SECOS Group Limited

Malcolm Maiden here for The Constant Investor and today we're talking to Richard Tegoni, the Executive Chairman of SECOS Group. They’re in the bioplastics business and they’ve got an interesting story to tell. 

Here's Richard Tegoni, the Executive Chairman of SECOS Group.

First of all, tell us a little bit about SECOS, it’s a combination of two companies, I think.  When was it, back in 2015?

That’s right, there was a merger back in 2015 but SECOS is basically a bioplastics company with a proprietary range of environmental bioplastic resins.  We have a number of core assets in a resin manufacturing plant in Nanjing China and two cast film manufacturing plants, one in Kuala Lumpur and one in Melbourne, which was part of the merger back in 2015 under The Stella Group and those cast film plants were ex-Orica businesses that were bought out by management 20 years earlier than that.  We merged the businesses because as part of our strategy to commercialise our bioplastic resin range into their film products which is one of the segments we work in.

Which were the two pieces that came together, was it a film company and a resin company that you combined?

That’s right.  Cardia Bioplastics was the technology company that developed the resins and it merged with Stella Films, the film business.  

Let’s talk a little bit about the market that you’re aiming at, it’s got great growth potential I think not just here but overseas?

Yeah, that’s right.  Really, SECOS is fundamentally a resin business.  Our entire growth strategy sits behind our resin technology.  We have a sort of 11 patent family of a range of resins, a variety of resins for different applications.  Yes, it’s a global business we target and our market is global and our resins have been adapted in different applications all over the world in different niche markets as different industries and different products are taking up or moving towards environmental plastics.  Which is happening in spots all over the world.  You’re sort of seeing it more dramatically in Australia recently. 

Obviously, the war on waste program has really brought that attention to the waste issues.  But in the local markets in Australia we’re focusing very much working with councils that work with waste diversion.  We supply them with bioplastic bags and those bags are used to help separate organic waste so that the organic waste doesn’t go into landfill. 

Does this end of the environmental industry get as much help from government policy as the energy piece?

No, not really.  We’re getting help.  There’s a number of drivers in this industry and governments driving this are usually more local governments, particularly councils.  They’re the groups that have the problems with the cost of managing landfill and the cost of landfill is becoming very prohibitive.  You would have heard, in particular, the recent ban of recycling from China and there’s now a lot of pressure on the cost of managing waste.  You’ve heard of stories about people trucking waste from New South Wales to Queensland where the tipping fees are more expensive and all these different really unusual scenarios where there’s diversity in terms of the different costs of managing waste.  That’s sort of coming to a head now and it’s really becoming problematic everywhere in the world.  Local councils are driving it and they’re changing legislations.  State government’s they announce the ban of single use plastic bags in Victoria and a number of other places.  That’s happening all over the world.  The federal governments tend to be the ones that sit back and do the least.  It’s where the problems are really impacting local governments and therefore they’re the ones that are acting and working on this.  In terms of support, like financial support, there’s not a lot.  

Yeah, there’s not the same kind of subsidisation that Green Energy is getting at the moment I guess?

That’s right.  In terms of, we see ourselves as an emerging market, the bioplastics industry.  We sort of analogise ourselves or compare ourselves with things like the energy market.  You look at companies like Tesla.  The difference is that our ability to commercialise now and grow, we don’t need to invest anywhere near as much in capital to manufacture resins that would today manufacture a car or to build windfarms or giant electricity grids or renewable electricity grids, so we think we’re in a much better space commercially to be able to penetrate the market. 

Recently, globally we’ve hit a scale of around 2 million tonnes of environmental biodegradable grade resins in the market.  We think that’s sort of starting to be a bit of a tipping point and look, it represents less – only 1 or 2% of the whole plastic market.  Just in hygiene film it’s about $72 billion dollars.  It’s a huge space to be in and it’s just growing very, very rapidly.

Of that 2 million how much are you guys?

Our current plan in China’s around 5 or 6 thousand tonnes, which is only a small part of that.  We’ve just commissioned to put on or we’ve announced recently that we’re going to be opening a new resin plant in Malaysia and we hope that once we rent that and sign the lease and we’re ready to fully fit it out with as many compounders that we can fit in there.  That will give us another 12,000 tonnes and then we probably look at further expansion in other markets as well and grow from there.

Is your business essentially a consumer-oriented business?  I notice that you’ve got brands, for example, you sell Pet Valu dog bags for example under the Greenbone brand and so on, or do you see the real growth in the business coming from being a supplier at a wholesale level or at an industrial level?

Yeah, look, the growth is in the industrial side of the market.  At the moment we do make finished products.  We make bags for Pet Valu in the US and supply them with bags.  We’re not really interested in growing that part of our business or even the film part of our business necessarily.  We’re interested in growing just the resin side.  The real growth we’re experiencing, we have experienced in the last 12 months, is supplying resin to other bag makers and to other film makers and where they’ll use our resin to make finished product and they’ll sell the finished product.  We do definitely see ourselves in that wholesale side of the market.

All right.  The combined group is still very young, we’ll talk about the financials in a minute.  But I know that you’ve been going through some quiet solid restructuring.  You mentioned in a recent report that the Australian production facilities and the Malaysian production facilities are now profitable.  Is that EBITDA profitable or are they actually turning a taxable net profit.  Then there’s Nanjing which hasn’t been in the black but has undergone quite substantial restructuring.  Tell us a little bit about that?

Yeah, so after the restructuring in Nanjing we’re seeing EBITDA profit in Nanjing and that profit also applies to our Malaysian and our Australian businesses as business units.  The business now only has to cover its head office costs which run at about between $1.5-2m a year.  That’s sort of the gap we’re trying to bridge and there’s a number of other initiatives that we hope to implement over the next 6 to 12 months in terms of consolidating some of our operations to cut costs and also, in particular our focus will be growing our resin plants in Malaysia which we think will give us the best revenue growth and margin growth and contribution margin in the short term to bridge that profit gap to get the business overall to be profitable on a net profit basis. 

It’s interesting to see you take in the next production increase in Malaysia rather than in China.  I think a lot of people think that if China are such a low cost producer, it’s a no-brainer to go over there and establish manufacturing facilities there.  You’re going to have a cost comparison advantage with almost anywhere in the world.  But obviously in it’s first incarnation, Nanjing was not making as much money as you hoped.  What’s the story there?  Has it turned out to be tougher to do the business in China than you expected?  And why is Malaysia such a good place to base?

Yeah, look, it’s a good question and certainly doing business in China is not easy if you don’t know how.  We’ve been there for a while and we’ve finally got it to work, we’ve got a good team there.  We see ourselves expanding our operations in China if we can keep the growth in there going.

It’s a really good market and…

It is.

Nanjing is a good place to be, it’s a good city.

It is a great city and it’s particularly welcoming foreign investment as well.  We do work very well there and the team we’ve got there are excellent.  Expanding in Nanjing, we hope to see that happen, but the reason we’re moving to Malaysia first, as opposed to expanding further in Nanjing is that there’s some excellent government grants and support through their Bio-Nexus program in the Malaysian government.  Our business in Malaysia has Bio-Nexus status which basically means that we get a range of subsidies or concessions on our income tax, import taxes and tariffs which make the economics behind doing business in Malaysia very, very attractive. 

The other part of it is that there’s a huge industry for bag manufacturing in Malaysia that supplies a lot of Europe and the US.  A lot of our customers actually reside in Malaysia and the Malaysian government have gone a long way or certainly a lot further ahead compared to a lot of other jurisdictions in banning plastics and actually, our bioplastics and resins are approved in Malaysia, so there is a strong demand for our resins in Malaysia.  It’s a very important market for us, Malaysia, but also it’s an important market to supply our customers to sell abroad into Europe and the US and back into Australia.  It’s a highly attractive market.  Resin, unlike a lot of other finished products, there’s some advantages of manufacturing locally. 

We would see in the future an opportunity to even manufacture resins in the US because you remove all the logistic costs.  It makes sense to be manufacturing your resins close to your customer.  Unlike manufacturing large finished products where you really need the scale.  Resins, you need scale to a point and then after that you’re better off being close to your customers, so having multiple plants seems to be the most economic way to structure the business. 

What are the raw materials and are they readily available around the world?

The core raw material that goes into our resins is corn starch and there’s certainly particularly commercial grade corn starch.  There’s an abundant amount of that available in the world.

You mentioned that you’re growing but still a small piece of what you estimate the total market is right now.  Who is the competition and are there any whales out there?

Yeah, there’s some large competitors.  There’s companies like Novamont, Braskem.  Novamont’s an Italian company.  Braskem is from Brazil, they use actually a sugar cane instead of corn starch.  We’re sort of that stage in the life of this industry that the more competition, the better.  We don’t really come across them a lot because the demand for our product is quite strong.  We don’t have enough competition.  It is actually a barrier for a lot of particularly large packaging companies that want to know that there are alternatives, not just one supplier.  But that was certainly a problem about 6-7 years ago.  We welcome more competition at this stage and I’ll probably change my tune in 10 years’ time.  Certainly, at this point there’s a need for more supply in the market as demand is starting to outstrip supply in this particular area.

I guess you’re all in the same boat and you all want to grow the market, you all want to basically get it out there in front of people and show them what it is and what it can do.

That’s right.  We want them to be successful, our competitors.  We want people to realise that bioplastics is actually a better alternative than an oil based plastic.  It’s just unnecessary to use oil based plastics in many, many applications now, so we want the market to move over, we want governments to keep legislating to support that move.  We want packaging companies to mandate that in their product development and we want the consumers to demand it.  We’re seeing the cost of oil going up which is driving it, we’re seeing the cost of landfill going up, we’re seeing the cost of recycling going up.  There’s so many drivers that sit behind this that it just makes perfect sense.

For Constant Investors, the financials matter very much.  It’s going to be a deciding factor I guess whether or not they’re on board as shareholders.  Let’s have a look at those for a while.  I pulled the numbers for the year to June 2017, because that’s the last full year.  The trend line on revenue was good, you’re up 5.2% to $22.4m, so there’s substantial business emerging here.  You improved the net loss from 4.96% to 2.95%, just under 3%.  But, operating cash flow declined, I think, in that year from 3.4% to 2.7%.  You’ve had the December half since then but the balance sheet certainly in the last full year was pretty tight.  What’s happened in the half to the December and what’s the outlook?

In the half to December we spent a fair bit of money on the restructuring side of the business, to get particularly our China business, Nanjing, profitable. 

So that’s about when you were investing in Nanjing?

Yes, we invested in Nanjing to the extent that…

Restructured it?

Yeah, restructured it to get it to EBITDA profitable.  We’ve had to invest in expanding our resin plants in Malaysia.  That’s chewed up a bit of cash.  In terms of cash burn, we’ve had to keep investing in that restructuring and development to get to where we are now and to allow us to continue to grow.  We need to continue to grow into next year.  We expect the resin side of the business to be our major growth arm and a lot of that is constrained by capacity.  With the recent placement that we completed in February, raised about $2.7 million.  A lot of that money will go to seeding the original plant in Malaysia to get that going and so that we can buy at least a couple of compounders to meet demand and back orders that we’ve got.

That was $7 million, did you say?  $7 million in the placement?

No, $2.7 million.  $2.7 million placement, that’s going to assist in starting production which we hope to have up and running before the 30^th of June in Malaysia.  That will allow for much stronger resin sales growth which is where the core of the business strategy lies.  Moving forward, clearly the company is still loss making.  We were continuing to burn cash but with the growth of sales we expect that as we grow into $24 million in sales up to close to the $30 million in sales and we improve our gross margins, which you’ll see have improved year on year as scale has enabled us to absorb the lot of our fixed manufacturing costs, which is why the gross margins are improving. 

As sales go up, you’ll see margins will continue to go up with that or gross margins go up with that.  There’s a breakeven point around that $28m or $32m mark that we’re aiming for and that’s before we do any other restructuring that we think could significantly cut some costs out.  We think there’s probably potential to cut another million dollars in fixed costs out of the business, over and above that as well.  Certainly, in the next sort of 12 to 18 months we can see our business definitely heading towards that target of breakeven and profit, and its challenge is being able to grow the business, keep up with the growth because we’re under a lot of pressure for our customers to meet growing demand. 

Being able to grow, at the same time, restructure, and at the same time, deal with net cash burn losses along the way is challenging but we certainly have a very, very clear path to achieve that over the next 12-18 months.

You’ve been relying on equity raisings for fundings predominantly more recently.  What is balance sheet gearing?  I read – I’m not sure whether this is finished or not – that there was some debt renegotiation going on with some finance providers in Malaysia.  What’s happening there and is that done?

Yeah, it’s still in progress.  Another reason Malaysia’s an attractive market is that we do have some good relationships with our debt providers from the Stella side of the business who have been there a long, long time.  We own our factory and plant and equipment.  We’ve depreciated nearly all the equipment down.  We actually own the building as well and there’s a bit of debt there.

And there’s been a property revaluation as well I guess, that’s one of the nice things about having a freehold. 

That’s right.  It’s worth about roughly $3 million Australian dollars I think we have on the balance sheet and the debt on there is about $1.3 million.  So there’s certainly an opportunity to unlock some equity out of that property either in debt or a sale and leaseback arrangement if necessary.  We’re considering those arrangements at the moment to help us with extra funding as well. 

So that reset is really about opening up some borrowing capacity rather than just rolling it?  You’re actually looking to restructure to get some more capacity over there?

That’s right.  Either through more debt or a sale and leaseback, which will just pay the debt down.  If we sold the property we have the opportunity to pay down about $1.3 million in debt and actually unlock about another $1.5 million in debt and actually unlock about another I’ll say $1.5 million dollars in free cash flow.  The other thing is, as we put on the new compounders and for every roughly $500,000 or $1 million in capital investment in compounders, or resin manufacturing compounders it will produce around $6 million in sales.  That’s sort of the equation we’re working on.  There is an opportunity to get equipment finance for those compounders as well, but there’ll be brand new German machines that we’re putting on that we’re currently looking at purchasing. 

You were saying that an extra $6 million on the top line is expected to be the difference between staying on losses and getting into the black that’s the EBITDA here again I think, right?

That’s right.  But, yeah, fundamentally it’s an extra $1 million investment in equipment there that if we can completely fill up that line, we’ve got a very strong order book, it would equate to at least around $6 million in sales and probably take us to that tipping point that get us across the line to profit. 

Just a couple of things before we finish up.  In China, you mentioned the restructuring was aimed at getting that to a point where it could grow sustainably.  Are you satisfied that you’ve done that now or will focus more heavily on Malaysia now?  It sounds like Malaysia’s a really good place for you to be.

It is and we’d love to focus on both but we’re not a huge company, so we have to use our equity and our capital very, very carefully so that we can sort of get to that breakeven point without continuing to having to raise money and dilute our shareholders.  It’s a balancing act really, so we’d love to do more and faster but we have to sort of live within our means, I suppose.

And you’ve said that the aim is obviously to get to cash flow positive.  I always tend to sort of think that EBITDA and cash flow positive are pretty much the same thing really.  What year are we talking about again now for that?  Of course, no one ever really wants to or should put firm targets out there but if it goes according to plan, when are you going to crack open a bottle of bubbly to celebrate hitting that mark?

Yeah, we don’t like to give those forward numbers.  I don’t think my board would be too pleased with me making that sort of announcement, but we certainly believe that in the next 12-18 months that on at least the run rate basis we should be hitting those numbers.  

That’s good.  All right, well it’s been great talking to you.  Is there anything else that you want to talk to us about?

No, just that it’s a particularly fast-growing market and there’s certainly a number of things that have happened particularly in the recent times that’s really driving this business and driving it fast.  It’s a very interesting space, so I’d be keen to speak to you again if you’re interested in how we’re going.

It’d be kind of nice if the Australian government was awake to what’s going on as the Malaysian government sounds like it is. 

That’s right.  Unfortunately, it’s sad that we’re so slow to move in Australia compared to, not just Malaysia but there’s other jurisdictions around the world that are just way ahead of us, particularly Europe.  Europe did introduce waste diversions programs years ago.  I think people sending organic waste to landfill, they would laugh at us if they knew how we just keep dumping stuff into landfill the way we do, particularly given the amount of methane gas that produces and the problems it causes with those landfill sites.  But you know, we’re getting there.  Every country seems to move at its own pace but slowly over time, I’m sure in 10 years’ time from now, plastic as we know it just will not be the same.  Bioplastics will be pretty much the standard, that’s what we expect.

And finally, just on equity raisings, there’ve been a few.  They’re always on investors minds when they’re looking at going into companies.  Are you done for the time being, are you set or are they going to continue?

Well, we’re set from the point of view of we’ve just completed one, so we don’t have any plans on another capital raising at the moment.  Obviously, we need to, long term, look at the way we’ll grow the business and how that will play out with equity and debt and the roles that each will play in that, but that’s certainly not something that in the short term we’re looking at. 

All right, great.  Richard, thanks very for talking to us and best of luck with it. 

Thanks so much.