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OPINION

Try fast for gains

Try fast for gains
August 18, 2014
Try fast for gains
IC TIP: Buy at 113p

My last recommendation was to run profits following the release of the company’s full-year results to end March 2014 (‘Bolting ahead’, 18 June 2014). The price then was 130p, close to a 13-year high. In the event, clearly some readers thought it was worth banking some profit, prompting a sell-off at the end of July.

But if the shares were worth holding at 130p, then in the absence of anything fundamental changing, at 113p they offer decent value now. I am not the only one thinking this way as analyst Robert Sanders at broking house Westhouse Securities upgraded his target price from 125p to 185p following those results and Jo Reedman at N+1 Singer upgraded the broking house’s target from 126p to 140p. Other analysts covering the shares are corporate broker Arden Partners (target 130p) and finnCap (target 131p).

I will not revisit the analysis I provided two months ago in that article, but having gone through all four analyst research notes on the company there are a few extra points worth flagging up, and ones I feel investors have yet to fully recognise.

 

Potential for an earnings beat

The first is that although Trifast is forecast to grow profits strongly again in the current fiscal year to end March 2015, there is clear potential for both sales and profit estimates to be exceeded yet again, a positive trend that has been prevalent for some time now.

Analyst David Buxton at broking house finnCap currently predicts Trifast will report revenues of around £151m in the 12-month period to produce pre-tax profits of £12.5m and EPS of 7.6p. The respective forecasts for the financial year to end March 2014 are revenues of £130m, profits of £9.2m and EPS of 6p. Dig down through the numbers and it is clear that the vast majority of this profit growth is being derived from the recent acquisition of VIC, an Italian manufacturer and distributor of fastening systems predominantly to the white goods industry.

The deal is significantly earnings enhancing because Trifast is paying €27m (£22.5m) for the business of which £20.1m is payable in cash, all of which will be funded by a bank facility, and only £2.4m is payable in Trifast shares. VIC made pre-tax profits of £4.4m in the last financial year on net margins of 20 per cent. The maximum earn-out is £4.1m based on VIC’s profits for calendar 2014. On this basis the maximum 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).

In other words, adjust for a doubling of interest payments to £1.1m in the current year and finnCap’s current year estimates, which are pretty much in line with the other broking houses, are attributing only a modest profit uplift from Trifast’s existing business prior to the acquisition.

 

Conservative organic sales growth assumptions

However, this is a way too conservative assumption to make in my view, a point that analysts are now openly acknowledging. In fact, in a note to clients, Mr Buxton at finnCap noted that "we believe our 2015 forecasts factor in very conservative rates of organic growth, with some potential upside later this year." That is putting it mildly once you consider that in the financial year to end March 2014, Trifast generated 7 per cent organic revenue growth with just a 1 per cent increase in staff. So with the benefit of operational leverage, pre-tax profits surged by over a quarter.

The important point I am trying to make in bringing this to your attention is that unless Trifast's underlying sales growth grinds to a halt, hardly a realistic possibility given the positive outlook statement from the company, then it’s only reasonable to assume incremental profit gains on rising sales as the operational gearing effect kicks in.

I also noted that house broker Arden Partners has advised its clients that "prior to the VIC acquisition, approximately a quarter of Trifast's products supplied were manufactured in-house. This rises to nearer 34 per cent which will have a favourable impact on mix and provides for higher returns through capturing the operating margin." Arden currently predicts Trifast's operating margin will rise from 7.5 per cent to 8.9 per cent in the financial year to end March 2015. But drilling down through those forecasts and it becomes apparent that all of the margin gain is down to the acquisition of VIC. Indeed, the brokerage has conservatively assumed only a maintained margin in the rest of the business, a very conservative assumption. It is also one that has led Arden to comment that if organic sales growth remains strong tthere is "scope to improve the underlying margin... providing upside in our forecasts should present trends be sustained." And that’s exactly what is happening because in response to the share price sell-off Trifast’s board issued a trading update on Thursday, 31 July.

The release confirmed that "management is confident that it can continue to deliver another strong performance and current trading in line with these expectations." In other words, organic sales growth is still coming though which makes this look a classic case of a company "under promising and over delivering". It also offers the distinct possibility that the forthcoming trading update at the annual meeting on Thursday, 18 September could lead to earnings upgrades. That's why I am comfortable advising a buy on the shares on a prospective PE ratio of 15.

 

Progressive dividend policy

I would flag up that the robust earnings growth is enabling Trifast’s board to pursue a very progressive dividend policy. Having lifted the payout by 75 per cent to 1.4p last financial year, analysts predict a dividend of between 1.70p to 1.75p in the year to March 2015, rising to between 1.9p and 2p the year after. On this basis, the forward yields are 1.5 per cent, rising to 1.8 per cent.

It could conceivably be even higher because prior to the VIC acquisition Trifast had completely degeared its balance sheet. With the benefit of £11.2m of operational cashflow in the last financial year, the company had net funds of £2m at the end of March 2014, reversing a net debt position of £5.2m in March 2013. Pro-forma net debt of £19m post the acquisition equates to only 30 per cent of shareholder funds of £61.7m.

Moreover, after factoring in a £5m increase in the working capital requirement in the current fiscal year, Trifast should still be able to generate operational cash flow of around £10m from cash profit estimates of £15.3m. This easily covers the £1.1m interest bill on those borrowings to fund the VIC acquisition, corporation tax of around £3.7m and leaves well over £5m to spend on capital expenditure and meet the £1.9m cash cost of the dividend.

 

Target price

So having taken all the above points into consideration, my current view is that a 140p share price target is not an unreasonable fair value estimate for Trifast’s equity. This would value the company's equity at £159m. Factor in net debt of £19m and the company's enterprise value would be £178m if my target price is achieved. Based on cash profits of £15.3m in the current financial year, the company’s enterprise value to cash profits multiple would be 11.6 in fiscal 2015.

However, with cash generation strong, net debt is expected to almost half to around £10m by March 2016. On this basis, the enterprise value to cash profits multiple is currently only 8.5 for fiscal 2016 based on a rise in cash profits to £16.4m, and would rise to 10 if my share price target is hit. That seems a fair valuation to me and one that is inline with that of Brammer (BRAM: 455p), Europe's leading distributor of maintenance, repair and overhaul products.

Needless to say, I now rate Trifast shares a decent buy on a bid-offer spread of 110p to 113p ahead of the forthcoming trading update at the annual meeting next month.

■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'