It has been a rollercoaster ride since then as takeover talks for the company failed to deliver a bid last year at a level that both US activist fund and 32 per cent shareholder Steel Partners, and 28 per cent shareholder Wynnefield Capital, would find acceptable. A weaker first half also dampened enthusiasm of investors’ to get involved.
That said, since I last updated the investment case when the price was 78p (‘Small-cap value plays, 5 Dec 2013), the company appears to have turned a corner a view that a trading update from the company at today's annual meeting highlights. In fact, second-half profits shot up 15 per cent and the board confirm that current trading is inline with the growth expected by analysts in the financial year to end March 2015. Admittedly, the second half uptrun last financial year was not enough to compensate for that weak first-half performance and meant that underlying pre-tax profits for the 12 months to the end of March 2014 fell from £6.6m to £6.3m. At the start of this year, analysts at broker Numis Securities were anticipating full-year adjusted pre-tax profit of £7.1m and underlying EPS of 9.2p, so it was quite some earnings miss.
However, it's clear to me from the latest trading update that API’s European foils business has been benefiting from restructuring, and the contribution from the laminates operation looks well underpinned by higher volumes and a new supply contract which came on stream in the second half. In fact, the laminates and European foils businesses grew profits by over £300,000 in aggregate in the 12-month trading period to the end of March 2014. Laminates is the largest income generator for API by far, accounting for £6.7m, or over two-thirds of the company’s operating profit of £9.8m before central costs. The European foils business accounts for over a fifth of API’s profit and reported growth for the second successive year.
That was just as well because API’s foils Americas operation is suffering from a sharp slowdown in sales to the metallic pigment sector reflecting a fall-off in demand from a key customer. It didn’t help matters, either, that the decorative foils business was impacted by a slowdown in demand due to the harsh US winter. The net impact was a £200,000 profit shortfall.
The balance of the earnings miss resulted from widening losses at API’s holographics unit, reflecting the loss of a contract after a long-standing client took business in-house. However, on a positive note a cost reduction programme brought the business back to break-even in the final quarter of the financial year, so the cost base has now been realigned. It also means that with the business no longer in the red comparatives will be very soft as holographics reported a £725,000 loss last year.
Also, a joint venture in the Czech Republic is making progress and a new holographic feature was launched at the Security Document World event in London last month. API’s board remains committed to growing the company’s presence in the security and authentication market despite slower than expected progress since implementing its strategy three years ago.
Impact on profits
The bottom line is that analyst Hanna Crowe at equity research house Equity Development expects modest revenue growth in API’s holographics business in the current financial year to the end of March 2015 and a small profit. True, part of the improvement will be offset by an ongoing profit squeeze in foils Americas, where profits are expected to reverse by £300,000 to £1.4m on slightly lower revenues of £21.2m as the trading climate remains subdued. But this pressure will be more than offset by another ramp up in profits in the European foils business.
Equity Development predicts this operation will grow operating profit by over £500,000 to £2.65m on a 3 per cent increase in revenues to £29.4m. This seems a sensible forecast to make since there will no repeat of last year’s disruption to business in the UK as the restructuring programme is now complete. Also, the benefits of an extended distribution network and a more efficient manufacturing capability at the Livingston facility should drive the margin improvement.
As a result, analysts expect API to grow operating profit by 12 per cent to £8.3m on a modest rise in revenues in the year to March 2015. And with the benefit of an ungeared balance sheet - the company ended the financial year with net funds of £200,000, the first time it has been debt free since 1999 - then a greater proportion of these profits are dropping down to the bottom line. At the pre-tax level, expect adjusted pre-tax profits to rise to £7.25m, up from £6.3m in the year to March 2014. The profit estimate is not unreasonable, either, considering that API has clients in some pretty defensive sectors - tobacco, beverages and health and beauty products - and three-quarters of revenues are derived from the European Union.
Assuming API hits these estimates, then expect underlying EPS to increase by over 10 per cent to 7.9p. On that basis, API’s shares are trading on only 9.5 times forward earnings. There is also an income as, having reinstated the dividend and made a full-year payout of 2p a share, analysts predict a payout of 2.1p a share in the current financial year, implying a yield of 2.9 per cent.
It’s worth flagging up the company’s robust cash-flow performance, too. In the last financial year, API reported a net cash inflow from operating activities of £7.4m, which helped fund investment of £3.5m in plant, equipment and a further £500,000 in a joint venture. Even after factoring in a forecast investment spend of £7.5m this year, and the £1.5m or so cost of the dividend, Equity Development believes API will still only have net debt of £500,000 by March 2015, well within committed bank facilities of just shy of £25m for its UK and US operations.
Target price
So, having taken all the above factors into consideration, and reappraised the investment case, I believe the combination of robust cash-flow performance, a progressive dividend policy, and a sharp improvement in profits driven by the European foils businesses are strong enough positives to warrant maintaining a positive stance on the shares. I have also taken into consideration the fact that finance director Chris Smith will be leaving the company at the end of the year to take up a main board position with household goods manufacturer McBride (MCB: 97p), a company three times the size of API.
Trading on a bid-offer spread of 71p to 73p, I continue to rate API a medium-term buy and still believe that a return to last year’s share price highs north of 90p is not an unrealistic possibility.
■ 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'
