Of course, you still have to make a call that the bull-run in the company’s shares is not over. But that’s the benefit of carrying out extensive equity analysis in the first place to ascertain a pre-determined entry point where the valuation you are paying for your stake in a company provides enough upside potential to compensate for the risk being taken on. Clearly, when both the technical indicators and the fundamentals point to a positive outcome, the investment risk is lower than when they are diverging.
So, with this thought in mind, I have noted an interesting share price movement in another one of my 2013 Bargain shares, Trifast (TRI: 78.5p), a leading global manufacturer and distributor of industrial fastenings.
A look at the company’s share price chart reveals that in the past 13 months, the price has bounced off its rising 200-day moving average no fewer than three times. In each case, the 14-day RSI had a reading around 40. On each occasion the share price upmove has been substantial. For instance, Trifast’s share price surged by 70 per cent between the end of July and mid-November when it hit a five-year high of 90p. That multi-year high was significant too, because it coincided with the bull market high and a major top dating back to 2007. There was always going to be some price resistance in this area, especially since the 14-day RSI was overbought too.
The good news is that Trifast’s share price has unwound its overbought position by moving sideways, rather than selling off strongly. More often than not this is a signal that the sideways move represents a consolidation period during an uptrend, rather than the formation of a major top. As I noted in my article yesterday when I covered financial services company Fairpoint (FRP: 133p), the best time to buy is when the rising 200-day moving average catches up with the share price, and when the 14-day RSI is oversold. This is the case with Trifast whose long-term trend line is around 72p and the 14-day RSI has fallen back once again to around 40, a level from which every other major rally has started from in the past 13 months.
So from a technical perspective, I feel that the consolidation period could be coming to an end, confirmation of which would be provided if Trifast’s share price breaks above January’s highs at 85p to signal a point-and-figure and swing-buy signal. It’s one I expect to happen and feel buying now is a sensible move given there is potentially 25 per cent share price upside to my long-term target price of 100p. It’s also one fully supported by the fundamental investment case.
Bumper profit growth
Trifast may be a stock market minnow, but it is one that has gone global, operating from 23 locations in 16 countries across Europe, Asia and North America. It’s a sizeable operation too, employing 1,000 staff and delivering 150 million components a day to meet demand from its large, multi-site, blue-chip customer base.
Products supplied include machine and tapping screws, automotive fasteners, self-clinching fasteners and micro screws. These are supplied to a range of industries including consumer electronics, medical equipment, domestic appliances and cash dispensers. Clients include Dell, Honeywell, Hewlett Packard, BAE Systems and Black & Decker. Around one third of revenues come from the automotive sector and this is usually on a per model basis. Given the longevity of car manufacturers’ models, this provides visibility of earnings as does Trifast’s focus on quality. In fact, the company boasts zero defects on its Hitachi contract in recent years. That’s pretty impressive considering the company has supplied over one billion parts.
It’s proving increasingly profitable too. That’s because having streamlined its operations, Trifast's management is discerning about the level of profit margins on the business it takes on; older contracts are either renegotiated upwards or simply 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. As a result when the company releases a pre-close trading update next month in advance of full-year results in June, expect upbeat news on margins, revenues and profits. Realistically this could lead to analyst upgrades.
Potential for earnings enhancing acquisitions and upgrades
In the first half to end September, Trifast’s operating margins surged almost one percentage point to 7.45 per cent and, with the benefit of a near 7 per cent rise in revenues to £65m, this helped drive operating profits up by over 20 per cent to £4.86m. For the full-year analysts at Arden predict revenues of £127m, up from £121.5m in fiscal 2013.
Moreover, the brokerage’s full-year operating profit estimate of £9.2m, up from £8m in fiscal 2013, factors in margins of only 7.2 per cent. So assuming operating margins have been maintained in the second half, or even increased, then operating profits would come in nearer £9.5m. Interestingly, in fiscal 2008, before the financial crisis and global recession, Trifast enjoyed margins of 8.1 per cent, so there is ample scope to boost them further driven by cost savings and top-line growth.
There is potential for earnings enhancing acquisitions too given that Trifast had slashed net debt to £3.55m at the end of September, or a miniscule 6 per cent of shareholders funds. Analysts at Arden Partners predict that net borrowings may be as low as £1m at the March 2014 year-end, down from £5.2m at the same stage last year. Trifast has total credit facilities of £23m, on which it pays interest at just 3 per cent per year, so not only has massive headroom, but also the scope to make value enhancing bolt-on acquisitions. Arden estimate the company has headroom of £10m plus above its working capital requirements to fund a deal.
Furthermore, with cash generation robust, analysts at Arden now expect the full-year payout to be lifted by 75 per cent to 1.4p a share, implying a prospective yield of 1.8 per cent. It could be more given that net borrowings have been almost wiped out and conservative adjusted EPS forecasts of 5.53p cover that payout more than four times over. Arden’s respective estimates for fiscal 2015 are for EPS of 5.8p and a payout of 1.6p. On this basis, the prospective PE ratio is 13.6 and the forward yield is 2 per cent.
But even those predictions look low ball once you factor in the ongoing strong recovery in the company’s Asian business. Buoyed by a number of contract wins, I expect this unit to report a headline grabbing double digit operating margin and profits as high, or potentially greater, than those of the UK business.
Anomalous valuation relative to peers
It’s worth noting too that with Trifast’s balance sheet lowly geared and the business in an earnings upgrade cycle, the company could end up being a target itself. An enterprise value (market capitalisation plus net debt) of £87m is too low for a business forecast to generate cash profits of almost £11m in the current year to end March 2014. To put this into some perspective, in the small-cap engineering sector, the shares are rated on a 33 per cent discount to the likes of Carclo (12 times cash profits to enterprise value); 20 per cent below the rating of Ricardo (RCDO), Renold (RNO) and Gooch & Housego (around 10 times); and almost half the rating of the highest rated company Halma (HLMA). Even if Trifast was only rated at the sector average rating of 9.4 times, this would imply a share price of 93p.
But with earnings per share growing at double digits - 24 per cent growth in fiscal 2013, and around 19 per cent forecast for the financial year to March 2014 - there is a case to be made that the shares should be rated well above the sector average given that half the company’s sales are generated from outside the UK, and thus exposed to global growth rates, in particular in the automotive and electronic markets.
In the circumstances, and with a real possibility of earnings upgrades at next month’s pre-close trading update, I am very comfortable with my 100p fair value target price. Trading on a bid offer spread of 77p to 78.5p, the shares are well worth buying.
Please note that I have published another column today: A high yield emerging market play. I am still working my way through a large number of announcements from companies on my watchlist. These include: LMS Capital (LMS), BP Marsh Partners (BPM), Eros (NYSE: EROS), First Property (FPO), Trading Emissions (TRE), Polo Resources (POL) and Cairn Energy (CNE). My next column will appear tomorrow morning.
