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OPINION

Foiled by a warning

Foiled by a warning
September 9, 2014
Foiled by a warning
IC TIP: Sell at 63p

It’s also fair to say that investors would have done well to accept the 90p a share indicative bid made for the company at the start of last year. Those takeover talks stalled after US activist fund and 32 per cent shareholder Steel Partners, 28 per cent shareholder Wynnefield Capital and small-cap investment fund Crystal Amber (11.6 per cent shareholder) found the cash offer unacceptable.

Moreover, a profit warning last week dampens my enthusiasm for the shares and means that my 90p target price is unlikely to be achieved. I last updated the investment case when the price was 73p (‘Packaged for gains’, 15 Jul 2014). That was in line with my original buy recommendation and little changed from when I previously updated the investment case at the end of last year (‘Small-cap value plays, 5 Dec 2013).

At the time the company appeared to have turned a corner driven by a restructuring of its European foils business and buoyed by higher volumes and a new supply contract at its laminates operation. Laminates is the largest income generator for API, accounting for £6.7m, or over two-thirds of the company’s operating profit of £9.8m last fiscal year before central costs. The European foils business accounted for over a fifth of API’s profit and the division reported growth for the second successive year. A cost reduction programme also brought API’s holographics unit back to break-even and the board confirm there are “good prospects for a return to profitability based on an improving development pipeline”. Given this unit reported a loss of £725,000 last year, it was only reasonable to assume that API’s overall financial performance in the 12 months to the end of March 2015 would show a marked improvement in profits when I updated my view in July.

Or that was the case until a trading update last week revealed that the slowdown in sales to the metallic pigment sector has been far worse and more protracted than expected at API’s Foils Americas operation. As a result, the unit will now post a small loss in the current financial year to the end of March 2015 rather than the £1.7m of profit earned last year. Analysts had previously forecast that the Foils Americas operation would report profits of between £1.1m to £1.4m, so this is a major earnings miss.

There is also a risk that profits at both the laminates and European foils businesses “could be somewhat shy of what we had expected”, according to analyst Charles Pick at broker Numis Securities. That’s because although laminates revenues are on track there has been some margin pressure, while the European foils business has been impacted by weak trading last month.

Impact on the bottom line

The bottom line is that instead of delivering adjusted pre-tax profit of £7.1m, up from £6.3m in the year to March 2014, analysts at Numis now predict that API will only report profit of £5.1m and EPS of 5.7p rather than the 8.1p previous estimate. They have also sharply downgraded forecasts for the March 2016 fiscal year, predicting that pre-tax profit and EPS will come in at £6.6m and 7p, respectively. That represents an 18 per cent earnings downgrade.

The additional worry for me is that although there is evidence of a recovery in the vacuum metallic segment of the foils America business (accounting for a quarter of the division’s revenues), it’s unlikely that sales will ever be able to recover to former levels. Moreover, prospects are becoming increasingly difficult to quantify because the metallic inks and paints used in consumer durables ultimately supply end users with long supply chains. Evidence of emerging Asian competition from pigment producers dampens my enthusiasm even further. It has also dampened that of Numis Securities, which cut its target price from 85p to 70p post the profit warning.

True, there is dividend support as the 2p a share payout provides a 3.3 per cent yield. Mr Pick at Numis still believes that the dividend will be raised to 2.2p a share in the 12 months to March 2015, rising to 2.35p a share the year after. A robust cash-flow performance is also supportive of the payout as is an ungeared balance sheet. Net funds of £200,000 at the end of March represented the first net cash position in 15 years. And there are no financial worries as the company has committed bank facilities of £25m for its UK and US operations.

It's worth pointing out, too, that I still believe there is hidden value in the shares, a point I made when I initiated coverage. So do the directors of Crystal Amber who note that “the consolidation of the two foils Americas sites could release considerable value from the Rahway freehold property in New Jersey, and be significantly accretive to margins”.

However, despite these positives, and even after the earnings downgrades, I feel that the short-term risk to earnings is on the downside and API's shares could struggle to make headway for the next six months. In the circumstances, I am reversing my buy recommendation and crystallising a 15 per cent loss on this holding. Medium-term holders may wish to hold out for recovery, but with a catalyst lacking for a re-rating I feel there are more attractive investment opportunities elsewhere.

■ 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'