Indeed, Aldi and Lidl captured a 10 per cent slice of the UK's grocery market between them for the first time last year and in the run-up to Christmas almost one in eight households shopped at the chains, in addition to the 15.6m households who visited them in the previous 12 weeks. Given that the two German chains are opening five times as many new stores as all their 'Big Four' rivals combined, expect further significant market share gains in the coming years.
A prime example of the cost savings is the pricing of kitchen and toilet rolls. In Sainsbury's, a pack of four Andrex quilted toilet rolls will set you back £2.25 - 50 per cent more than a pack of Aldi's private label Saxon Aloe Vera toilet rolls. The savings are even greater on facial tissues: in Asda, a pack of 100 Kleenex mansize tissues costs £1.50 - almost double the price of Aldi's Softy range of large tissues. With such significant savings to be made, and with quality not being compromised on private-label substitutes, it's hardly surprising that an increasing number of middle-class shoppers are voting with their feet.
That's rather good news for the suppliers to discount retailers. It's also good news for suppliers to the 'Big Four' as they have been forced to introduce lower-cost private-label ranges to compete with the low pricing of the likes of Lidl, Aldi, Wilkinson, Home Bargains and B&M. And one of these suppliers, Accrol (ACRL:100p), a Blackburn-based maker of toilet rolls and tissues, which manufactures the Aldi ranges I have mentioned, is listing its shares on the Alternative Investment Market on Friday, 10 June. It's a company well worth considering an investment in, given the dynamics driving the business - not to mention the reasonable pricing of the shares and prospects for an attractive dividend.
History
Accrol is currently owned jointly by the Hussain family, who founded the business in 1993, and private equity group NorthEdge Capital, who came on board a couple of years ago to fund growth. It was a wise move because, having gained significant traction in winning contracts with discounters, the company has been targeting the large multiples as they shift towards the provision of private-label products in response to the competition from the low-cost retailers. In fact, Tesco (TSCO), Wm Morrison (MRW) and Asda accounted for 7.5 per cent of Accrol's revenues in its 2015 financial year (April year-end), having only come on board in 2013.
To highlight the rapid growth being generated, sales to Wilkinson, Tesco and Aldi have grown from a standing start to £11m in the two years to end-April 2015, ramping up to £22m in the first 10 months of the financial year to end-April 2016. Revenues from Accrol's top three customers, Booker Wholesale, B&M and Home Bargains, have shot up too, doubling to £45m in the three years to April 2015 and accounted for 45 per cent of Accrol's annual revenue of £101m. Analysts Mike Allen and Andy Hanson at house broker Zeus Capital predict that Accrol will deliver revenues of almost £120m in the financial year just ended, and have pencilled in turnover of £138m for the current financial year to April 2017.
I wouldn't bet against it as the company has reported compound annual sales growth of 16 per cent over the past three years, and profitably too as cash profits have increased by almost 14 per cent per year in the period to £12.2m in the 12 months to end-April 2015. Forecasts from analysts point towards cash profits of £15m in the year just ended, rising to £16.4m in the current financial year.
Cleaning up
Those estimates seem realistic to me once you factor in that experts predict 10 per cent annual growth for toilet, kitchen and facial tissues in the discount segment for the foreseeable future and Accrol has a 35 per cent market share of this part of the market. The segment represents 14 per cent of an overall UK market worth £1.47bn and means that the company controls a 7 per cent market share.
It may seem odd for a small-cap company operating from a 350,000 sq ft facility in the north of England to have such a dominant market position, especially as the three largest global competitors (SCA, Kimberly-Clark and Sodifel) account for 74 per cent of the UK market. But it has achieved this for a number of reasons.
Firstly, Kimberly-Clark is primarily focused on its branded offering (Andrex and Kleenex) and SCA is being held back by restrictive supply agreements with existing customers that prevent expansion. As a result, the large players dominate the branded segment, while small and medium-sized players have far greater strength in the private labels and the 'away from home' segments that Accrol has been targeting. An above-average exposure to the consumer segment of the market relative to its small-cap rivals has been a key driver of its far superior operating margins (12.6 per cent in 2015).
Another reason for the rapid profit growth is that, unlike its larger rivals, Accrol doesn't own paper mills, so avoids the hefty cost burden. Instead, the company outsources supply, so enjoys the lower cost advantages that international manufacturers of paper reels benefit from compared with UK peers. It's also benefiting from a global oversupply of both pulp and industrial paper reels as additional capacity is set to flood the market until 2019. In fact, a further 5.5m of additional global capacity is set to come on stream by then, or almost five times UK consumption.
As a result of this overcapacity, paper reel prices are not only low, but are expected to remain so for the foreseeable future. And because the company imports 23 per cent of all paper imported into the UK it has significant leverage with suppliers in the market, which in turn gives it a cost advantage when pricing up contracts for the discounters.
I would also point out that Accrol is the only company in its peer group able to supply the multiples, discounters, wholesalers and the away-from-home market. Coupled with the lack of any tie to any retailer, and its unique market positioning, this means that it has a larger addressable market than its rivals. It also explains why the company is forecast to produce double-digit growth in the next three years, a growth rate twice that of its small-cap peer group. And because Accrol has invested heavily in increasing capacity, spending £18.2m in the past three years, during which time capacity has more than trebled to 143,000 tonnes across 15 production lines, the business has both the scale and an impressive track record of delivering on large contracts.
For instance, Accrol's management team spotted a gap in Asda's product range (jumbo kitchen rolls), which has enabled it to develop a supply relationship with the retailer for both four-pack toilet rolls and jumbo kitchen rolls. And because Accrol can deliver promptly and efficiently, it's an attractive supplier for retailers, so much so that the company now produces 17m products per week, has a client base of 450 customers and has developed strong relationships with its top 10 customers, who account for more than two-thirds of annual revenues. Churn rate is less than 2 per cent, so there is a high level of customer satisfaction.
Sound financials
When the private equity and family owners of a firm decide to sell down part of their stake, it's always worth asking why. In this case, the majority of the £63m being raised in the placing will be used to pay down Accrol's borrowings of £66m, to leave net debt of £23m on listing. The Hussain family and NorthEdge will retain a stake of 15 per cent each, with management holding 2 per cent. This means that new institutional shareholders participating in the placing will own 68 per cent of the shares in issue but, importantly, existing investors will have significant skin in the game.
Net debt of £23m is 1.4 times likely cash profits of £16.4m for the current financial year and, given the business's strong cash generation, the multiple is forecast to drop to only one times cash profits by the April 2017 year-end, according to analysts at Zeus Capital. So not only is the company very modestly geared, but it should be able to recycle a chunk of those cash profits into dividends for shareholders. In fact, Accrol's board has committed to declaring a dividend equating to 6 per cent of the placing price in the current financial year, implying a payout of £5.5m of forecast post-tax profits of £10.7m and dividend cover of almost two times.
The pricing of the equity-raising also means that Accrol's market value of £93m on listing equates to a modest 8.7 times forecast post-tax profits and its enterprise value of £115m is seven times forecast cash profits for the 12 months to end-April 2017. The valuation represents a chunky 26 per cent discount to the average cash profit to enterprise multiples of large-cap peers such as Rexam (REX), RPC (RPC), DS Smith (SMDS) and Mondi (MNDI), and a hefty 40 per cent discount to their average forecast PE ratios. So, even after factoring in a small-cap liquidity discount, this is an attractive entry point in my view, not to mention one of the few ways of gaining exposure to the rapid growth of the discounters at a sub-market earnings multiple.
Risks and rewards
Of course, there are risks with any investment and the main ones to consider here are: potential loss of a major client given the high concentration of customers; a spike in paper reel prices, which would hit margins; the impact of currency volatility on overseas earnings, albeit that Accrol hedges its exposure; entry of new competitors into the discounter market; and the most immediate one, Brexit. The main impact of the UK leaving the EU would be a hike in raw material input prices on imported paper reels if sterling falls heavily against the US dollar and euro as economists predict would be the case. However, the company could mitigate this negative factor by sourcing its paper reels from UK suppliers.
I would also flag up that the senior management team, although highly experienced, has been with the company for a short tenure. Chairman Peter Cheung was appointed only 18 months ago, finance director James Flude took up his position in January 2015, and chief executive Steve Crossley has just joined the company. That said, they have more than 70 years of combined industry experience and both Mr Crossley and Mr Flude held prominent roles at Northern Foods. I note that non-executive director Steve Hammett has over 25 years' experience with Tesco, both in the UK and internationally.
Finally, the broker to the issue is Zeus Capital, the same firm that floated Safestyle (SFE), Watkin Jones (WJG), Flowtech Fluidpower (FLO) and Epwin (EPWN), all of which have proved decent investments if you followed my advice to buy at the time of those flotations. I seriously think we could clean up with Accrol too, which is why the shares are well worth investing in close to the placing price of 100p. My initial target price of 130p could prove conservative. Buy.
