Yowie Group — Update 4 May 2016

Yowie Group

Exceeding expectations

Business update

Food & beverages

4 May 2016

ADR research

Price	US$7.13*
Market cap	US$122m
*Calculated ADR/Ord conversion ratio 1:10
A$/US$1.38
Net cash (US$m) at 31 March 2016		11.7

ADRs in issue	17.1m
ADR Code	YWRPY

ADR exchange	OTC
Underlying exchange	ASX
Depository	BNY

Business description

Yowie Group, listed in Australia, is engaged in brand development of the Yowie chocolate confectionery product, digital platform and licensed consumer products. The company’s brand vision includes distribution in North America, with further expansion planned into Australia, New Zealand and Asia, where Yowie’s brand equity remains strong. Expansions into Europe and the Middle East are strategic priorities for a second-stage brand roll-out.

Next events

FY16 results	September 2016
September results	November 2016

Analysts

Beth Senko	+1 646 653 7026
Paul Hickman	+44 (0)20 3681 5201

consumer@edisongroup.com

Edison profile page

Yowie Group is a research client of Edison Investment Research Limited

An investor day at Yowie’s new manufacturing facility on 25 April revealed a smooth relocation and the successful production of its first in-licensed product – Angry Bird character Yowies – to coincide with the upcoming Angry Birds movie in mid-May. Retail revenues rose another 29% on a sequential basis in the March quarter, to an estimated US$8m as the company filled reorders from existing customers and new customers including Walgreens. Volumes appear in line with our estimates so we are maintaining our top-line expectations for now. We will revisit our forecasts after the FY16 results in September when more information is available on the reduction of patent royalty fees resulting from the new contract manufacturer, as well as any additional cost savings.

Year end	Revenue (US$m)	PTP* (US$m)	EPADR (US$)	DPADR (US$)	P/E (x)	Gross Yield (%)
06/15	1.9	(2.4)	(0.19)	0.0	N/A	N/A
06/16e	15.5	(0.7)	(0.04)	0.0	N/A	N/A
06/17e	33.5	4.1	0.24	0.0	29.7	N/A
06/18e	44.6	7.6	0.44	0.0	16.2	N/A

Note: *PTP and EPADR are normalized, excluding intangible amortization, exceptional items and share-based payments. Converted at A$/US$1.38. Investors should consult their tax advisor regarding the application of any domestic and foreign tax laws

Quarterly retail sales rise 29% sequentially

Yowie Group posted another strong quarter of retail sales as the company introduced seasonal products for Walmart stores and signed new customers. Management comments that it achieved US$8m in retail sales value in the quarter to March 2016, up from US$6.2m in the December quarter. With retail sales prices for Yowies typically ranging from a low of US$2.48 (at Walmart) to a high of US$3.99 (at specialty candy retailers), we estimate that the company sold c 3.2m units in the quarter, in line with our expectations.

Walgreens signs on as new tier one client

Yowie’s success at Walmart is drawing interest from new customers. In the quarter, Yowie added its third tier one client in less than two years, Walgreens drug stores. The confectionary will be sold at all 6,500 Walgreens stores, with the roll-out expected to be complete by the end of May.

Valuation: Reasonable with upside possible

The shares have risen 48% since our February update, which we believe reflects a modest bounce back in equity markets in general and Yowie’s continued strong sales performance. A reverse DCF at the current price with a WACC of 10% implies compound average revenue growth from FY16e to FY18e of 70%, fading to terminal growth of 2% and a terminal EBIT margin of 22%. There is nothing in our forecasts for roll-out to other geographies, which would present further upside. We also believe there is a real opportunity for investors as Yowie demonstrates that it can move beyond confectionery into licensing the brand for other products.

New customers and products boost case for longevity

Yowie Group is an emerging growth, brand development and marketing company. It is launching a unique and patented chocolate/toy novelty in the US market as the first step in reviving a highly successful Australian children’s brand that teaches environmental awareness and conservation through whimsical cartoon characters and stories.

In many ways, Yowie Group has achieved the Holy Grail for new consumer products. Without any real sales track record in the US, Walmart came on as a beachhead customer in 2014 and Yowies have been available in 4,300 Walmarts since late 2015. Following Walmart’s success, Yowies are now available in 23,000-25,000 retail outlets in the US, including the recent addition of 6,500 Walgreens drug stores, 500+ Pilot/Flying stores and 600+ Cracker Barrel restaurants.

The company also completed the initial roll-out of its first in-licensed product extension, Angry Bird Yowies, a tie-in with the upcoming Angry Birds animated film. Angry Bird Yowies will be formally introduced in late May at the 2016 Sweets & Snacks Expo, the leading confectionary trade show in the US. In addition, the company is working on new in-licensing opportunities and expanding sales into the Middle East.

March quarter sales up 29% sequentially

Yowie Group reported another quarter of record sales in the March 2016 quarter with an estimated US$8m of retail sales value, up 29% q-o-q. Consistent with ASX practices, Yowie Group does not file an income statement on a quarterly basis, so we have to infer unit sales from management’s comments and its 4C filing. Given that the retail sales prices for Yowies typically range from a low of US$2.48 (at Walmart) to a high of US$3.99 (at specialty candy retailers), we estimate that the company sold c 3.2m units in the quarter (consistent with our expectations), compared with c 2.2m units in the December quarter.

Sensitivities: Easing with experience

In many ways, Yowie Group is still a high-risk start-up venture, while it is still somewhat early to know whether consumers will consistently flock to a premium priced, novelty candy based on little-known characters. However, consistent growth in sales volumes, in-licensing agreements and new customer wins over the past year boost our confidence in the story.

Foreign exchange sensitivity for ADR investors has been mitigated as the company has switched its functional currency from Australian dollars to US dollars as of this current fiscal year (1 July 2015).

Success at Walmart is crucial to our sales forecasts. Walmart not only has 4,300 outlets in the US, but also tends to have more points of sale (PoS) in each store and higher sales per PoS than Yowie’s other outlets. While we expect Walmart to remain Yowie’s key customer for the foreseeable future, the addition of 6,500 Walgreens stores in the quarter and a total distribution base of 23,000- 25,000 outlets diversifies its customer base.

In the past, we considered Yowie’s reliance on a single manufacturer a sensitivity because of the potential risk for supply disruption. However, by creating its own FDA-approved and patent pending capsule, Yowie has mitigated the single manufacturer risks although, as we discussed in our previous note, the company may have invited legal action from its previous supplier, albeit Yowie’s board and legal counsel are confident of its position. Other sensitivities for the company include commodity pricing and typical regulatory and legal issues.

Valuation

Our primary valuation metric for Yowie is DCF, since the full value of the current opportunity is likely to become apparent over a number of years rather than from near-term results. We believe that if the brand proves itself in the next year, the WACC and relative risks to the story should more closely reflect a consumer goods story, albeit one with very high growth. In this context, the retail sales data over the past nine months are quite encouraging.

Our 10-year reverse DCF model builds to sales of approximately US$120m by 2025. There is nothing in our forecast for roll-out to other geographies, which thus represents substantial upside. We also believe there is a real opportunity for investors should Yowie move significantly beyond confectionery into other products and licensing. Evidence of success in this area would lead us to adjust our forecasts to more accurately reflect the impact of the increased licence income.

We assume a terminal growth rate of 2% and use a WACC of 10.0% (based on a 10% gearing, an equity risk premium of 5.4% and a beta of 1.2), reflecting a once strong and proven children’s franchise in Australia and a business model that is not capital intensive. Based on these metrics, as well as what we believe to be conservative earnings forecasts, our reverse DCF indicates that the current share price implies a terminal EBIT margin of 22%. In our model, we currently forecast a modest increase in licensing income over the next 10 years to c 9% of total revenue, although this is still significantly short of management’s aspirations. The growing licensing income will result in EBIT margin expansion, as there are no related direct costs.

Exhibit 1: Valuation (US$ per ADR)

WACC	Terminal EBIT Margin
		14%	18%	22%	26%	30%
	7.0%	8.58	10.90	13.22	15.54	17.87
	8.0%	6.83	8.66	10.49	12.32	14.14
	9.0%	5.60	7.08	8.56	10.04	11.52
	10.0%	4.68	5.91	7.13	8.36	9.59
	11.0%	3.98	5.01	6.04	7.07	8.11
	12.0%	3.42	4.30	5.18	6.06	6.94
	13.0%	2.97	3.73	4.49	5.25	6.01

Source: Edison Investment Research. Note: Bold indicates current level.

Financials

Yowie reported US$1.3m in operating cash flow in the quarter to March (US$0.9m in the December quarter), its second quarter of positive operating cash flow. The company began working down inventory in the September quarter as it worked through the initial stocking for its Walmart roll-out and continued through March as it moved to its new manufacturing facility, resulting in the 44% sequential increase in operating cash flow in the quarter.

Net cash at March 2016 was US$11.7m, stable with levels at December 2015 (US$11.6m) without any additional funding, as net investing cash flows are largely offset by the operating cash flows in the quarter.

Consistent with our expectations, Yowie management confirmed that it will ramp up production and rebuild inventory now that its manufacturing transition is complete. It therefore seems reasonable to expect that operating cash flow may return to negative territory for the next few quarters as the company looks to expand distribution and begins to work with retailers that may have a longer accounts payable cycle.

Exhibit 2: Financial summary

	US$000s	2013	2014	2015	2016e	2017e	2018e
Year end June		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		11	19	1,917	15,520	33,456	44,595
Cost of Sales		0	(4)	(885)	(9,731)	(19,056)	(24,128)
Gross Profit		11	15	1,032	5,789	14,400	20,467
EBITDA		(810)	(3,283)	(2,619)	(785)	3,950	7,102
Operating Profit (before amort. and except.)		(814)	(3,298)	(2,678)	(903)	3,799	6,911
Intangible Amortisation		0	(0)	(3)	0	0	0
Exceptionals		(912)	(1,441)	(111)	0	0	0
Other		0	0	0	0	0	0
Operating Profit		(1,726)	(4,739)	(2,791)	(903)	3,799	6,911
Net Interest		18	75	258	243	340	672
Pre-tax Profit (norm)		(796)	(3,223)	(2,419)	(660)	4,139	7,584
Pre-tax Profit x (FRS 3)		(1,708)	(4,665)	(2,533)	(660)	4,139	7,584
Tax		0	0	0	0	0	0
Profit After Tax (norm)		(796)	(3,399)	(2,418)	(658)	4,141	7,587
Profit After Tax (FRS 3)		(1,708)	(4,665)	(2,533)	(660)	4,139	7,584
		0.0	0.0	0.0	0.0	0.0	0.0
Average Number of ADRs Outstanding (m)		4.1	9.7	12.7	16.0	17.1	17.1
EPADR - normalized (US$)		(0.19)	(0.35)	(0.19)	(0.04)	0.24	0.44
EPADR - (IFRS) (US$)		(0.41)	(0.48)	(0.20)	(0.04)	0.24	0.44
Dividend per share (US$)		0.00	0.00	0.00	0.00	0.00	0.00
		0	0	0	0	0	0
Gross Margin (%)		100.0	80.3	53.8	37.3	43.0	45.9
EBITDA Margin (%)		-7643.6	-17646.0	-136.7	-5.1	11.8	15.9
Operating Margin (before GW and except.) (%)		-7676.0	-17730.2	-139.7	-5.8	11.4	15.5
		0	0	0	0	0	0
BALANCE SHEET
Fixed Assets		1,100	980	1,488	1,657	2,122	2,402
Intangible Assets		410	173	364	362	362	362
Tangible Assets		690	807	1,123	1,295	1,760	2,041
Investments		0	0	0	0	0	0
Current Assets		2,851	8,907	13,449	12,592	17,664	25,728
Stocks		0	2,019	4,920	5,060	6,670	7,480
Debtors		28	54	302	310	669	892
Cash		2,335	5,975	8,013	7,000	10,034	17,029
Other		488	859	215	221	292	327
Current Liabilities		(352)	(677)	(1,485)	(1,460)	(2,858)	(3,619)
Creditors		(352)	(677)	(1,485)	(1,460)	(2,858)	(3,619)
Short term borrowings		0	0	0	0	0	0
Long Term Liabilities		0	0	0	0	0	0
Long term borrowings		0	0	0	0	0	0
Other long term liabilities		0	0	0	0	0	0
Net Assets		3,598	9,210	13,452	12,789	16,928	24,511
		0	0	0	0	0	0
CASH FLOW
Operating Cash Flow		(1,166)	(5,611)	(5,671)	(723)	3,650	7,467
Net Interest		18	75	0	0	0	0
Tax		0	0	0	0	0	0
Capex		(957)	(911)	(275)	(290)	(616)	(471)
Acquisitions/disposals		(180)	0	0	0	0	0
Financing		3,465	10,088	7,984	0	0	0
Dividends		0	0	0	0	0	0
Net Cash Flow		1,181	3,640	2,038	(1,013)	3,034	6,996
Opening net debt/(cash)		(1,154)	(2,335)	(5,975)	(8,013)	(7,000)	(10,034)
HP finance leases initiated		0	0	0	0	0	0
Other		0	0	0	0	(0)	0
Closing net debt/(cash)		(2,335)	(5,975)	(8,013)	(7,000)	(10,034)	(17,029)

Source: Company accounts, Edison Investment Research. Note: Historical results reflect past results prepared under presentation currency of A$ to June 2015 and translated at US$0.725/A$. Presentation currency for financial reporting changed from A$ to US$ from 1 July 2015.

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