Pioneering Technologies: Part 4

• Parts 1 through 3 reviewed recent activity, solvency and risk, and future potential.
• In Part 3, we determined that regulation changes in 2019 could drive large sales.
• In Part 4, we show how increased sales will impact the company and share price.

We closed Part 3 of our review with the belief that regulation changes to coil top stoves in 2019 would create safety awareness, and in turn, could drive increased sales of the Smart Burner product. Given the very large size of the US market (43.8 MM rental households), we decided that only a small fraction, 274,000, or about 6/10 of 1%, might install a Smart Burner once the regulation change takes effect.

What’s the impact of sales of 274,000 units: Now that we have determined what we believe sales could look like in 2019 (post “regulation change”), we can relatively easily determine what the economic impact (on the company) will look like.
From publicly available information, we can see that the Smart Burner sells for anywhere between $190.77 US and $221.99 US, as per information from both the Staples Supply and Interline Wilmar websites (below):

 

Source: https://www.staples.com/Smart Burner/directory_Smart Burner

Source: https://www.wilmar.com/Search?keywords=Smart Burner&filterByCustomizedProductOffering=False&previouslyOrdered=False

These prices are not reflective of what Pioneering might be receiving, as both Staples, Wilmar, and HD supply act as distributors. Therefore, this leaves us with an unknown: we know how much the distributor receives when the consumer buys a Smart Burner, but we do not know how much Pioneering is receiving from the distributors. However, we do know that the distributors apply their own mark up. If we can make a reasonable estimate as to how much distributors typically mark up an item, then we can effectively determine how much they are paying when they purchase it from Pioneering.

While I am no “supply chain” expert, some web research provides us with the following information:
“The average wholesale or distributor markup is 20%, although some go as high as 40%.”

Source: https://www.pros.com/blog/distributor-pricing-profit-margins-pricing-markups/

This is validated via another source, as shown below:

Source: http://www.tom-gray.com/2012/04/26/reasonable-markup-to-distributors/

Both of these data sources suggest that the distributor markup could be anywhere in the range of 20% to 40%. With this data in hand, we can then calculate what the revenue stream to Pioneering would be, using these ranges as bookends. With this information, we can extrapolate what the sale of 274,000 units could look like, under the following assumptions:

• We are only calculating sales of Smart Burners in the US market. Sales in the Canadian market would be incremental to this analysis.
• We are not attributing any value to any other Pioneering products, nor are we attributing any value to the partnership Pioneering has with Innohome.
• We use the lowest price we could find, $190.77 US.
• We assume that COGS (& gross margin) will come in at 50%.
• Because Pioneering is domiciled in Canada, we convert gross margin from US$ to CAD$.
• We use a conservative FX rate of $0.90 US$ = $1.00 CAD$. This is the weakest US$/CAD$ FX rate over the last 5 years, and the average FX rate (2014 to June 2018) has been approximately 0.80. A stronger US$ would improve these results.
• We apply the FX rate directly to the US$ gross margin, rather than attempting to model how the accounting for FX gains or losses would appear on the income statement. We realize that actual accounting gains/losses would be realized via currency hedging, etc.
• After converting gross margin to CAD$, we continue to use CAD$ for the rest of the analysis, as Pioneering G&A costs are denominated in CAD$.
• We assume G&A increases significantly, coming in at an annual amount of $12 MM CAD, double the current G&A costs which are forecast at ~ $6.0 MM CAD for fiscal 2018.
• We ignore non-cash charges such as DD&A, as they are not material (~ $30,000 CAD$ for fiscal 2017).
• We assume a corporate tax rate of 25%.
• We use the total diluted shares outstanding.

The outcomes of a sales volume of 274,000 Smart Burners under various distributor mark up percentages is shown below:

When we began this analysis, our thesis statement was that this was “a sales story”, and the key was whether or not Pioneering could increase sales. We believe that with pending regulation coming into effect in 2019, sales are likely to increase, and in doing so, will drive the profitability (and share price) of Pioneering. This being the case, we believe that todays share price weakness is a significant opportunity for those investors that are risk tolerant and have a longer time horizon.
Disclosure: The author of this analysis holds a long position in PTE. The author has received no compensation from Pioneering Technologies for the writing of this analysis.