In the current bull market, this has happened repeatedly as a number of the shares I have recommended have soared past my targets. In the case of Trifast (TRI: 74p), a nuts-and-bolts specialist, the shares have now risen above my 71p target. Moreover, from both a technical and fundamental perspective I can see little reason at all why the price is going to peak out here especially as I expect Trifast to report a bumper set of half-year results on Tuesday, 12 November.
To recap, the company is a leading global manufacturer and distributor of industrial fastenings, employing over 1,000 staff around the world. It's a highly competitive market to be in, so to stay ahead of the game and keep the cost base low, Trifast operates from six low-cost manufacturing sites in Asia and has a logistics network in 23 locations in 16 countries across the UK, Europe and US and Asia.
Disciplined approach to profitability
Having streamlined the operations, Trifast's management is far more discerning about the level of profit margins on the business it takes on; older contracts are renegotiated upwards or withdrawn. Better sourcing from suppliers has led to improved pricing, quality and lead times, while product innovation has enhanced the offering and helped the company win new contracts. In turn, this is pushing up profits even on modest sales growth.
For example, in the financial year to the end of March, the company increased revenues by 8 per cent to £121m, but with the benefit of cost savings and higher-margin contract wins, operating profits shot up by a third to £7.2m. Underlying EPS increased by over a quarter to 4.73p and with cash generation strong - cash flow from operations increased sharply from £4.4m to £7.9m - this enabled the board to lift the dividend by 60 per cent to 0.8p a share.
The company can certainly afford to be generous with the payout as it only accounted for £868,000 of the operating cash inflow and still had a further £3.2m spare to pay down borrowings from £8.4m to £5.2m. As a result the balance sheet is very lowly geared. In fact, net debt is less than 9 per cent of shareholders funds of £60m and should have fallen even more by the end of September. This also means that with the dividend covered over six times by earnings, there is ample scope to lift the payout sharply again - analysts are looking for a 25 per cent hike in the payout to 1p a share, rising to 1.2p a share the year after. This implies a prospective yield of 1.4 per cent, rising to 1.6 per cent.
International focus driving growth
Trifast’s international focus is paying dividends too. Sales in Europe have benefited from the ongoing recovery in the automotive industry, in particular in Norway and Sweden. The auto sector accounts for around half of the fasteners in the world, but importantly the company has very low exposure to European original equipment manufacturers (OEM) suffering from volume pressure.
In total 60 per cent of profits are now generated outside the UK, half of which comes from Asian manufacturing operations. Trading in the region has been underpinned by buoyant sales to the electronic sector, a trend that was apparent when Trifast released a trading update in August and I anticipate a further positive update on these operations when the company updates investors in three weeks time.
How Simon Thompson's 2013 Bargain Shares Portfolio has performed
| Company | TIDM | Opening offer price on 8 February 2013 | Bid price on 21 October | Dividends paid (p) | Total return (%) |
|---|---|---|---|---|---|
| Inland Homes | INL | 23.5 | 47 | 0 | 100.0% |
| Terrace Hill | THG | 15.4 | 27.5 | 0 | 78.6% |
| Randall & Quilter (see note one) | RQIH | 113.3 | 165 | 8.40 | 53.0% |
| Trifast (see note four) | TRI | 51.9 | 72.75 | 0.80 | 41.7% |
| Fairpoint (see note two) | FRP | 98.25 | 124 | 5.70 | 32.0% |
| Noble Investments (see note three) | NBL | 199.4 | 250 | 2.50 | 26.6% |
| Oakley Capital Investments | OCL | 139.7 | 169 | 0 | 21.0% |
| Cairn Energy | CNE | 287.2 | 285.5 | 0 | -0.6% |
| Polo Resources | POL | 24.53 | 24 | 0 | -2.2% |
| Heritage Oil | HOIL | 202.3 | 193.25 | 0 | -4.5% |
| Average | 34.6% | ||||
| FTSE All-Share | 3275 | 3542 | 10.4% | ||
| FTSE Small Cap | 3659 | 4321 | 19.4% | ||
| FTSE Aim index | 742 | 801 | 7.7% | ||
1. Randall & Quilter returned 5p a share on 3 May 2013 to shareholders through the issue of L and M shares and proposes a return of 3.4p a share through the issue of N and O shares on 28 October (ex-div: 16 October). 2. Fairpoint paid a final dividend of 3.55p a share on 20 June and an interim dividend of 2.15p on 25 October (ex-div: 2 October). 3. Noble Investments paid a dividend of 2.5p a share on 19 July. 4. Trifast paid a final dividend of 0.8p a share on 18 October (ex-div: 3 July). Note: Latest prices taken at 11am on Monday 21 October 2013 | |||||
Margin improvement and earnings momentum
We can also expect good news on the margins Trifast earns on its contracts. That’s because as lower-margin legacy contracts are replaced with much more profitable contract wins, this boosts margins markedly
Ahead of the half-year figures, analysts at Arden Partners estimate that margins will rise from 6.5 per cent to 6.9 per cent in the financial year to March 2014, having already been lifted from 4.8 per cent in the 12 months to March 2013. So, once you factor in a modest 4 per cent rise in revenues to £126m, the improved profitability is forecast to drive pre-tax profits up over 11 per cent to £8m.
On this basis, underlying EPS increases to 5.2p, which means the shares are only trading on a prospective PE ratio of 14. That’s still a discount to other component distribution companies and a wide discount to trade valuations of fastener manufacturers and distributors, based on recent merger and acquisition activity in the sector.
Also, the fact that Trifast has such low borrowings makes the company appear more highly valued that it actually is. In fact, I estimate the shares are only trading on a modest enterprise value (market value plus net debt) to cash profit multiple of eight times in the current financial year. The company’s low debt level also mitigates financial risk, so we can benefit from the operational gearing of the business without worrying about the ability of the company to service its borrowings.
It’s worth pointing out too that the relatively attractive valuation of Trifast, coupled with the earnings recovery story, could easily prompt an opportunistic bid for the company. That’s because the shares are only being valued on just 1.25 times book value, an anomalous valuation for a company forecast to grow earnings per share by 17 per cent between March 2013 and 2015.
Positive technical set-up
The share price action is also very supportive of further upside. The shares are currently riding a six-year high and have just taken out the September high of 71p. This is an important buy signal as there is very little technical resistance on the charts until the price hits a major resistance level around 90p, dating back to the period between December 2006 and June 2007.
For good measure, the moving average convergence/divergence (MACD) is on the verge of issuing a buy signal and the 14-day RSI has a reading just above 60 so is not overbought, thus allowing scope for further upside in the current rally. From a technical perspective, no matter which way I look at it Trifast shares are a buy.
Attractive valuation
Having reassessed the investment case, a share price around 90p is a far more realistic valuation. Even then, the shares would still only be rated on 1.5 times March 2014 book value and on 9.5 times cash profits. Trading on a bid offer spread of 72.75p to 74p, I continue to rate the shares a value buy offering 21 per cent upside to my newly upgraded target price.
Finally, as a pre-Christmas offer exclusive to Investors Chronicle readers, all telephone orders placed with YPDBooks for my new book Stock Picking for Profit will receive complimentary postage and packaging. This offer is strictly for a limited period, is subject to stock availability and applies to only telephone orders placed until Friday 15 November 2013.
Please note the book is only being sold through YPDBooks and no other source. Full details of the content of the book is available online at www.ypdbooks.com. If you would like to take advantage of this offer, please contact YPDBooks on 01904 431 213 and quote reference ‘ICOFFER’. The book is priced at £14.99. Internet orders will continue to incur the normal postage and packaging cost of £2.75. I have also published an article outlining the content of the book: 'Secrets to successful stock picking'. The book also includes a dedicated chapter on how I select my annual Bargain shares with case study analysis.
MORE FROM SIMON THOMPSON ONLINE...
Finally, in the past fortnight, I have published 12 other articles on the following 18 companies or trading strategies:
■ Inland ('Property plays with foundations, 7 Oct 2013)
■ Terrace Hill ('Property plays with foundations, 7 Oct 2013)
■ Sanderson ('A smart tech share', 9 Oct 2013)
■ Pure Wafer ('Time to chip in', 10 Oct 2013)
■ US debt ceiling deadline looms ('Debt ceiling dilemma', 11 Oct 2013)
■ Air Partner ('Gaining altitude', 14 Oct 2013)
■ Polo Resources ('Targeting special situations', 14 Oct 2013)
■ Greenko ('Targeting special situations', 14 Oct 2013)
■ Randall & Quilter ('Bargain shares flying', 15 Oct 2013)
■ Oakley Capital Investments ('Bargain shares flying', 15 Oct 2013)
■ Marwyn Value Investors ('Exploiting an arbitrage opportunity', 16 Oct 2013).
■ Entertainment One ('Exploiting an arbitrage opportunity', 16 Oct 2013).
■ NetPlay TV ('Punting on new highs', 16 Oct 2013)
■ Global Energy Development ('Pay dirt beckons', 17 Oct 2013)
■ Bezant Resources ('Binary bet', 17 October 2013)
■ Cairn Energy ('Bargain shares update', 21 October 2013)
■ Noble Investments ('Bargain shares update', 21 October 2013)
■ Stanley Gibbons ('Bargain shares update', 21 October 2013)
