If there were any doubts that Mpac (MPAC:145p), a small-cap niche packaging engineering business supplying customers in the pharmaceutical, healthcare, nutrition and beverage industries, is back on track then this week’s annual results put them firmly to rest.
Having delivered underlying pre-tax profit of £1.4m on revenue of £58.3m, up from £1.1m and £53.4m, respectively, in 2017, and closed 2018 with a 16 per cent higher year-on-year closing order book of £39.8m for delivery this year, analyst Paul Hill at Equity Development raised his 2019 pre-tax profit forecast by 17 per cent to £3.5m based on annual revenues rising to £63m. Panmure Gordon has an identical profit forecast. On that basis, expect earnings per share (EPS) to almost treble from 4.5p in 2018 to 13p in 2019.
The upgraded forecasts have substance. That’s because chief executive Tony Steels says that after taking into account Mpac’s monthly service revenues then this year’s projected sales target is almost fully covered. Also, Mpac was impacted by legacy contract issues in the first half of 2018, which led to break-even on an underlying basis after the company took a £1m hit to profits, but it subsequently delivered £1.4m of operating profit in the second half on a margin of 4.7 per cent. Moreover, as revenues scale up then expect operating margins to expand to 5.5 per cent this year.
Investors will have noted a much improved cash-flow performance, too, with second-half free cash flow of £4m reversing a first-half outflow of £3.2m to boost net cash by £2.1m to £27m. This gives the board ample firepower to make earnings-accretive acquisitions.
Importantly, demand from Mpac’s blue-chip client base for the high-speed, cutting-edge packaging machinery and equipment that the company supplies is well underpinned by underlying market growth of 5 per cent, and an ongoing need for large original equipment (OEM) customers to improve efficiency and lower costs and wastage in their production lines.
Demand is particularly strong in the US, a region that accounted for almost two-fifths of Mpac’s turnover last year, and is being driven by new technology. Indeed, Mpac has been winning new contracts following the launch of several new products at a major industry exhibition in Chicago as clients increasingly look to “future proof their investment”. That’s worth noting because 80 per cent of Mpac’s sales are derived from outside the UK, thus offering exposure to faster-growing overseas markets.
Admittedly, Mpac’s legacy pension situation complicates matters. The US scheme has a £6.2m deficit, and although the UK pension scheme is in surplus on an IAS19 basis (assets of £398m exceed liabilities of £377m), tiny changes in bond yields can have a major impact on the pension liabilities. Also, the assumptions used in actuarial valuations are far more conservative than for IAS19. This explains why analysts believe the current actuarial deficit could be around £50m. Mpac is making a £1.9m payment into the UK scheme to bridge the funding gap, and has agreed to pay additional payments if annual operating profit exceeds £5.5m. Please note that I took into account Mpac’s pension schemes when I suggested buying the shares, at 156p, in my 2018 Bargain Shares Portfolio.
True, the shares are down 7 per cent in the past 13 months, a fallout from the legacy contract issues in the first half of 2018. However, what’s clear to me and to Mr Steels, whom I interviewed prior to publishing this article, is that Mpac’s organic growth trajectory is back on track. That’s worth considering given the shares trade on a small premium to Mpac’s cash pile, so the potential to deliver an increasingly level of profitability on rising sales to a blue-chip client base is being woefully underpriced. In fact, my target price of 225p offers more than 50 per cent potential upside. Strong buy.
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