Discovered this little company while doing some screens along the lines of Greenblatt's secret formula. EZZ Life Science Holdings Limited provides skin care and consumer health products in Australia, New Zealand, Mainland China, and internationally. The company operates in two segments, Brought in Lines and Company Owned products. It is involved in the wholesale distribution of EAORON branded skin care products to pharmacies, supermarkets, and specialist retailers, as well as grocery retailers. The company also designs, develops, produces, distributes, and sells consumer health products, including vitamins and dietary supplements, sports nutrition, weight management and wellbeing, herbal/traditional, and paediatric products under the EZZ brand through its e-commerce platforms and stores, such as Tmall Global. EZZ Life Science Holdings Limited was incorporated in 2015 and is based in Silverwater, Australia.
Basically they were totally dependent on revenue from the distibution of EAORON products a few years ago, they have transformed that to where their own EZZ product line is over 80% of revenues now - on much higher margins obviously. They are growing revenue fast, and are profitable, paying a dividend in the last couple of years.
I think because there are only a few years data available the metrics are distorted in the companies favour, but here is what caught my eye.
One of the things that I noticed reading back thru 4Cs & reports is that the marketing spend is very high, the last 4C shows just how much,
Although OCF was -$749k, the revenue was $13575k and sales and marketing a massive $9040k - yes, $9m!! you can imagine how much cash it would be throwing off if they significantly reduced spend on S & M. The question is, how dependent are sale on S & M?
Also product manufacturing and operating costs were up more than 2x, company noted both were up due to the new product lines being released. Notably there was almost no impact yet on sales from the new product lines but sales still rose 100% from Q1!
Looking at FY 22 & FY 23, basically in 12 months they7x'd S&M spend for 2.5x in Sales and 2.75x in NPAT. I think that link between sales growth and earnings growth is important, I suspect it doesnt matter much what you spend on S&M if you can increase Revs and NPAT at similar rates. At some point you should be able to cut S&M and still see plenty of cash generation. Although as my mate Claude pointed out when I discussed with him, online sales tend ot have high fixed advertising costs, you cant reduce spending or sales fall. So I think I am looking at it wrong, the very strong Sales growth is driving the S&M expense growing so much rather then the other way round.
FCF for 2023 by my calculations after adding back SBC, Lease payments and PP&E, was $3575267 - nearly exactly the same as NPAT, so FCF of 8.5c per share. Given its trading at 60c thats a 14% FCF yield!
Because it hasnt been listed very long I cant do my usual 5 year ROIIC calcs, I adjusted back to 4 years. Looks very impressive on all my metrics.
The issue for me is the negative OCF last quarter, that would normally be enough to stop me considering a position, but the other metrics are very strong so I am encouraged to explore the reasons for the negative OCF. Clearly its caused by the growth in manufacturing costs and Advertising and marketing. The manufacturing costs alone would have had very little impact given the big jump in revenue, but they are also likely to be sticky and in fact continue increasing as revenues increase (if they do.)
The advertising and marketing costs are the key to deciding the future of the business, if they are transitory to some extent then OCF will increase by the amount these can be reduced. Last year OCF was about 10% of sales, if it returns to a similar amount this year, it would only require a fairly small reduction in A&M expenses - under $1 out of a spend of $9m last Q.
This seems a reasonable probability and would make the business cheap on most metrics. So the positive thesis is cash flows revert to the historical pattern, business trades on a PEG or under 0.5, EV/Sales of 0.2, operating cushion of 18% and a DCF valuation range about 2x its price.
The negative thesis is the business continues to run Manufacturing costs and A&M spend ahead of revenue growth and so OCF remains negative.
The upside is high, given the strength of all the other metrics, if they turn OCF round it will be deserving of a much high price and will also be able to continue to pay dividends. The downside is quite possible, the only mitigation is that it looks to have quite a lot of that downside priced in. If the OCF doesnt revert then they can still cut the spend and maintain previous margins on smaller revenues in all likelihood.
On the basis of all the above, I plan to take a small position in EZZ in the personal pf, the thesis is then for a reversion to +'ve OCF over the next half and if this is unsuccessful then exit the position.
Bought 9615 shares in EZZ at 52c. 16/2/24
