The elevator pitch: Advance Nanotek is a specialty materials company based in Australia that has significant cost and quality advantages in producing certain nanomaterials thanks to a proprietary mechanochemical process (MCP) that enables desired chemical reactions and physical characteristics at room temperature, replacing the extremely high heat needed in traditional vaporization techniques with high pressure using a ball mill. The Company generates nearly 90% of its revenue from Zinclear, a unique form of zinc oxide that exhibits superior UV absorbance across the UVA/UVB spectrum as well as superior transparency as compared to competing nanoparticle zinc oxides. Thanks to an organizational overhaul, an operational turnaround, capital injection and capacity expansion led by a successful entrepreneur and activist investor, Zinclear is now also the cheapest and most readily available zinc oxide on the market, setting the stage for rapid market share gains and potential mass-market adoption as sunscreen chemicals come under fire for posing health and environmental risks. The business is already highly profitable, and the stock is cheap in relation to its growth rate and long-term prospects.
As the full year of operations at the new Brisbane manufacturing facility opened in May 2019, FY2020 was originally expected to be a banner year with management guiding for 150% revenue growth, which at the time actually looked conservative. Unfortunately, the year was shortened on both ends; first by a lengthier than expected certification process that delayed first production into September, and then by the coronavirus lockdowns in China, Europe, and the U.S. earlier this year that significantly disrupted the global sun care industry supply chain. Despite recording only about six months worth of sales, ANO’s FY20 results still looked great, with sales up 46% and PBT up 121%:
As the owners of the leading sunscreen brands (Edgewell – Banana Boat and Hawaiian Tropic, Johnson and Johnson – Neutrogena and Aveeno, Beiersdorf – Nivea and Coppertone) report their June quarter results, we are getting a better sense of just how bad things were for sunscreen sales during lockdown. Edgewell reported that sales fell as much as 60% in April as many people canceled vacations and stayed indoors. Such a large drop in sales caused retailers to delay orders from brands, which backed up the whole supply chain including the active ingredients (ANO). However, Edgewell also noted that sales recovered in June and started showing solid growth again in July, as people stayed closer to home but engaged in more outdoor activity. This is consistent with worldwide Google search trends for “sunscreen,” which dropped sharply in April and is now tracking about 10% higher than this time last year:
The news is even better for mineral sunscreen, which is tracking about 50% higher than this time last year:
According to the Company, another factor that has delayed the full-scale resumption of sunscreen manufacturing is that “many sunscreen producers refitted their production facilities to meet the increased demand for sanitising products.” As a result, ANO’s sales essentially ground to a halt for the last four months of the fiscal year, with only $1.6m recorded. However, management isn’t standing still.
ANO management took advantage of the supply chain shock to stop playing catch-up on production (in FY2019 about half of Zinclear production was shipped by air at great expense) and finally get ahead of demand. Production continued in Brisbane while sunscreen manufacturing was halted, and the Company continued to ship Zinclear by sea freight to warehouses in the U.S. and Europe, where it can now be delivered to end customers within a week. This has been confirmed by U.S. import records, compiled from ImportGenius:
The Company plans to continue building stock in anticipation that inventories of finished sunscreen products will eventually need to be replenished for next summer, and that growing concerns over the personal and environmental safety of chemical-based sunscreens will continue to drive demand for zinc-based products. The Company is also going ahead with plans to expand capacity to 5,000MT per annum by September 2020 and plans to introduce a variety of new dispersions and powders by December. In a nutshell, management is positioning the Company to tick every box for their customers, in terms of quality, quantity, cost, variety, and convenience, so that there is no other logical choice to make.
The long-term opportunity for the Company continues to be significant, and I appreciate management’s first step towards quantifying the opportunity in their annual report. The global retail market for sun care products is estimated to be worth about US$20 billion this year and growing ~6% annually (ex-COVID), with demand for mineral sunscreen driving a disproportionate amount of growth. Management’s near term goal is to capture 2-3% of the active ingredients market, which I estimate to be around $2 billion or 10% of the retail market value. That would imply A$56m-A$84m of Zinclear revenues, a 3-5x increase from FY20 sales. This target is well within the Company’s grasp over the next couple of years given current production levels and would not require any further capacity increase, which I think can help push operating margins well over 50%. I think Zinclear growth could continue beyond that point at a high rate for many years given several factors: Continued global sun care growth with increasing contribution from emerging markets such as China, low and rapidly growing penetration of mineral sunscreen products due to increased consumer awareness of potential health and environmental dangers of sunscreen chemicals, the emergence of daily SPF as perhaps the single most important trend in beauty, and the optionality of further regulatory action against sunscreen chemicals.
Each of these factors probably deserves their own post at some point in the future, so I will leave them for now. There were a few more nuggets in the annual report that are also worthy of extended discussion, so perhaps I will put out a Part II on Alusion, the Nasdaq listing, and hinokitiol. For now, the main driver of value is Zinclear, and the stock is quite cheap based on likely sales and profits to come from Zinclear over the next few years. However, given the uncertainty still hanging in the air about the ongoing impact of COVID-19 on anything not related to software, it may take another sales update at the end of this year for investors to regain confidence in ANO’s rapid growth trajectory.
Disclosure: Long ANO
P.S. For anyone interested in going deeper, I published this report last year.
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Will – great write-up, thanks for posting your thoughts.
Reading the Edgewell quarterly and listening to the presentation, they mention favourable materials pricing. Is this a result of reformulation and using XP powder, as opposed to their previous activities? Not sure if they give the answer, but curious to know your thoughts.
I’m sure you know this part – but Edgewell were asked if excess inventory was building in Sun care (roughly 42minutes in the webcast). They basically said they lost the first part of the season was lost. Spring break, memorial day, etc (early to mid June).
The category has since recovered from the beginning, to having growth in recent weeks. So they’re ending the season that inventory is now moving and turning. But no specific comments on manufacturing more just yet.
Nevertheless, they’re very confident on the brand (which gained market share) and future American summer sales.
Foti,
Thanks for reading. I suspect that for a mass-market brand like Banana Boat, zinc oxide is still a low single-digit proportion of their overall active ingredient cost, which makes it an even smaller proportion of their overall material cost. What may be happening is that they are seeing cost savings in their Simply Protect line, which claims to use 25% fewer ingredients, or perhaps in their other lines as they drop some of the chemicals to make “Reef Friendly” claims and keep selling in Hawaii. Last year they launched an all-zinc Simply Protect product in Australia that was likely Zinclear, but this was still a small part of their line-up, and Australia is a small part of their global market. The Simply Protect mineral sunscreen I found on the shelves in the U.S. at the time was likely neither Zinclear or nanoparticle zinc, as the concentration was relatively low (5%) and the product rubbed on thicker. That type of zinc may very well be cheaper than Zinclear, but it would be noticeably different from chemical formulations and undesirable to most consumers.
Zinclear is still more expensive than chemicals, and this is one of the primary points of resistance from the industry to banning them. There is not nearly enough supply to serve the whole market with mineral active ingredients, so prices would go way up in the short-term without chemical competition. As it stands now, brands can pass on the higher cost of mineral actives and more because consumers that actively choose mineral sunscreen are willing to pay more, but the average consumer is looking for a good deal and would definitely notice if the price of sunscreen doubled on them. At last years’ AGM, the Chairman expressed his desire to one day compete with chemicals on price, saying that at scale in the future they could drop the price of Zinclear by 50% and still be very profitable. I think the most likely way for this to play out is that the mineral sunscreen market will continue to grow at a rapid pace from a very small base, and pricing for actives will remain firm for some time given the expectation of higher prices from consumers who prefer mineral products as well as the structurally high cost of production at competing nanoparticle zinc oxide manufacturers. The excess margin for ANO will allow them to continue to ramp up production and extend their product range, and the excess margin for successful brands will allow them to spend more and more on customer acquisition. The FDA may never actually ban chemicals, and it may be difficult scientists to reach a consensus on the actual health impacts of having high concentrations of sunscreen chemicals in the bloodstream for an extended period of time, but at some point within the next decade ANO could achieve a financial and competitive position on their own that allows them to make a big push for share of the mass market. Then again, you may have some states like Hawaii proactively ban all chemicals and force companies to launch new products that they then market across the country, kind of like how California’s emission standards impact what autos are sold across the country.
If the biggest impact of this crisis is a permanently higher base of e-commerce penetration, this is very good for ANO. You are not going to learn about any of this stuff in the supermarket aisle, but you will learn it when browsing for sunscreen online. Digital-first brands like SuperGoop! have a much broader mineral product range, many of those products use zinc oxide, and they are growing very quickly. In the near term, I think that SuperGoop! will end up being a more important driver than Edgewell for Zinclear sales, but Edgewell gives us a useful picture of the overall sun care market, as you pointed out.
Thanks Will – appreciate the detailed reply.
Makes a lot of sense.