Each month Richard Beddard trawls through annual corporate results for his Watchlist and the Share Sleuth portfolio of companies that satisfy key valuation metrics such as earnings yield and return on capital – and profiles the most interesting candidates.
Alumasc (ALU): Profits on a roll
Despite the higher costs of imported raw materials, Alumasc reported double-digit revenue and profit growth in 2017, fulfilling the building product supplier’s ambitions of growing revenue faster than the construction sector grows, and growing profit faster than revenue.
The company is a conglomeration of relatively small businesses that manufacture and source specialist products. Its UK market leading brands are Levolux, which makes solar shading, and Alumasc Rainwater, which makes aluminium guttering and downpipes. Gatic is also a market leader in access covers (for example, for manholes). Alumasc has substantial roofing and walling businesses, including Blackdown, which supplies living roofs planted with vegetation, and Timloc, a small but highly profitable business that supplies housebuilders.
The company is on a bit of a roll, having disposed of unrelated and sporadically loss-making engineering businesses, paid off most of its borrowings and lifted profitability to impressive levels. Return on operating capital was 26 per cent in the year to June 2017, a year in which it doubled export sales. They now account for 17 per cent of total revenue.
Alumasc’s focus on specialist products seems to be paying off . Often these products help buildings meet regulations, for example by saving energy and protecting the environment. Because they are on the exterior of buildings, they must also look good, which is another point of differentiation for Alumasc.
A share price of 174p values the enterprise at just over £90 million or 12 times adjusted profit. The earnings yield is 8 per cent.
However, while the earnings yield is attractive, investors should proceed with caution. Alumasc has a large deficit in its defined benefit pension scheme, which it’s plugging valiantly to the tune of £3.2 million a year. And the construction industry is notoriously cyclical. Although the spread of its businesses may afford some protection in a downturn, it would be reckless to assume it will always be this profitable.
Industry forecasts indicate modest growth for the year ahead, and the company expects to improve profit margins as the impact of the devaluation of the pound recedes, investments come on stream, and efficiency improves as production levels increase.
Finsbury Food (FIF): Baker’s big leap forward
Considering the devaluation of the pound, which increased the price of imported raw materials such as butter and sugar, and higher labour costs due to the national minimum wage, Finsbury Food probably did well to equal revenue and marginally lift profit in the year to July 2017.
Finsbury Food bakes cakes and bread, which it sells to supermarkets and, via distributors, to coffee shops, restaurants and canteens. As well as supplying supermarkets with their own brands, it differentiates itself by producing themed cakes under licence. During the year it renewed a longstanding agreement with Thorntons to manufacture and market bite sized cake treats, and launched a low-sugar Disney range and a range of cakes developed with Mary Berry. Cranks, Vogels, and Village Bakery lend their names to healthy loaves of bread.
Despite the brands and licences, Finsbury Food’s business model is mostly about efficiency, keeping costs down so it can keep its big customers happy with low prices. The company made a big leap forward in 2014 when it acquired Fletchers, which brought it new customers in the food-service industry and made it one of the UK’s biggest bakers. In subsequent years Finsbury Food has lifted capital expenditure to record levels, automating production lines and opening a new bread factory.
The investment is necessary to keep bearing down on costs, because baking is still fairly labour-intensive and further increases in the minimum wage are to come. Impressively, though, acquisitions and investment have not driven Finsbury Food to take on too much debt as it did during the financial crisis. Chief executive John Duffy, who was promoted to turn the company around 2009, is probably alive to the dangers.
In the year to July 2017 the company took another step to defend profitability, when it closed Grain d’Or, a loss-making pastry business it acquired with Fletchers in 2014. A share price of 107p values the enterprise at £195 million, about 13 times adjusted profit. Trading on an earnings yield of 8 per cent, the shares could well be good value.
Haynes (HYNS): Looking to digital future
An acquisition and the weak pound enabled Haynes Publishing to raise revenue and profit strongly in the year to May 2017. Haynes publishes famous and distinctive motor manuals, not just in the UK but also under other brand names in the USA and Australia.
Demand for motor manuals has been waning for many years, though. Cars are more complex these days, so more people rely on mechanics to maintain and service them. Hard-core DIY enthusiasts tend to swap information on the internet rather than using manuals. The heyday of the printed manual is over, which is why revenue and profit have fallen dramatically over the last decade.
Even in 2017, revenue in the US, Haynes’ biggest market, fell 18 per cent as major customers reduced stock. But the company have restructured, outsourcing production and distribution in the UK and the US, selling off offices, warehouses and equipment, and using the cash to fund investment in new products and acquisitions.
In the UK profit rose due to the launch of a new novelty range of manuals, Haynes Explains, which cashes in on the Haynes brand. Titles from the new imprint include ‘Marriage’, ‘Teenagers’, and ‘Pensioners’. In Europe, HaynesPro, a stable of products for car mechanics and parts suppliers, grew strongly and was augmented by the acquisition of OATS, a lubricants database. Haynes also launched Haynes OnDemand, short videos for DIY motor mechanics.
Whether OnDemand will be more successful than its previous consumer-oriented digital product, which served up whole manuals, remains to be seen. But HaynesPro is emerging from the shadow of the print business as a future growth engine. According to the company’s broker, HaynesPro profit margins have always been higher than print profit margins, and if current trends persist the day will soon come when digital is earning the bulk of revenue.
A share price of 200p values the enterprise at about £38 million or 14 times adjusted profit. The earnings yield is 7 per cent.
Courageous investors may look past Haynes’ considerable defined benefit pension deficit, to a time when the predominantly digital business is reaping the reward of the heavy investment it’s making now, but to make that leap of faith would be speculative.
Tristel (TSTL): Expertise driving growth
Despite a 19 per cent increase in revenue, Tristel’s results for the full year to June 2017 may have disappointed some shareholders. The company aims to achieve average annual revenue growth of 10-15 per cent over the three years to June 2019, excluding the eff ect of currency movements.
Last year the pound depreciated markedly against foreign currencies due to Brexit so, if we strip out the currency windfall from foreign earnings, revenue increased by 16 per cent, still at the top end of the range. During the year, though, the company acquired its Australian distributor, which also added to revenue; so although Tristel met its target, the businesses it operated at the start of the year grew only 7 per cent in constant currency terms.
While that’s a perfectly good result, Tristel is expected to do very well. A share price of 280p values the enterprise at £118 million or about 36 times adjusted profit. The earnings yield is just 3 per cent. Tristel makes and packages disinfectant, so it can be applied safely to simple medical instruments and surfaces. The company already supplies most of the disinfectant required by the National Health Service in its target markets, so its growth rate in the UK is modest. To meet its 10-15 per cent target it must grow faster abroad, where it already earns 47 per cent of revenue. Probably beyond its 2019 horizon lies the prospect of significant revenue from the giant US market, where Tristel is currently registering products.
If the revenue growth target is coming under question, Tristel is comfortably meeting another target, to maintain pre-tax profit margins at 17.5 per cent. Growing profit margins and capital turnover have contributed to a resurgence in return on capital since Tristel lost its position as the market-leading supplier of disinfectant for hospital washing machines earlier in the decade.
The decline in this business, which the company exited entirely, masked the growth of innovative new products that now form its core product range – wipes and foams that are applied by hand.
Tristel has two decades of expertise in manufacturing and product design, and over 200 patents. It seems likely it will continue to grow. How long it will take to grow into its current valuation is another question.
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