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Buy Avon Rubber on the bounce

Avon Rubber has just raised guidance, but its masks and dairy equipment are selling so well it may have to do so again.
April 10, 2014

Avon Rubber (AVON) makes lots of money selling high-tech rubber gas masks to the US military, but a pick-up in orders elsewhere at higher margins has created excitement in the Square Mile. Management will confirm "substantially" better first-half results at the end of April, and full-year adjusted operating profit is on track to hit the top end of City forecasts. And with demand rising, the earnings upgrades that followed may not be the last.

IC TIP: Buy at 610p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Predicts results at top end of forecasts
  • Earnings upgrades
  • Winning higher-margin work
  • Interim results on 30 April
Bear points
  • Defence spending under pressure
  • Dairy progress "modest"

Much of the growth is coming from South America, as revealed in Avon's previous update in February. Opposition to this summer's World Cup in Brazil has turned violent, and police and armed forces there are preparing for more trouble. "The phone rings every time there's a world event," chief executive Peter Slabbert tells us. "Be it Syria, Crimea, the World Cup or Olympics." Israel always gets nervous when Iran begins flexing its muscles, too.

A £4m US homeland security order, Avon's largest such individual deal, will be delivered through 2014, and US fire departments will likely begin buying Avon's new Deltair breathing apparatus. It's commercial work like this that explains last year's 25 per cent surge in sales at Avon's protection & defence division, which now makes up three-quarters of the business. A 170 basis-point increase in margin, driven by cost-cutting and lucrative non-US defence work, had underlying operating profit up by almost half to £11m.

Avon supplies special forces in Europe and elsewhere, but a highly profitable mask contract with the Pentagon still has five years to run. It's contracted to supply about 200,000 masks a year, and adjusting the price either higher or lower to account for any fluctuation in annual orders means revenue is pretty steady - 85,000 were ordered in the second quarter alone.

AVON RUBBER (AVON)

ORD PRICE:610pMARKET VALUE:£189m
TOUCH:610-615p12-MONTH HIGH:670pLOW: 360p
FORWARD DIVIDEND YIELD:1.2%FORWARD PE RATIO:16
NET ASSET VALUE:67pNET DEBT:23%†
*Includes intangible assets of £16.5m, or 53p a share 

Year to 31 SepTurnover (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
201110810.223.33.0
201210711.025.43.6
201312514.034.04.3
2014**13415.336.25.5
2015**14016.538.97.3
% change+4+8+7+33

Normal market size: 500

Matched bargain trading

Beta: 0.6

**Investec Securities forecasts, adjusted PTP and EPS figures

†As at 31 December 2013

Of course, Avon is more than just gas masks. It makes both liners and tubing used to milk cows, too, and while last year was tough - lower milk prices and high feed costs affected demand from hard-up farmers - the worst is over. Indeed, animal feed prices are back to normal and Avon's own-brand Milkrite vented liner is selling well in the huge North American market. It's also making progress in Europe where Avon has beefed up the sales team.

Despite Dairy's strong first quarter last year, Avon still expects modest growth this first half, and further growth after that. A new service doing farmers' dirty work has been "well received" in the US. For a fee, Avon will take away their old "clusters" (the four-pronged device used to milk cows), on which liners are both difficult and time-consuming to change, and send them a new one. Brazil is another "potentially huge market", says Mr Slabbert. Buying a local operator to bypass hefty import taxes looks like the cheapest way in.