Avon Rubber-stamps growth potential

Avon's high-tech gas mask business accounts for about three-quarters of its revenues. Prospects here are underpinned by long-term contracts with the US Department of Defence (DoD). And in spite of well-documented military budget cuts, Avon's boss, Peter Slabbert, expects no slowdown in demand from North America as there are currently 2m soldiers that still require its advanced masks. This DoD work is relatively low margin, which in part reflects the attractions of the long-term contracts. But the high-profile nature of the work has helped to encourage more orders from higher-paying customers elsewhere as other countries take note of Avon's relationship with the world’s biggest military and show willing to pay top dollar to acquire the same gear.

Mr Slabbert says Avon's long standing relationship with the DoD has enhanced its reputation in the 60 other countries it now serves, including regions like the Middle East, where money and civil wars are both plentiful. This international interest has started to filter into operating margins, which were up 270 basis points to 14.6 per cent in the year to the end of September. What's more, analysts expect margins to keep rising, and management's strong record on this score is worth highlighting - when they took on their current roles in 2008 adjusted operating margins were down 7.5 per cent.

The recovery of Avon's smaller but highly profitable dairy segment should boost profitability. In recent years low milk prices and poor crop harvests led farmers to delay liner replacement and push back on pricing. Now, however, the market has picked up, with the milk to feed price ratio standing at its highest since October 2007. And Avon looks well placed to take advantage of the improving environment based on its recent market share gains in Europe and North America.

The group's new cluster exchange service, a combined milking-equipment hire, cleaning and replacement service, is proving popular. And it is now selling its Milkrite brand directly to farmers through local dealers, rather than selling to original equipment manufacturers, which helped push operating margins up 160 basis points to 17.9 per cent. But the big potential comes from its expansion into emerging markets.

The international automated milk drive started three years ago in China and Avon has recently ramped up its efforts by opening a distribution centre in Brazil. Though automated milk was previously only a concern for developed nations, Avon's ability to maximise milk quality, improve milk hygiene and help maintain animal health has caught the eye of developing regions dealing with changing consumption trends. Population, income and living standards growth has increased demand for diary ingredients, with the Chinese government responding by establishing regional automated milking parlours. This should help fuel further growth.

Product development should also aid prospects and include plans for new products for the navy, a masks to fight the ebola virus. The company is also well financed to invest in growth and make acquisitions. Cash from operating activities jumped 71 per cent last year to £26.5m. This enabled the company to boost the dividend by 30 per cent whilst turning net debt of £10.9m at the 2013 year end to a small net cash position.