The current rating is even more unwarranted once you factor in the company's net cash pile of £5.2m on its balance sheet, worth 26p a share or the equivalent of 17 per cent of the share price. Adjust for that and the cash adjusted historic PE ratio is ludicrously low at 5.3. The discrepancy is even more pronounced if you value Molins on an enterprise value to operating profit basis. Deduct the £5.2m of net cash from a market value of £30.8m and the company is being valued on around 4.5 times last year’s underlying operating profits of £5.5m. By comparison, the peer group average rating is 13 times operating profits to enterprise value.
And it's not as if Molins doesn’t offer a decent income stream. The board declared a maintained payout of 5.5p a share last year, so the yield is well over 3.5 per cent. Covered more than four times by adjusted PES of 23.9p, it’s pretty safe too. Analysts predict dividend per share will be raised by around five per cent to 5.75p this year, so there is even growth to come. And there is obvious value in the shares as they now priced almost 25 per cent below book value of 201p a share.
Investors overreaction
True, news that Molins’ order intake has been below last year levels has dampened investor enthusiasm, albeit sales have been flat in the year to date. But this should be put in context because the board also recognised that "order prospects remain strong and the shortfall in intake is expected to be closed." Moreover, the company hasn't warned on profits and analysts Paul Hill and Gilbert Ellacombe at research firm Equity Development still expect Molins to grow pre-tax profits from £5.4m to £5.8m in 2014.
As in previous years, trading is weighted to the second half so if orders pick up, then the first half shortfall can easily be made up at this stage as the board anticipate. This explains why the company is comfortable with its guidance.
Another reason for the relative weak share price performance is that some investors have clearly lost patience waiting for the US regulators to make an announcement in respect of changes in US tobacco testing legislation. But it's worth flagging up that analysts had not factored any contribution from regulatory changes into their estimates for Molins' US tobacco testing operation, Arista Laboratories. I would also point out that the other part of the scientific services business, Cerulian, posted record results last year which helped drive up revenues from the division by 15 per cent to £26.5m, almost completely offsetting a subdued performance from Arista.
The problem being that with no regulatory testing required in the US last year due to delays in the introduction of tighter US regulations, industry demand for Arista’s services fell. That said, operating profits from the scientific services unit only fell by £100,000 at £1.1m which is hardly a bad result and does not justify the ongoing weakness in Molins share price.
Furthermore, it’s only reasonable to expect further growth to come from Milton Keynes-based Cerulean, a market-leading supplier of quality control instruments and analytical smoke constituent capture machinery to the global tobacco industry. Demand here is being underpinned by Cerulean's largest market, China, and multinational cigarette companies for the supply of both standard instruments and machines.
And it’s not as if its core tobacco machinery business has been flagging. Last year, the division increased sales by 11 per cent to £34.4m, a third of the total, and lifted operating profits by £700,000 to £2.9m. New product development should support demand from customers, including Molins new Alto and Octave filter making machines, and help maintain Molins’ established position within the tobacco industry both in terms of design and manufacture of specialist machinery, but also in maintaining its extensive and profitable aftermarket support base of customers.
Investors also seem to be ignoring the fact that Molins is a truly international business as 90 per cent of revenue originates from overseas of which a quarter of the total comes from the US, a fifth from Europe excluding the UK, a quarter from Asia and the balance of 15 per cent from other emerging markets. With such a geographic spread the company is less exposed to any one region which mitigates risk, albeit it is exposed to currency fluctuations on unhedged foreign earnings.
Corporate developments
Factoring in all the above key points, I see no reason why the shares should be trading on such a lowly earnings multiple. The proposed transfer of the shares listing to the Alternative Investment Market (Aim) is hardly a negative either as it will lower transactional costs, reduce ongoing costs and simplify administration and regulatory requirements.
Subject to shareholder approval, the shares will be admitted to trading on Aim on Thursday, 19 June. I also noted in the listing document that "the board believes that a transfer to Aim will offer greater flexibility to supplement organic growth with complementary acquisitions since larger corporate transactions can be executed more quickly and cost effectively compared with the Official List." Interestingly, the board believes that this is "likely to be of benefit to Molins going forward" so the company is clearly eyeing up acquisitions to deploy its low yielding cash pile on. I view this as a positive development.
Target price
Although the share price performance this year has been disappointing, Molins shares are still well ahead of my 107p buy in price in my 2012 Bargain shares portfolio in February 2012. If you followed that buy recommendation you would have banked five dividends totalling 13.75p a share to give a total return of 53 per cent in 26 months. Admittedly, the share price weakness has eroded some of the gains this year, but I am not bailing out and not just because the valuation shouts value.
It’s worth noting too that the shares are now massively oversold with the 14-day relative strength indicator (RSI) on the floor. Its latest reading is 20! The price is also close to the 149p support level dating back to April last year and with the shares so heavily oversold it is only sensible to believe that a bounce could be imminent from the 150p level.
Clearly, sentiment needs to improve for the share price to regain its long-term trendline and recapture the 200-day moving average at 177p. Beyond that there is now major resistance at the autumn highs around 195p. But on valuation grounds my fair value target of 220p, well below the 260p target of research firm Equity Development, is not unrealistic. Trading on a bid offer spread of 150p to 153p, and offering almost 50 per cent upside to my fair value target price, Molins shares rate a value buy and one which should reward investors looking to invest for more than just short-term gains.
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: Pure Wafer (PUR), Eros (EROS), Inland (INL), API (API), H&T (HAT), Record (REC), Charlemagne Capital (CCAP), Oakley Capital Investments (OCL), Pittards (PTD), Thalassa (THAL), Camkids (CAMK), Taylor Wimpey (TW.), Barratt Developments (BDEV), Bovis Homes (BVS), Aurora Russia (AURR) and Terrace Hill (THG).
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