The initial consideration payable to the owners of VIC, an Italian manufacturer and distributor of fastening systems predominantly to the white goods industry, is €27m (£22.5m). That’s hardly an exacting valuation for a business that made pre-tax profits of £4.4m in the last financial year and enjoyed a robust net margin of 20 per cent. The maximum earn-out is £4.1m and is based on VIC’s profits for calendar 2014 on the basis of €5 of additional consideration for every €1 of post tax profit made above €3m for the current financial year. The earn-out is capped at €5m so it’s fair to assume all this will be payable. On this basis the total consideration of £26.6m equates to 9.4 times historic post tax profits (the Italian business is taxed at 36 per cent for corporation tax).
It’s earnings enhancing for Trifast too, and significantly so, because £20.1m of the initial consideration is payable in cash, all of which will be funded by a bank facility, and only £2.4m is payable in Trifast shares. As a result analyst Ben Thefaut at brokerage Arden Partners increased his pre-tax profit estimate by 30 per cent to £12.5m for the financial year to end March 2015 and raised his EPS forecast by 22 per cent to 7.5p. Shareholders can expect a higher dividend too as Mr Thefaut now expects a payout of 1.7p a share, up from the 1.4p predicted in the financial year to March 2014. This means even after an 11 per cent share price rise this morning Trifast shares are still only trading on 13 times current year earnings estimates and offer a prospective dividend yield of 1.7 per cent. That’s hardly a racing valuation for a company set to deliver 27 per cent earnings growth.
Established in 1964 by the Perini family, initially specialising in self tapping and thread forming screws, VIC subsequently expanded to establish a strong market position manufacturing and distributing highly engineered parts for leading European domestic appliance manufacturers including Indesit, Whirlpool, Electrolux, Elica, BSH Bosch and Siemens. Currently only 8 per cent of Trifast’s revenues are generated from domestic appliance sector and this will rise to 20 per cent post completion of the acquisition.
Importantly, VIC has enjoyed a steady growth record in recent years and with the benefit of a lean cost base its net margins are almost three times higher than the 7.5 per cent forecast for Trifast in the financial year to end March 2014. VIC will operate as a stand-alone entity within the Trifast group structure. It’s a good geographic fit as VIC offers an additional manufacturing facility outside Asia where the group’s existing manufacturing facilities are based.
Although no cost savings are expected, there are undoubtedly reasons to expect further profit gains. That’s because VIC has a limited sales and marketing budget so should be able to leverage off Trifast’s infrastructure. The acquisition should also lead to a greater proportion and range of in-house manufactured threaded fasteners rather than using third parties. This will boost margins and profits.
Surging profits
The aforementioned analyst estimates are based on a 10-month contribution from VIC in the current financial year to end March 2015. However, estimates for fiscal 2016 have had a major boost too as analyst Jo Reedman at brokerage N+1 Singer expects to upgrade current EPS estimates somewhere in the region of 20 to 25 per cent to around 7.8p to 8.1p. On this basis Trifast’s shares are priced on a little over 12 times earnings for the 12 months to March 2016. It also means that EPS is set to rise by an eye-catching 37 per cent in the next two financial years.
It could easily be more because as I reported last month (‘Bolting ahead’, 16 April 2014), Trifast is firmly in an earnings upgrade cycle itself even without the benefit of acquisitions. For instance, post a pre-close trading update ahead of results in June, Mr Thefaut at Arden Partners raised his pre-tax estimate from £8.6m to £9.1m for the financial year to end March 2014 which resulted in his EPS forecast being lifted from 5.5p to 5.9p. 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 natural operational gearing of the business, the incremental £8m increase in revenues for the financial year just ended resulted in a £1.9m boost to profits.
And this upgrade cycle has some way to run in my view. That’s because Trifast is benefiting from improving economic conditions across all its territories and in particular 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 margin 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.
And 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. Products supplied to a range of industries include machine screws, automotive and self-clinching fasteners. Clients include multi-nationals: Dell, Honeywell, Hewlett Packard, BAE Systems and Black & Decker.
Strong balance balance sheet
It’s well worth flagging up given the scale of this acquisition that Trifast had 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.
Factoring in the initial consideration for the acquisition, I estimate that Trifast will have proforma net assets of well over £60m post completion at the end of May and net debt of well below £20m, so balance sheet gearing is comfortable. After factoring in Trifast’s robust cash flow performance analyst Arden Partners predicts net borrowings will fall to £17m by the end of this year. So not only does Trifast offer bumper earnings growth prospects but it also has a rock solid balance sheet.
Target price
Following the announcement of the VIC acquisition this morning, shares in Trifast surged 11 per cent to my 100p target price. This means they have almost doubled since I first advised purchasing the shares 15 months ago at 52p (‘How the 2013 Bargain shares portfolio fared’, 7 February 2014).
However, this is a material deal and after factoring in the earnings upgrades today, and the real possibility of further ones to come as the year progresses, I have no hesitation in raising my fair value target by 25 per cent 125p.
I am not the only one thinking this way as analyst Robert Sanders at Westhouse Securities reiterated his 125p target price this morning, David Buxton at finnCap raised his target from 95p to 124p, and Jo Reedman at N+1 Singer reiterated a buy recommendation ahead of the aforementioned massive earnings upgrades.
If my target is achieved, Trifast shares would be rated on 16 times current year earnings estimates, a fair valuation considering the explosive earnings growth coming through. Trading on a bid offer spread of 99p to 100p, Trifast shares are still well worth buying.
Please note that I am still working my way through a list of companies on my watchlist including: Inland (INL), API (API), Charlemagne Capital (CCAP), Oakley Capital Investments (OCL), Thalassa (THAL), Taylor Wimpey (TW.), Barratt Developments (BDEV) and Bovis Homes (BVS).
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