Very well positioned to benefit from structural change, says fundie

Founded in 1997 and listed on the ASX in 2006, Probiotec Limited (ASX: PBP) is one of the largest vertically integrated manufacturers and distributors of pharmaceutical products in Australia.

Servicing more than 200 clients, including conglomerates Pfizer, GSK, DuPont, Woolworths, Nestle and Coca-Cola Amatil, the company provides end-to-end contract manufacturing and distribution services.

Probiotec facilitates products such as prescription and over-the-counter pharmaceuticals, vitamins and supplements, food and beverages, veterinary products, and cosmetics. It also operates six manufacturing facilities across Melbourne and Sydney, and has extensive distribution channels internationally.

During his appearance on Reach Markets’ Meet the Fund Manager webcast in April, Yarra Capital Management’s Joel Fleming, a CFA Charterholder, described his investment as a value opportunity.

The Portfolio Manager highlighted a “significant opportunity for (Probiotec) to continue to grow their business by working with their existing customer base and doing more for them”.

Probiotec’s FY22 underlying financial results saw revenue up 14% to $182.3 million, EBITDA up 34% to $32.8 million and NPAT up 45% to $13.5 million, all compared to FY21.

This continues a period of profitable growth for the company across FY18-FY22, with compound annual growth rates (CAGR) being 26% for revenue, 37% for EBITDA and 44% for NPAT.

Noting a structural shift in the market where businesses are looking to solidify their supply chains by bringing manufacturing on shore, Mr Fleming said he believes Probiotec is “incredibly well positioned to benefit from that structural change”.

This was no coincidence – the company underwent a strategic refresh during 2017-18 that involved divesting non-core assets to raise $60 million. Probiotec reinvested this capital into more supply chain initiatives, including the acquisition of South Pack Laboratories in 2017, Australian Blister Sealing in 2019 and H&H Packaging in 2021.

The company also built a state-of-the-art warehouse and processing facility in Victoria during 2019, and acquired the assets of Contract Pharmaceutical Services Australia in 2020.

Mr Fleming said he saw this site consolidation and optimisation as potential for significant upside, igniting the thought that there could be “a longer-term story there about putting the footprint together and driving some real synergies”.

What makes Probiotec’s growth worthy of note is its management of debt, which is shown in its interest coverage ratio (ICR). Reflecting a company’s ability to meet its interest payment liabilities with EBIT, an ICR of less than 1 means that a company is not earning enough to repay the interest due on its debt.

According to analysis by Coolabah Capital veteran Christopher Joye, 38.6% of all ASX-listed companies had an ICR of less than 1 in FY21. In FY22, Probiotec had an interest expense of $4.3 million, and an EBIT of $22.9 million, resulting in an ICR of 5.326.

The company derives a significant portion of its revenue from cold and flu products, and has presented data from a sample population of 63,724 people that shows domestic incidences of fever and cough have risen to over 3% during August 2022 – which has led to a welcomed boost in revenue.

Mr Fleming described this return to a normal flu season as “a key delta on earnings and revenue”.

Click here to view more videos from Joel Fleming’s The Insider: Meet the Fund Manager session.

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