line on the chart). As such, we think prices near the support level of $2.16 (the blue line on the chart) are attractive for new buyers.
We see share prices of $4.00 and higher very much possible in the next 2-3 years when the new site becomes operational and makes a significant difference in the company’s earnings. In the meantime, patient investors will be rewarded with regular dividend payouts.
We recommend using the bottom of the range at $2.00 (the red line) as a stop-loss level. A confirmed break below the important support level of $2.00 would indicate a significant bearish sentiment on the stock that can open the way down to lower levels.
Probiotech, Weekly Chart in Semi-log Scale (Source: Metastock)