Having acquired Wrexham-based Vannplastic, trading as Ecodek, a leading manufacturer and supplier of wood plastic composite, for £5.2m in early November (‘Decked out for further gains’, 10 November 2015), Epwin has just announced the acquisition of Tamworth-based Stormking, a leading supplier of moulded GRP building components to the housebuilding and construction industry in the UK. The company’s product range includes dormers, chimneys, bay window roofs, entrance canopies, copings and support brackets, as well as time-saving components for the housebuilding and construction sector.
The 30-year old business is very profitable too, having reported cash profits of £3m on revenues of £22.8m in the 12 months to end February 2015. And with the benefit of cost savings and stronger trading in the new build sector Stormking is predicted to report cash profits of £4.5m on revenue of £25m in the 12 months to end February 2016. On this basis, the initial consideration, comprising £20.25m in cash and £6.75m in new Epwin shares, equates to six times cash profits. There is also deferred consideration of up to £8m based on Stormking’s performance for the financial year to end February 2017. This is payable in May 2017 and is based on a maximum cash profit multiple of six times incremental profit earned in that period.
To put the pricing of this latest deal into perspective, the consideration of £5.2m for the Ecodek acquisition, of which £3.64m was payable in cash and the balance in shares, represented a multiple of 5.2 times cash profit. There is a maximum earn-out of £3.3m based on Ecodek's financial performance in 2016. For this to be paid in full, the business would have to lift its cash profits by two-thirds to £1.66m, a material increase on forecasts for 2015.
Sound strategic fits
In my view, both acquisitions are sensibly priced and also offer cross selling opportunities into Epwin’s existing sales channels into its core repair, maintenance and improvement (RMI) market which currently accounts for 70 per cent of its sales. They also add new materials and technologies to the product offering that Epwin did not previously have. The maximum total earn-outs of £11.3m payable over the next 15 months are sensible given that Ecodek and Stormking would have to increase cash profits by £4m in total over the next financial year for the full deferred consideration to be payable.
And the funding arrangement looks sound. With operating cash flow strong and net debt only £2.2m at the end of June 2015, down from £9m at the time of the flotation in the summer of 2014, Epwin has the financial firepower to drive earnings higher even in lacklustre markets by making earnings accretive bolt-on acquisitions that fit into its existing product portfolio. The company has taken on a four-year term loan to settle the initial cash consideration for the Stormking acquisition, and also has a £25m revolving credit facility that runs until July 2019 and a £5m overdraft facility. Analyst Andy Hanson expects the company to have post acquisition net debt of £16.8m, well within those borrowing facilities.
Moreover, after factoring in the contributions from both deals, Mr Hanson predicts Epwin’s pre-tax profit will rise by 24 per cent to £24.1m in 2016 based on revenues of £291m, up from £254m in 2015. On this basis, expect EPS of 14p, representing a near 10 per cent upgrade on his previous estimate, and well ahead of the 11.8p expected in 2014. This means that Epwin’s shares are currently rated on a modest 10 times earnings estimates, or 30 per cent cheaper than its peers, and offer a 4.6 per cent prospective dividend yield based on a declared payout of 6.6p in 2016, up from 6.4p in 2015. And that dividend looks safe because Epwin should be able to generate around £29m of cash from its operations this year, so even after factoring in finance costs, tax and capital expenditure, forecast free cash flow should be around £13.9m, or about 50 per cent higher than the cost of the annual dividend.
Raised target price
So, having recommended buying Epwin's shares when it listed on the Alternative Investment Market at 100p a share in the summer of 2014 ('Moulded for gains', 29 Jul 2014), since when the price has risen by 43 per cent, I feel that investors are likely to continue to warm to the investment merits of the company given the board’s desire to make selective earnings accretive acquisitions, and pursue a progressive dividend policy.
In the circumstances, I feel the four point earnings multiple discount to peers is unwarranted. On a bid-offer spread of 141.5p to 143p, I would continue to run your healthy profits and target fair value nearer to 170p a share, a valuation equivalent to 12 times earnings estimates for 2016. Run profits.
Please note that I have published four columns today, all of which are available on my home page.
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