DuluxGroup Limited (ASX: DLX) faces an interesting conundrum; it has grown so much in recent years that demand for its product has outstripped the potential for its production and distribution facilities to make it.
More specifically, the group notes that “it is increasingly difficult and expensive to further invest in modern, waterbased production capability at an old operating site” (referring to the Rocklea production site which is over 50 years old).
With this in mind, management has announced construction of new production facilities in Melbourne and a new distribution centre in Sydney.
The factory in Rocklea will continue to produce solvent-based paints like Dulux Super Enamel and some woodcare products, while Melbourne will handle all water-based products going forwards.
The major item of concern for shareholders will be the cost of the projects, which is high.
$165 million has been allocated for the construction of the new facility, and provisions worth $17 million total have been set aside for redundancies at the old production and distribution sites.
This is compared to Dulux’s profit after tax figure of ~$104m in the most recent final results, and management has announced its intention to maintain its dividend payout ratio while the new projects are completed.
The capital expenditure for the projects (over and above Dulux’s base $30m capital spend per annum) will be spread out over the next three years:
- $25m in Financial Year (FY) 2015 – the current financial year
- $50m in FY2016
- $55m in FY2017
Both projects are expected to be fully operational by FY2019.
Readers will note that these figures don’t add up to $165m – that is because Dulux is also expecting to net approximately ~$30 million from the sale of its Glen Waverley site in coming years.
In management’s ‘base case’ scenario (excluding any revenue increase and assuming a base level of cost savings), the developments are expected to deliver Net Positive Value (NPV) to the company.
Once both projects are operational, they are also expected to contribute operating cost savings that more than outweigh the expected depreciation on the assets of $5 million per annum.
In addition to this, the developments are expected to have a neutral Net Profit After Tax (NPAT) in 2019 – the first year of operation – but should deliver positive benefits from then on.
There is also a secondary benefit of Dulux vacating a distribution site next to its Selleys production facilities, which leaves that land free for future opportunities.
While the news may be a bit much for Dulux shareholders to swallow in one hit – especially given the high cost of the development – it is a fantastic investment in the company’s long-term future.
Seemingly heavy costs now will pay dividends for decades, in addition to saving the company money when compared to a ‘do nothing’ scenario.
If you’re a long-term Dulux shareholder or awaiting your chance to become one, there’s nothing here that should dissuade you from that ambition.
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Motley Fool contributor Sean O'Neill doesn't own shares in any company mentioned.