Shares in Mpac (MPAC:140p), a small-cap niche packaging engineering business and a constituent of my 2018 Bargain Shares portfolio, slumped from 215p to below my 156p entry level after the company warned on profits.
Mpac’s order book was £34.4m at the start 2018, up 35 per cent year-on-year, and was in line with internal budgets at the time of the annual meeting on 19 April. However, chief executive Tony Steels says it’s now around £26m as the business climate has softened in part to general economic as well as Brexit related uncertainty, leading to customers deferring machinery investment decisions. He believes these contracts will be delivered in future financial years, a view backed up by the favourable underlying growth drivers for the high-speed packaging machinery and equipment Mpac supplies to customers operating in the pharmaceutical, healthcare, nutrition and beverage industries. End markets are still expanding at around 5 per cent a year and have attractive underlying long-term growth drivers such as urbanisation, convenience and health awareness. Mpac’s core clients include Nestlé, GlaxoSmithKline, AstraZeneca, Unilever, Diageo, and Ferrero.
The real issue behind the warning related to “£1m of cost overruns on two significant, technically challenging legacy projects which will not be completed until the end of the 2018”. Mr Steels says the contracts account for around £5m of revenue in 2018. True, Mpac has achieved efficiency gains in the first half, and has taken steps to make further cost savings, but the cost overruns means that operating profit will be £1.2m lighter than management’s previous guidance. House broker Panmure Gordon now expects Mpac’s full-year adjusted pre-tax profits to rise by 24 per cent to £1.4m on 7 per cent higher revenues of £57m to lift EPS by a third to 5.6p.
Importantly, there are no more onerous contracts, which is why Equity Development’s and Panmure expect 2019 pre-tax profit to double to £2.75m and £3m, respectively, to produce EPS of 10.3p and 12.1p. After taking into account forecast closing 2018 net cash of £24m, a sum worth 119p a share, this implies that Mpac’s shares, at 140p, are rated on a cash-adjusted 2018 PE ratio of 4, falling to 2 in 2019! Investors have severely overreacted to the warning, and I rate the shares a recovery buy.
