The company is scheduled to release its half-year results on Wednesday, 14 September, and a pre-close trading update last Friday confirmed that the business is trading inline with market estimates. Importantly, this includes a seven-week period post the EU Referendum. Analyst Andy Hanson at house broker Zeus Capital predicts Epwin's pre-tax profit will rise by 23 per cent to £24.1m in the 12 months to end December 2016 based on revenues of £291m, up from £254m in 2015. On this basis, expect EPS of 14.1p, well ahead of 12p in 2015.
This means that Epwin's shares are currently being rated on less than 8 times earnings estimates, and offer a 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 solid because Epwin should be able to generate around £23m of net operating cashflow after accounting for the payment of corporation tax, and interest costs on borrowings. So even after factoring in likely capital expenditure of around £10.5m this year, forecast free cash flow should be around £12.6m, or about a third higher than the cash cost of the annual dividend.
It's a company I know well, having recommended buying the shares when Epwin listed on the Alternative Investment Market at 100p a share a couple of summers ago ('Moulded for gains', 29 Jul 2014), and last advised running profits when the price was 143p at the start of this year ('Epwin on the acquisition trail', 6 Jan 2016). From my lens at least, the subsequent pull back in the share price since the EU Referendum seems at odds with the operational performance the company is delivering as confirmed by Friday's trading update.
Delivering profitable growth
True, organic growth is modest and the sharp rise in forecast profit is mainly down to some well-timed earnings enhancing acquisitions made in the final quarter of last year. However, these bolt-on deals also de-risk earnings estimates.
Having acquired Wrexham-based Ecodek, a leading manufacturer and supplier of wood plastic composite, for £5.2m in early November ('Decked out for further gains', 10 Nov 2015), Epwin subsequently acquired Tamworth-based Stormking, a leading supplier of moulded GRP building components to the housebuilding and construction industry in the UK. Its 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 outlook for both end markets is positive. The wood plastic composite decking market is relatively new in the UK and is forecast to demonstrate good growth, while the glass reinforced plastic moulding market, while being more mature, has being posting decent growth as new housebuilders in particular look to improve efficiency via off-site manufacture. Financially the acquisitions were sensibly priced too.
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. The initial consideration of £27m, made up of £20.25m in cash and £6.75m in new Epwin shares, equated to six times cash profits with a future earn-out of up to £8m based on a maximum cash profit multiple of six times incremental profit in the financial year to end February 2017.
The £5.2m paid for the Ecodek acquisition was based on a multiple of 5.2 times cash profit with a maximum earn-out of £3.3m dependent 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.
The profit from the two acquisitions aside, strategically they made sense by enhancing Epwin's product offering and cross selling opportunities into Epwin's existing sales channels in its core repair, maintenance and improvement (RMI) market. This business segment accounts for 70 per cent of total sales. In addition, for the full deferred consideration to be payable, Ecodek and Stormking would have to increase cash profits by £4m next financial year, an outcome Epwin's shareholders are hardly going to complain about. The point being that the acquisitions account for the majority of the increase in Epwin's pre-tax profit forecast this year, so underpinning the earnings growth analysts anticipate.
I would also point out that the share price weakness seems more a reflection of investors anticipating a drastic softening of the RMI market even though anecdotal evidence suggests that they are being far too cautious. In fact, Epwin reported 2 per cent organic growth in the first half in a flat market. Of course, the vote to leave the EU has increased uncertainty since the end of June, but that uncertainty looks priced in to me with the shares trading on a forecast PE ratio of 8 and offering a chunky dividend well covered by both earnings and cash flow. And it's not as if the company doesn't have scope to do more acquisitions either.
Potential for further earnings accretive acquisitions
That's because at the start of this year, Epwin had cash of £22.1m on its balance sheet and gross borrowings of £36.5m. Funding lines include a four-year term loan to settle the £20m cash consideration for the Stormking acquisition, a £35m revolving credit facility that runs until July 2019, and a £5m overdraft facility. This means that the company not only has ample headroom on its existing credit facilities, but has the financial firepower to drive EPS higher even in lacklustre markets by making earnings accretive bolt-on acquisitions that fit into its existing product portfolio.
Interestingly, Epwin's share price seems to have based out following the decline post the EU Referendum and is tantalisingly close to moving up above the 110p resistance level to signal a break-out. In the circumstances, I feel that the forthcoming half-year results, which will benefit from the two acquisitions, are likely to be just the catalyst and I rate Epwin's shares a short-term trading buy on a bid-offer spread of 107p to 109.5p. My initial target price is 140p. Buy.
