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OPINION

Bolting ahead

Bolting ahead
April 16, 2014
Bolting ahead
IC TIP: Buy at 89p

For instance, analyst Ben Thefaut at broking house Arden Partners has raised his pre-tax estimate from £8.6m to £9.1m for the financial year to end March 2014 which has resulted in his EPS forecast being lifted from 5.5p to 5.9p. Mr Thefault has similarly increased his profit estimates for the current financial year to March 2015 by £500,000 to £9.6m to produce EPS of 6.1p. To put the strength of the earnings upgrade cycle into some perspective, in the previous year to March 2013 Trifast reported profits of £7.2m on revenues of £122m.

So, with the benefit of costs savings from a restructuring programme and the operational gearing of the business, the incremental £8m increase in revenues for the financial year just ended has resulted in a £1.9m boost to profits. Similarly, Arden expects Trifast to increase revenues from £130m to £135m in the 12 months to 31 March 2015 which will produce a further £500,000 uplift to profits. Following upgrades, broking houses N+1 Singer and finnCap have almost identical estimates to Arden’s.

Interestingly, Mr Thefault notes "potential for further upgrades" so the upgrade cycle looks far from over. He has a point as Trifast is benefiting from improving economic conditions across all its territories and in particular very strong growth from the car industry and from 4G applications. Around one third of the company’s 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 also clear that having streamlined its operations, Trifast's management is now far more 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the level of profit margins on the business it takes on; older contracts are either renegotiated upwards or simply withdrawn.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. All of these factors are driving profits ahead at the same time that new more profitable contracts are boosting margins.

It’s also apparent that by scaling up the business - Trifast now services the needs of no fewer than 40 multi-national clients from 23 locations in 16 countries across Europe, Asia and North America - then this is delivering more opportunities to win new contracts. To give you some idea of the size of the operation, Trifast currently employs 1,000 staff and delivers 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 multi-nationals: Dell, Honeywell, Hewlett Packard, BAE Systems and Black & Decker.

 

Potential for more earnings enhancing acquisitions and upgrades

The other key point to note in the pre-close trading update is that Trifast has completely de-geared its balance sheet and ended the financial year to March 2014 in a cash rich position. A year ago the company had net debt of £5.2m, so this highlights the cash generative nature of the business. Analyst Jo Reedman at brokerage N+1 Singer estimates a current net cash position of £1m and predicts this will increase to £4.7m by March next year even after factoring in a 50 per cent increase in the dividend from 0.8p to 1.2p a share for the fiscal year just ended, rising to 1.4p in the current year to March 2015. Mr Thefault at Arden is even more bullish predicting a 75 per cent increase in the dividend to 1.4p a share for the year just ended, rising to 1.6p for the current financial year to March 2015.

Trifats’s cash position is a really important point to note because it means that the company’s enterprise value is currently around £99m, so unless the share price makes headway, this is set to fall to £95m by next March. In other words, the company is currently only being rated on only 8.5 times the £11.4m of cash profits it is expected to generate in the current financial year. To put this rating into some perspective, in the small-cap engineering sector, the shares are priced on a 30 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). Even if Trifast was only rated at the sector average rating of 9.4 times cash profits, this would imply a share price of 102p.

However, with profits ramping ahead, 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.

The other benefit of the company’s impressive cash generation is that it means that cash can be recycled back to shareholders through higher dividends or be used to make acquisitions to widen the geographic footprint of the business and increase the number of potential customers. 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 clearly has scope to make value enhancing bolt-on acquisitions. It goes without saying that this should boost shareholder returns and can only be positive for the shares.

Moreover, with analysts upgrading their organic sales growth rates to around 5 per cent (embedded in current earnings forecasts), Trifast is now operating in a sweet spot whereby the company offers the combination of both organic growth and potential for value enhancing bolt-on acquisitions to drive profits higher. As a result, the scope for additional upgrades to earnings looks obvious to me as the year progresses. In turn, this partly explains why analysts at the aforementioned three brokerages all have buy recommendations on the shares.

In fact, since the trading update Jo Reedman at N+1 Singer upgraded the house target price from 89p to 100p, to bring it inline with my own. David Buxton at brokerage finnCap raised his fair value estimate from 91p to 95p and Ben Thefault at Arden rates the shares a "conviction buy given the potential for upgrades." I have a strong feeling that in the course of time analysts will be raising these targets yet again.

 

Valuation not yet extended

So with the shares offering a prospective yield of around 1.8 per cent, rated on a very modest 8.5 times cash profits to enterprise value, the valuation looks anomalous to me. It also means that I have no hesitation repeating my buy recommendation having first advised purchasing the shares 14 months ago at 52p (‘How the 2013 Bargain shares portfolio fared’, 7 February 2014).

In fact, with a real possibility of earnings upgrades, I feel my 100p fair value target price is now looking conservative and I could be forced to upgrade it again if the current earnings momentum continues. Trading on a bid offer spread of 87.5p to 88.75p, Trifast shares are still well worth buying.

Please note that I am working my way through a long list of companies on my watchlist that have reported results or made announcements recently including: IQE (IQE), Pure Wafer (PUR), (LMS), Communisis (CMS), Eros (EROS), Inland (INL), Netplay TV (NPT), API (API) H&T (HAT) and Record (REC).