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RPC and the price of growth

A dissenting analyst view has cast doubt on the investment case for a 2016 Tip of the Year
April 6, 2017

The share price of RPC Group (RPC) remains under the cosh a fortnight after Northern Trust Capital Markets cast doubt on the plastic packager's underlying performance. In a note to clients, the investment house ventured that a spate of recent acquisitions - 10 deals in a little over 12 months - had served to mask disappointing capital returns and free cash flows. The analysis questioned why the tailwind derived from falling input (polymer) prices wasn't more apparent in the group's year-end figures to March 2016. Northern also believes that the accumulated synergies from the M&A schedule haven't delivered the gains that one might expect.

IC TIP: Buy at 799p

The note, which was widely reported in the financial press, sent the shares down 4.8 per cent on the day of release. However, the group's market valuation had been in retreat since the high water mark of 1,007p in the first week of January. This is despite a pre-close update on 30 March announcing revenue for the year ending March 2017 would be ahead of expectations, as well as "good cash flow development".Admittedly, RPC announced a discounted one-for-four rights issue in the intervening period to fund the acquisition of US plastics manufacturer Letica for a maximum consideration of $640m (£512m). Regardless of this dilutive effect, the shares remain under pressure.

Although institutional shareholders have yet to rebel in the face of RPC's accounting conventions, the group's treatment of performance metrics came under fire by Northern Trust. The charge runs that a step up in M&A activity has destroyed shareholder value, but has been obscured by what Northern considers contentious interpretations of capital/asset returns. If true, investors would be entitled to question if accounting treatment had effectively skewed valuations of target companies, or whether it had distorted performance metrics subsequent to the integration of acquired assets.

The explicit criticism centres on RPC buying lower-margin businesses - a misallocation of capital, according to the analysis. The note highlights the possibility that management incentives rewarding acquisitions have encouraged value-destructive deals, particularly if hurdle rates linked to bonuses don't adequately reflect the impact of acquisitions on returns. But a spokesman for RPC counters that "only a fraction" of the 300 or so opportunities the board has considered since the launch of the group's Vision 2020 strategy have been completed. RPC also points out that its return on capital employed (ROCE) has consistently outstripped its weighted average cost of capital (WACC). However, Northern questions why the packager has disregarded hefty exceptional costs when calculating the former measure.

Northern's interpretation of the investment case is somewhat at odds with the general view of 'sellside' analysts. As we went to press, nine analysts had allocated the stock a buy rating, with a consensus price target of 1,166p - a 46 per cent premium to the current share price.

Investors know that intrinsic value is an elusive concept. We're reluctant to offer a definitive call on the packager's underlying value due to the sheer weight of intangible assets on its books - but that's simply the nature of the beast at the moment. Nobody is questioning the strategic rationale behind RPC's recent buying spree; the European packaging sector remains fragmented and inefficient. If you take this view, then you might accept that the group is in a transitional phase. The full benefits of upscaling or repositioning within the marketplace may take time to accrue.