GLG Life Tech Q314 results light, looking ahead Update Q3 results Pharma & biotech Q314 results were below our expectations and we are reducing 2014 and 2015 estimates. We retain confidence in GLG s prospects, as growth in deployment of its high extract-yielding Huinong 3 (H3) leaf and the start of Luo Han Guo (LHG) extract sales in Q414 should improve margins. Recent stevia pricing increases may help GLG return to positive EBITDA in 2016. Year end Revenue (C$m) PBT* (C$m) EPS* (C$) DPS (C$) 12/12 21.7 (24.3) (0.89) 0.0 N/A N/A 12/13 16.0 (21.7) (0.55) 0.0 N/A N/A 12/14e 20.4 (18.0) (0.52) 0.0 N/A N/A 12/15e 52.2 (11.7) (0.30) 0.0 N/A N/A Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments. Q314 results below our forecasts P/E (x) Yield (%) Price Market cap Net debt (C$m) at Q314 (before proceeds of C$3.4m note conversion post-q314) Shares in issue (incl.post-q314 note conversion to 4.3m shares) 12 December 2014 C$0.40 C$15m C$1.14/US$ 87.2 37.8m Free float 62% Code Primary exchange Secondary exchange Share price performance GLG TSX N/A GLG s Q314 revenue of C$3.78m and negative EBITDA of C$3.26m was below our forecasts (of C$7.18m and negative C$1.35m, respectively), and we reduce our 2014 EBITDA forecast by C$2m due to the Q314 underrun. We estimate GLG needs C$50-60m of annual extract sales to deliver sustainable positive cash flow. Luo Han Guo and Huinong 3 leaf to drive 2015 results Higher extract-yielding H3 leaf should account for the majority of leaf in GLG s supply chain going forward, which we believe should lead to a more sustainable path towards profitability (and a cost advantage vs competitors). GLG will also complete its first LHG extract contract by mid-2015, valued at C$9-12m, which should improve utilisation and diversify its revenue stream. Improved pricing could support margins and growth GLG indicates that pricing for stevia extracts has increased in recent weeks by up to 20-25%, which suggests that stevia industry overcapacity from 2011-12 is finally abating. If sustained, given H3 leaf s potential cost and yield advantages (compared to more conventional stevia leaf strains), GLG may be in a position to sell its extracts at a mild discount vs competitors to grab market share and improve capacity utilisation, while still retaining a positive margin. Valuation: NPV of C$143m, equity valued at C$59.5m We have lowered our stevia sales volume estimates, but raised our extract pricing forecasts. This leads to a slightly changed NPV of C$143m (from C$144m), or C$1.58 per equity share (after removing C$84m in Q414e net debt). Our 2014 and 2015 forecasts are contingent on an uplift of stevia sales and the initiation of LHG sales in Q414. We forecast GLG s operations will return to positive EBITDA in 2016, which would help de-risk the story given its history of operating losses since 2011. The sale of one of GLG s underutilised processing facilities could be a nearer-term catalyst to reduce debt, which may catalyse interest among investors concerned about the firm s high debt-to-equity ratio (>85%). % 1m 3m 12m Abs (24.4) 34.8 (48.3) Rel (local) (21.5) 47.8 (51.5) 52-week high/low C$0.68 C$0.22 Business description GLG Life Tech is a vertically integrated supplier of stevia-derived extracts primarily for use as lowcalorie, high-intensity sweeteners (HIS) in the food and beverage industries. It sources stevia in China and processes extracts at its China-based facilities. Next events Q414 results March 2015 Q115 results May 2015 Analysts Pooya Hemami +1 646 653 7026 Christian Glennie +44 (0)20 3077 5727 healthcare@edisongroup.com Edison profile page GLG Life Tech is a research client of Edison Investment Research Limited
Update: Q314 sales light, but outlook remains positive GLG Life Tech reported Q314 financials on 14 November 2014, with revenue (essentially from the sale of stevia extracts) of C$3.78m (down 27% y-o-y), negative gross profit of C$1.05m and negative EBITDA of C$3.26m. Our cost of sales and G&A expense calculations differ slightly from the firm s reported statements, as we remove depreciation and amortisation components from these items (the reported figures are inclusive of such amounts). Our EBITDA calculation also differs from the firm s reported figures as we do not exclude certain components such as non-cash share compensation from our EBITDA assessment. Stevia extract revenue was below our C$7.18m estimate, which suggests that GLG needs to continue working on building new customer relationships and grow sales. We estimate that GLG needs C$50-60m of (stevia or LHG) annual extract sales to cover its fixed costs and reach sustainable positive operating cash flow. A favourable trend, as has been shown in Q114 and Q214, is that the company continues to increase sales to international (ex-china) customers and move away from one-off sales of lower-margin and lower-purity extracts to clients based in China. International sales in Q314 increased by 59% y-o-y and reflected 54% of Q314 sales. GLG indicates that its sales efforts are concentrating on customers that intend to make recurring extract purchases which, over the long term, should form a stronger base for sales growth and improve revenue predictability. As only two of GLG s four manufacturing facilities were operating during Q314, GLG s cost of goods sold also included C$0.9m in capacity charges (vs C$0.8m in Q313), which relate to the fixed overhead costs of maintaining and/or running GLG s processing facilities while they operate below peak or optimal utilisation. Increased stevia (and/or LHG extract revenue) would improve companywide capacity utilisation, which should lead to lower capacity charges. Exhibit 1: Q314 financial results Year-end Dec-31 (C$000) Q314 Q314e % chg Q214 % chg q-o-q Q313 % chg y-o-y Revenue Total corporate revenue 3,775 7,175 (47) 4,008 (6) 5,196 (27) Expenses Cost of sales (4,829) (6,672) (28) (2,158) 124 (6,563) (26) Gross profit (1,054) 502 (310) 1,850 (157) (1,367) (23) Net R&D costs - - N/A - N/A - N/A G&A expense (excluding D&A) (2,208) (1,850) 19 (2,238) (1) (1,630) 35 EBITDA (3,261) (1,348) 142 (388) 741 (2,996) 9 Depreciation & Amortiz. (1,084) (496) 119 (1,565) (31) (507) 114 Operating income (loss) before exceptionals (4,346) (1,844) 136 (1,953) 123 (3,503) 24 Net interest income (expense) (1,699) (1,842) (8) (1,823) (7) (1,677) 1 Foreign exchange gain (loss) (663) - N/A 620 (207) (373) 78 Financial and other income (loss) (83) - N/A 378 (122) (8,784) (99) Earnings (loss) before tax (6,791) (3,686) 83 (2,777) 145 (14,338) (53) Taxes (2) - N/A (32) (95) (0) 6,616 Net income (loss) (6,792) (3,686) 83 (2,809) 142 (14,338) (53) Net EPS (IFRS, fully diluted) ($0.20) (0.11) 87 ($0.08) 142 ($0.43) (53) Source: Company documents, Edison Investment Research In Q314, GLG continued to work through its inventory of earlier-generation (Huinong 1 or 2) leaf, which carries lower yields of glycosides including Rebaudioside A (RebA, the primary commercial stevia extract). GLG expects higher extract-yielding Huinong 3 (H3) leaf will account for the majority of processed leaf in GLG s supply chain in Q414 and H115, which we believe should lead to reduced COGS and a more sustainable path towards profitability. GLG indicates that H3 leaf carries a 13-15% glycoside content by weight (65-70% of which would be RebA), which we estimate could yield up to a ~50% raw material cost savings compared to H2 leaf. GLG Life Tech 12 December 2014 2
Initial Luo Han Guo contract proceeding as planned In July 2014 GLG signed a 12-month agreement (with potential for renewal) with an undisclosed global food industry participant (situated outside Asia), whereby GLG would produce and supply LHG extracts (such as mogroside V, the primary zero-calorie ingredient conveying sweetness in this plant). Since this signing, GLG has completed modifications to its Runhai processing facility to enable the production of LHG extracts. It estimates that it now has LHG processing capacity at Runhai of up to 130Mt per year, which at current market prices (pricing for 50% mogroside V extracts is about US$350-400/kg) could reflect up to US$50m in peak annual revenue. GLG expects to have produced its first 10Mt of LHG extract by YE14. Exhibit 2: GLG s Luo Han Guo Runhai processing facility Source: Company documents The customer is currently testing production batches and GLG expects to commence recording LHG revenue in Q414. It expects total revenues from this initial customer contract to be in the range of US$9-12m (given current market pricing), with the bulk of revenue from the arrangement recognised in H115. GLG announced on 10 December 2014 that the US FDA issued a no-objection letter for the Generally Recognized as Safe (GRAS) status of GLG s LHG extracts. This favourable response helps reassure prospective food and beverage (F&B) industry customers of the safety of GLG s LHG extracts and can thus support GLG s sales initiatives for LHG products. Industry pricing may be picking up, potential margin boost GLG indicates that market pricing for stevia extracts has increased in recent weeks by up to 20-25%, and pricing for high-purity RebA (HPRA) extracts is currently in the range of $125-150/kg, up from the $100-125/kg range we estimate it held for most of the past 12 months. This pricing increase suggests that stevia industry overcapacity from 2011-12 (during which HPRA extract pricing fell below $100/kg at times, from c $200/kg in 2010) is abating, given that many smaller China-based stevia producers have since exited the business and that stevia demand and utilisation continues to grow worldwide (according to research firms Mintel and Zenith International). GLG Life Tech 12 December 2014 3
If sustained, stronger extract pricing should benefit GLG s margins in 2015 (the majority of product to be shipped in Q414 was negotiated at earlier prices). Given GLG s potential cost and yield advantages with its H3 leaf (compared to more conventional stevia leaf strains), it may be able to take advantage of this price increase and sell its extracts at a mild discount to gain market share and improve capacity utilisation, while still maintaining a positive margin. Given the yield advantages of H3, GLG plans to have a higher amount of stevia extract available for sale in 2015 vs 2014. However, given the seasonal nature of GLG s leaf procurement activities (GLG purchases harvested stevia leaves in the late summer months and the fall), it needs to anticipate future stevia demand carefully; purchasing excess leaf in the past led to excess inventory and related carrying costs and eventual write-downs. Equally, purchasing insufficient leaf quantities in a rising price environment could pose a missed opportunity for the firm. Altogether, compared to leaf harvested in H213 (which forms the bulk of current inventory being sold), a much higher proportion of leaf procured in H214 is higher-yielding (H3) leaf, so GLG s cost competitiveness could be more pronounced in 2015. GLG develops proprietary leaf with 600% higher RebC content GLG announced on 9 December 2014 that it has developed and patented a proprietary strain of stevia leaf (Huiniong 6, or H6) which has 600% higher quantities of Rebaudioside C (RebC) compared to conventional stevia leaf. Conventional stevia leaf has RebC concentrations of around 1%, and GLG's H6 strain contains RebC concentrations nearing 7%. GLG expects to produce limited quantities of H6 leaf (primarily for customer sampling purposes) in 2015, but plans to produce much commercial quantities of H6 on a much wider scale in 2016 and beyond. While GLG expects that RebC would have a better taste profile than RebA (high sweetness with less bitter aftertaste), RebC s historically minute concentrations in conventional stevia leaf, combined with the high processing required to purify them to sufficient levels, made this extract generally cost-prohibitive for F&B industry applications. However, the H6 leaf, which contains much higher quantities of RebC, would require less leaf processing to deliver extracts of sufficient purity. GLG expects that RebC COGS could be up to 6-7x lower with H6 compared to its earlier leaf generations (eg H2 or H3). The firm estimates that it will be the only large-scale agriculture-based stevia producer and processor that will have the capability to produce RebC extracts at a cost comparable to RebA extracts. RebC s potentially superior taste profile can potentially add a differentiated new growth avenue for GLG s stevia business in 2016 and beyond. Debt situation stable; facility divestiture could be on the table On 30 September 2014, GLG had C$87.2m of net debt (gross debt of C$90.5m offset by cash and equivalents of C$3.2m), with C$51.4m due within 12 months. C$60.5m of GLG s debt was owed to Chinese government-affiliated banks and C$18.8m is owed to related parties (GLG chairman and CEO Dr Zhang had lent C$13.2m to the company as of 30 September 2014 bearing interest at China s 10-year benchmark government bond rate plus 11% pa). The debt calculations also include a C$7.0m interest payable liability, a C$0.7m loan from a private lender and C$3.4m in convertible notes. Subsequent to quarter end, the holder of the convertible debt converted this liability into 4.295m common shares. According to GLG, its C$60.5m external debt due to Chinese government-affiliated banks is secured by its four primary extract-processing facilities (Runhai, Runyang, Runde and Runhao) and their recoverable values, as recorded under the Chinese lender agreements, exceed this outstanding debt by a ratio of about 2:1. Given the value of the assets secured against the debt, GLG is confident its lenders will continue to renew the loans as needed. Nonetheless, the company is also reviewing its current capacity needs and may consider divesting one of its two currently idle facilities to reduce debt given that its newer-generation leaf has higher RebA content (thereby GLG Life Tech 12 December 2014 4
decreasing the amount of processing capacity needed to produce a given amount of commercial extract). We estimate the sale of one of the idle facilities could generate between C$10-20m in funds for the firm. Financials and valuation Given lower than expected Q314 stevia revenue, we have lowered our near- to medium-term stevia extract volume estimates (Q414 through 2017) to adopt more conservative growth assumptions. However, we have also raised the average stevia extract pricing forecasts in our model to take account of the recent uptick in market pricing. We have not yet made any specific forecasts for the RebC opportunity through H6 leaf, although we believe that this differentiated product offering adds support to the growth assumptions we employ in our model. As GLG s marketed stevia extracts and blends vary in price and composition, we continue to model GLG s stevia extract revenues as a blend of average stevia extract (ASE), which reflects a blended average of the stevia extract sold by the firm. We model GLG s ASE realised price as 70% of the market price of HPRA. We previously assumed an average HPRA price of ~US$118/kg for 2015, and are now raising this to US$130/kg. We previously forecasted ASE sales volumes of 1,630Mt in 2015 and 2,081Mt in 2016 and we now project volumes 1,420Mt and 1,736Mt, respectively. We present our new stevia revenue assumptions in Exhibit 2 below. Exhibit 3: Changes to stevia revenue assumptions for GLG Year-end Dec-31 2015e Old 2015e new 2016e Old 2016e New 2017e Old 2017e New High-purity RebA price (US$/kg, yearly average) 118.12 130.00 126.98 139.75 136.50 150.24 Average stevia extract (ASE) price for GLG (US$/kg) 82.68 91.00 88.88 97.83 94.68 105.17 ASE volumes sold by GLG (MT) 1,631 1,420 2,081 1,736 2,544 2,164 Stevia extract revenue (US$) 33,742 32,352 46,272 42,529 60,797 56,983 Stevia extract revenue (C$) 36,778 36,881 50,437 48,484 66,268 64,960 Source: Edison Investment Research The recent depreciation of the Canadian dollar (from C$1.09/US$ in our previous estimates to C$1.14/US$) also benefits the firm s valuation, given that its customer revenues are mostly denominated in US dollars. While we are not revising our existing LHG forecasts in US dollar terms, our modelled LHG revenue in Canadian dollar terms increases as a result of currency revaluation. Our new 2014 estimates anticipate C$2.0m lower EBITDA than previously, which is primarily due to Q314 EBITDA falling C$1.9m below our previous forecasts. We anticipate that Q414 results will show a meaningful sequential improvement, as we assume GLG should begin recording LHG extract revenue (and our 2014 forecasts depend on this realisation). We forecast that GLG s margins will begin to improve significantly in 2015 as the H3 leaf strain makes up the majority of its leaf supply for processing. We continue to assume GLG will return to generating consistently positive EBITDA in early 2016. While we have lowered our stevia volume forecasts, we have not negatively revised our margin assumptions as we anticipate that any negative impacts on profitability from the loss of scale or utilisation efficiency are compensated by higher stevia pricing. Further, while our medium-term revenue (2015-17) forecasts have decreased, our longer-term projections (2018 and beyond) are slightly raised as we have not lowered our stevia extract volumes in these periods as materially (while raising our stevia pricing assumptions). GLG Life Tech 12 December 2014 5
Exhibit 4: Changes to forecasts (2014-16e) Year-end Dec-31 (C$000) Q414e new 2014e old 2014e new 2015e old 2015e new 2016e old 2016e new Revenue Stevia extract revenue 5,573 22,242 17,770 36,778 36,881 50,437 48,484 LHG and other revenue 2,385 2,924 2,635 14,739 15,304 16,966 17,509 Total corporate revenue 7,958 25,166 20,405 51,517 52,185 67,403 65,993 Expenses Cost of sales (7,401) (22,103) (18,993) (45,016) (45,594) (54,919) (53,762) Gross profit 557 3,063 1,412 6,501 6,591 12,484 12,231 Net R&D costs - - - - - - - G&A expense (excluding D&A) (1,850) (7,719) (8,076) (7,496) (7,860) (7,646) (8,018) EBITDA (1,293) (4,656) (6,665) (994) (1,270) 4,838 4,214 Depreciation & Amortiz. (555) (3,343) (3,995) (1,930) (2,184) (1,872) (2,143) Operating income (loss) before exceptionals (1,848) (7,999) (10,660) (2,924) (3,454) 2,967 2,071 Net interest income (expense) (1,962) (7,425) (7,380) (8,106) (8,274) (8,396) (8,914) Foreign exchange gain (loss) - 80 (583) - - - - Financial and other income (loss) - 356 273 - - - - Earnings (loss) before tax (3,811) (14,988) (18,350) (11,030) (11,728) (5,429) (6,843) Taxes - (32) (34) - - - - Net income (loss) (3,811) (15,020) (18,383) (11,030) (11,728) (5,429) (6,843) Net EPS (normalised, fully diluted) ($0.10) ($0.46) ($0.52) ($0.31) ($0.30) ($0.14) ($0.16) Source: Edison Investment Research We value GLG using a net present value (NPV) analysis. We use a weighted average cost of capital (WACC) of 10%, given a cost of equity of 12.5% and GLG s capital structure, which is weighted to debt at 90% given current market values (and its average cost of debt is estimated at 9.0%). Exhibit 5: Revenue and gross margin forecasts for GLG (C$000s) Year 2014e 2015e 2016e 2017e 2018e Stevia extract revenue 17,770 36,881 48,484 64,960 78,640 LHG and other revenue 2,635 15,304 17,509 18,330 19,933 Total revenue 20,405 52,185 65,993 83,290 98,573 Gross profit 1,412 6,591 12,231 16,658 19,715 Gross margin 6.9% 12.6% 18.5% 20.0% 20.0% EBITDA (6,665) (1,270) 4,214 8,480 11,373 EBITDA margin N/A N/A 6.4% 10.2% 11.6% Source: Edison Investment Research Given our revenue assumption changes, we obtain a total NPV for GLG of C$143.2m (vs C$144.2m, previously). Net of Q414 estimated net debt of C$83.7m (net debt expected to decline from Q314 due to the removal of the C$3.4m convertible note), this provides an equity valuation of C$59.5m, or C$1.58 per share. The lower per-share valuation than previously (C$1.87 per share) is primarily due to the addition of 4.296m shares (reflecting a 12.8% increase in share count) from the debt conversion. GLG Life Tech 12 December 2014 6
Exhibit 6: Financial summary C$(000) 2012 2013 2014e 2015e 2016e 31-December IFRS IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 21,709 16,022 20,405 52,185 65,993 Cost of Sales (26,958) (17,724) (18,993) (45,594) (53,762) Gross Profit (5,250) (1,702) 1,412 6,591 12,231 General & Administrative (10,229) (8,425) (8,076) (7,860) (8,018) EBITDA (15,479) (10,127) (6,665) (1,270) 4,214 Operating Profit (before exceptionals) (17,389) (14,483) (10,660) (3,454) 2,071 Exceptionals (10,436) (8,096) (310) 0 0 Other 0 3,378 0 0 0 Operating Profit (27,825) (19,200) (10,970) (3,454) 2,071 Net Interest (6,913) (7,181) (7,380) (8,274) (8,914) Profit Before Tax (norm) (24,301) (21,664) (18,039) (11,728) (6,843) Profit Before Tax (FRS 3) (34,738) (26,382) (18,350) (11,728) (6,843) Tax (83) (49) (34) 0 0 Minority interests (4,856) 3,378 0 0 0 Profit After Tax and minority interests (norm) (29,240) (18,335) (18,073) (11,728) (6,843) Profit After Tax and minority interests (FRS 3) (39,676) (23,052) (18,383) (11,728) (6,843) Average Number of Shares Outstanding (m) 32.9 33.4 34.5 39.4 41.6 EPS - normalised (C$) (0.89) (0.55) (0.52) (0.30) (0.16) EPS - normalised and fully diluted (C$) (0.89) (0.55) (0.52) (0.30) (0.16) EPS - (IFRS) (C$) (1.21) (0.69) (0.53) (0.30) (0.16) Dividend per share (C$) 0.0 0.0 0.0 0.0 0.0 BALANCE SHEET Fixed Assets 50,225 55,012 55,644 54,571 53,651 Intangible Assets 0 0 0 0 0 Tangible Assets 50,225 55,012 55,644 54,571 53,651 Current Assets 52,840 32,784 24,896 33,836 49,896 Cash 3,582 5,133 3,363 3,614 14,390 Other 49,258 27,651 21,533 30,221 35,505 Current Liabilities (86,694) (62,229) (80,443) (83,741) (94,401) Creditors (26,811) (21,566) (28,321) (31,619) (42,279) Short term borrowings (59,883) (40,663) (52,122) (52,122) (52,122) Long Term Liabilities (8,683) (38,935) (26,881) (41,881) (51,881) Long term borrowings* (8,673) (35,755) (26,881) (41,881) (51,881) Other long term liabilities (10) (3,179) 0 0 0 Net Assets 7,688 (13,367) (26,784) (37,216) (42,736) CASH FLOW Operating Cash Flow 8,865 8,396 7,668 (5,362) 10,913 Net Interest (6,913) (7,181) (7,380) (8,274) (8,914) Tax 0 0 0 0 0 Capex (568) (81) (857) (1,112) (1,223) Acquisitions/disposals 0 0 0 0 0 Financing 0 0 0 0 0 Net Cash Flow 1,384 1,134 (568) (14,748) 776 Opening net debt/(cash) 66,087 64,974 71,285 75,641 90,389 HP finance leases initiated 0 0 0 0 0 Other** (271) (7,445) (3,787) 0 0 Closing net debt/(cash) 64,974 71,285 75,641 90,389 89,613 Source: Edison Investment Research, GLG accounts; Note: *Convertible notes (valued at C$3.2m in 2013) and related-party liabilities (valued at C$17.8m in 2014 and C$15.9m in 2013) are included as part of long-term borrowings. **Includes effects due to revaluations of assets (eg inventory, doubtful accounts) and liabilities. GLG Life Tech 12 December 2014 7
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Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE s express written consent. Frankfurt +49 (0)69 78 8076 960 GLG Schumannstrasse Life Tech 34b 12 December 280 High 2014 Holborn 245 Park Avenue, 39th Floor Level 25, Aurora Place Level 15, 171 Featherston St 8 60325 Frankfurt Germany London +44 (0)20 3077 5700 London, WC1V 7EE United Kingdom New York +1 646 653 7026 10167, New York US Sydney +61 (0)2 9258 1161 88 Phillip St, Sydney NSW 2000, Australia Wellington +64 (0)48 948 555 Wellington 6011 New Zealand