Uncertainty around the UK’s exit from the European Union, inflation holding back real wage growth and subdued consumer confidence are just some of the headwinds facing Epwin (EPWN:79p), a manufacturer of extrusions, mouldings and fabricated low-maintenance building products. So too is the knock on effect of sterling’s loss of value against the euro and US dollar since the end of 2015, the effect of which led to input costs pressures and a £7.6m like-for-like increase in raw material costs last year. Two-thirds of the increase was offset by price increases and operational efficiencies, but operating margins still declined by 1.2 percentage points to 7.5 per cent in 2017.
To compound matters, Entu, a company accounting for 5 per cent of Epwin’s revenue, went into administration last summer and Epwin is now supplying extruded products to the new owners at lower volumes. It also led to a £3.9m bad debt charge in Epwin’s 2017 accounts, and prompted the board to sell its window manufacturing operation which was primarily engaged in fabricating window frames for Entu. A loss of £400,000 was booked on the disposal. In addition, another one of Epwin’s customers, building products distributor SIG (SHI:137p), sold its building plastics business to a rival, GAP Plastics. SIG’s business accounted for 5 per cent of Epwin’s revenue, albeit the company still retains a share of that business through alternative distributors.
The directors have sensibly rationalised operations, including the consolidation of sealed glass unit fabrication from two sites into one in Northampton, and laid off some staff. These ‘one-off’ costs knocked a further £4.9m off reported pre-tax profits, which almost halved to £12m. Add back all the exceptional charges, and Epwin’s underlying pre-tax profits were still down by around 14 per cent to £21.1m on revenues of £298m last year. Net debt increased from £20.6m to £25.1m, albeit £3.9m of that sum represented the earn-out on two acquisitions. This didn’t impact the dividend which was raised from 6.6p to 6.69p, covered two times by underlying EPS.
However, with analysts nudging down their current year pre-tax profits and EPS estimates to £18.2m and 10.6p post the 2017 full-year results in light of the ongoing market environment, then expect a cut in the payout to 5.3p a share in 2018 based on targeted dividend cover of two times. It still means that Epwin's shares are lowly rated on less than eight times earnings estimates, and offer a 6.6 per cent prospective dividend yield. This low rating explains why (after taking into account the 2017 final payout of 4.46p a share, which has just gone ex-dividend) Epwin’s share price has held up relatively well since I rated the shares a hold, at 86p, ahead of last month’s results (‘Running the slide rule’, 19 Feb 2018).
That said, I first suggested buying Epwin’s shares, at 103p, at the time of the IPO ('Moulded for gains', 29 Jul 2014), so even after taking into account total dividends of 23.89p a share paid to date, the holding is modestly under water.
My view remains that as and when there is an improvement in the repair, maintenance and improvement (RMI) cycle, Epwin’s modest valuation will offer upside. However, I can’t ignore the 'lacklustre' market outlook, nor recent trading statements from companies operating in the sector, and the possibility of further earnings downgrades. Also, although house broker Zeus Capital is maintaining its 2018 profit forecasts following today's trading update at the company's annual meeting, there will be a greater second-half weighting to the numbers which increases risk. In the circumstances, I am calling time. Sell.
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Simon's second book Stock Picking for Profit has now been reprinted and is available to purchase online at www.ypdbooks.com for £16.95, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order.
