This is very relevant right now, because one of the companies in my 2013 Bargain share portfolio, Trifast (TRI: 85p), a leading global manufacturer and distributor of industrial fastenings, employing more than 1,000 staff around the world, has just announced a forecast busting set of half-year results. It not only vindicates my decision to rate the shares a strong buy ahead of the announcement when the price was 74p ('A timely bolt on purchase', 21 Oct 2013), but also justifies my decision to massively raise my target price from 72p to 90p at the time. That target was hit last week after the results.
Moreover, it also highlights the value of running with winning holdings, and the value of being patient to realise their potential as I had previously discussed the merits of the company in quite some depth when the price was trading at a bargain basement 56p ('A share ready to bolt', 20 May 2013). That was a repeat buying opportunity if you missed my initial advice to buy at 51.9p in my Bargain share portfolio) in February. Importantly, the bumper gains look fully justified.
Margin and sales growth boosting profits
To recap, having streamlined the operations, Trifast's management is far more discerning about the level of profit margins on the business it takes on; older contracts are renegotiated upwards or withdrawn. Better sourcing from suppliers has led to improved pricing, quality and lead times, while product innovation has enhanced the offering and helped the company win new contracts. Progress on this front was evident in this week's half-year figures as operating margins surged almost one percentage point to 7.45 per cent in the six months to end-September. So, with revenues up almost 7 per cent to £65.3m in the period, which was comfortably ahead of brokers forecasts, this meant operating profits rose by three times that rate, up 22 per cent from £3.98m to £4.86m.
It is only reasonable to expect this positive trend to continue. Interestingly, the UK division was the strongest performer, lifting sales by 11 per cent to £32.1m and growing operating margins from 5.4 per cent to 8.2 per cent. The business accounts for almost half of the company's revenues and the growth here, as well as in the European operation, which increased sales by almost 10 per cent to £12.5m, was underpinned by demand from the automotive sector. This is a key earner, accounting for a third of Trifast's revenues. It's therefore worth noting that demand from the company's customers has proved resilient even through the recession, in particular in Norway and Sweden, and is now seeing volumes build as the macroeconomic recovery gathers pace.
It's worth noting, too, that about 22 per cent of sales are from the electronics sector, 11 per cent from distributors and 8 per cent from domestic appliances. Importantly, the company has very low exposure to European original equipment manufacturers suffering from volume pressure. It's also notable that the recovery in the US market has been marked and Trifast's management, under the leadership of chief executive Jim Barker, are aiming to exploit this trend by targeting a number of new business opportunities in the region.
The company certainly has ample funding to support further orders, having slashed net borrowings by a third to £3.55m in the latest six month period. This means balance sheet gearing is a miniscule 6 per cent of shareholders funds of £59.5m. It also paved the way for the reintroduction of an interim dividend of 0.4p a share. Following a 20 per cent upgrade, analysts at brokerage Arden Partners expect the full-year payout to be lifted by 50 per cent to 1.2p a share, implying a prospective yield of 1.4 per cent. For the financial year to end-March 2015, consensus is for a payout of 1.4p a share, implying a forward yield of 1.65 per cent. It could easily be more as analysts predict net debt will be slashed to around £2.6m by the March year-end, reflecting Trifast's strong cash-flow generation.
Earnings upgrade cycle
Furthermore, following 11 per cent earnings upgrades for the full-year, and 7 per cent in fiscal 2015, analysts at broking house finnCap now expect Trifast to increase pre-tax profits from £7.3m to £8.6m in the current financial year, rising to £9.2m the year after. On this basis, expect full-year EPS of 5.5p and 5.9p, respectively, up from 4.7p in the 12 months to end-March 2013. In other words, the aforementioned dividend estimates are comfortably covered more than 4.5 times.
It also means that the shares are trading on 14.4 times March 2015 earnings estimates, around two points less than the average of its peer group: Brammer (BRAM - 17.6 times); Electrocomponents (ECM - 16.5 times); Premier Farnell (PFL - 13.2 times); and Diploma (DPLM - 18.7 times). This looks anomalous to me once you consider the lowly geared nature of Trifast's balance sheet. In fact, on an enterprise value (market value and net debt) to cash profits multiple, Trifast is only rated on 8 times prospective cash profits of £11.4m for March 2015. That's half the rating of Diploma and a chunky 40 per cent discount to Brammer, which is rated on a multiple of 13.
Moreover, Trifast's earnings guidance looks conservative especially since the Asian business is now showing a strong recovery, buoyed by a number of contract wins. This division accounts for a third of total revenues and margins in the first half were almost 13 per cent. There should be scope for further margin gains, too, across the company as legacy contracts are unwound and replaced by higher margin new business. In my opinion, the risk to earnings forecasts remains heavily skewed to the upside, and I would not be surprised at all to see further upgrades come through as the year progresses. The next trading update will be a pre-close interim management statement in mid-February.
Target prices
True, Trifast's share price hit my upgraded target price of 90p post last week's results, in line with the target price of broking house finnCap, but I still feel there is scope for more upside. It's also worth noting that other broking houses are starting to think this way; analyst Jo Reedman at N+1 Singer massively upgraded her target from 68p to 89p post the half-year results. I think that's too conservative especially as N+1 Singer "sees potential for further upgrades as the year progresses".
In fact, I think upgrades are nailed on since Trifast is now looking at accretive bolt-on acquisitions to accelerate its top-line growth, as well as bringing to market new products and targeting new customer relationships to drive revenues up further.
The chart set-up looks positive, too. From a technical perspective, if the 90p price level can be taken out - this resistance dates back to the highs of 2007 - this opens up the potential for a run up in the price to the 2003 high of 94.25p. Beyond that there is no resistance at all until the 2001 high of 120p.
So, based on an enterprise value to cash profits multiple of around 10 times 2015 estimates of £11.4m, I feel that a more reasonable valuation for the equity of Trifast is £110m. Factoring in 108.5m shares currently in issue, this gives a new upgraded target price of around 100p. It's also worth noting that merger and acquisition activity in the sector supports my valuation target based on proven trade valuations of fastener manufacturers and distributors. Trading on a bid-offer spread of 83.5p to 85p, and offering potentially 18 per cent upside to my new target price, I continue to rate Trifast shares a buy. The time frame for this trade is four months.
Finally, and in response to recent news flow, I am currently working my way through a number of updates on my following recommendations: Eurovestech (EVT), Global Energy Development (GED), Heritage Oil (HOIL), Bezant Resources (BZT) and Eros (NYSE: EROS).
MORE FROM SIMON THOMPSON ONLINE....
In the past week I have published three other articles in the past fortnight on the following five companies:
■ 32Red ('Hitting the jackpot', 11 Nov 2013)
■ Macau Property opportunities ('Hot property plays', 12 Nov 2013)
■ First Property ('Hot property plays', 12 Nov 2013)
■ Inland ('Bargain shares updates', 12 Nov 2013)
■ Terrace Hill ('Bargain shares updates', 12 Nov 2013)
■ LMS Capital ('LMS worth capitalising on', 18 Nov 2013)
