Eco Investor April 2017

Pre Profit Securities

Secos Targets Profitability

Biodegradable and compostable plastics maker Secos Group says it is getting closer to achieving group profitability now that two of its three business units are operating profitably.

Last month Secos said its Malaysian operations have traded profitably so far this financial year and its Australian operations are trading profitably on a monthly run rate basis. The company's Chinese business unit is now being reviewed so the group can become cashflow positive.

Secos manufactures biodegradable, compostable and hybrid resins that can be used to make sustainable hygiene and packaging materials that can substitute petroleum based plastics. As well as supplying resin to other manufacturers, Secos makes sustainable films and components for third party hygiene products such as nappies, incontinence pads and feminine pads; and it manufactures its own sustainable waste management products such as dog waste bags, garden bags, and kitchen tidy and bin liners.

The China plant makes the resin plus bags and film, the Malaysian and Australian plants both make film. The Australian plant has 45 per cent of its capacity available to utilize and the Malaysian plant has 40 per cent spare capacity so there is no problem in meeting greater demand.


Secosí compostable kitchen tidy bags.

Chairman Richard Tegoni said there are three contributors to future profitability: increasing sales, reducing costs, and using a higher proportion of sustainable plastics in its own manufacturing of products and components.

The December 2016 half year revenue was down 3 per cent to $10.5 million on the 2015 interim revenue, so the latest operating profits are from lower costs. However, Mr Tegoni is expecting sales to start growing again. 2015-16 revenue was $20.9 million and, with the current potential to add up to another $7.5 million of new revenue minus some withdrawals, 2016-17 revenue could come in at around $23-24 million. There is potential to nearly double this with up to another $22 million in 2017-18.

Managing director Stephen Walters said the company has about 10 or so key clients, and some are major manufacturers with great scope to increase sales if Secos can show there are cost and other advantages to them substituting oil based plastics in their products with a greater percentage of Secos' resin based plastics. Clients include a major nappy manufacturer and major waste management companies.

Products with good growth potential include pet sheet pads, dog waste bags, hygiene films, resin including food packaging resin, compostable air pockets, bin liners, and breathable film. Councils are also looking at compostable bags so householders can dispose of food waste without it going to landfill.

On cost reduction, Mr Tegoni said another $250,000 can be saved from lowering head office costs and fixed overheads.

There are also opportunities for Secos to use more of its sustainable resin in the plastic components it supplies to other manufacturers for use in their hygiene products. The trick is to match the cost of oil based films and show other benefits such as greater softness and strength. The company feels this is now increasingly possible.

At present about 75 per cent of revenue comes from hygiene products, with about half of the balance from waste management products and the rest from trading, resin sales and films and packaging.

The waste, trading, resin, film and packaging products all utilize the eco-friendly ingredients, and these are currently about 25 per cent of total revenue. Mr Walters said there is scope to add another 10 per cent or more by utilizing resin in some of the third party hygiene products and their components. For example, in feminine hygiene pads Secos has developed a film for the outer cover that is about 18 per cent renewable content and this can get higher with development. The backsheet of the sanitary napkin has about 11 per cent renewable content and will get higher with development. That is in addition to the bamboo absorbent layer. The sanitary napkin's outer point of sale Biohybrid bag can have up to about 30 per cent renewable content.

Mr Walters said the renewable Cardia Bioplastics side of the business will grow quickly and will eventually pass the conventional Stellar Films side of the business as the overall move to "Eco Friendly" packaging starts to gain traction with brand owners and legislators around the world.

At present, resin sales are a small part of total revenue, but Mr Tegoni said Secos' prefered business model would be to increase this to 100 per cent and specialize in supplying the resin to other manufacturers. The resin is simple and cheap to make, and being a supplier would avoid the capital costs and other issues of being a manufacturer. However, such a change to the business model is not likely in the foreseeable future.

Secos has come a long way since it was Cardia Bioplastics and in 2015 acquired Stella Films Group to give it manufacturing capacity. It has tidied its non core assets, further developed its patent portfolio, expanded its product range and grown its international sales and distribution network. Although it is still making losses, these are declining. The December half loss was $1.6 million, down from $2.4 million. That also augers well for a better full year result than the 2015-16 loss of $5 million.

The clear path to commercialization makes it easy for investors to follow the company's progress. At this stage the key numbers are sales revenue, costs and emerging profitability.

But so far investors have been cautious. The company's share price has consistently declined over the past 10 years and is now just under 10 cents. So Secos has a big job to reverse this. It needs a good story. If they arrive as suggested, rising sales and initial profits are as likely as any to do the job. (ASX: SES)

 

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