Mpac delivers third major earnings upgrade since March

At the time of the full-year results, 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 from £58m to £63m, highlighting the operational gearing of the business as a high proportion of incremental gross margin earned drops through to operating profit as sales rise. House broker Panmure Gordon had an identical profit forecast. It wasn’t a one-off upgrade either.

In May this year, Mpac announced the earnings-enhancing £15m acquisition of Tadcaster-based Lambert Automation, a provider of automation solutions that has offered the company an entry into the medical and healthcare product assembly and packaging market, and exposure to demand for wellness products ('Bargain shares: small-cap buying opportunities', 7 May 2019). Following the acquisition, both Equity Development and Panmure upgraded their 2019 pre-tax profit estimates by a third to £4.6m, and raised their 2020 estimates by around a half to £6.6m. On this basis, Panmure Gordon expected adjusted EPS to more than quadruple from 4.5p in 2018 to 19.9p in 2019, rising to 28.6p in 2020.

But analysts at both equity research firms have been forced to upgrade their estimates yet again after Mpac announced this morning that demand in the US healthcare market has been stronger than expected, good progress has been made on delivering the significant value contracts won last year against prudent contingencies, and the company’s operating margin is benefiting from the extended service model offered to customers.The directors also point out that the integration of Lambert is bang on track to deliver the financial results that underpinned the hefty earnings upgrades in May.

As a result, both Equity Development and Panmure Gordon have raised their 2019 revenue estimates by 6 per cent to £85m. Moreover, reflecting a better operating margin earned on these sales, analysts have upgraded their 2019 pre-tax profit estimate from £4.6m to £5.5m, implying a quadrupling of pre-tax profits year-on-year. On this basis, Panmure is pencilling in adjusted earnings per share (EPS) of 23.6p in 2019, up from 4.5p in 2018, rising to 28.6p in 2020 on the assumption that Mpac delivers 2020 pre-tax profits of £6.6m on revenue of £95m. Equity Development has almost identical revenue and pre-tax profit estimates.

This positive news flow follows on from last month’s announcement that the actuarial deficit in the legacy Molins UK Pension Fund scheme has been cut in half from £69.9m at 30 June 2015 to £35.2m at 30 June 2018 on a technical provision basis. Analyst Sanjay Jha at house broker Panmure believes that the actuarial deficit is expected to be eliminated completely by July 2024, five years earlier than under the previous valuation. That’s good news for Mpac’s shareholders.

Unwarranted earnings discount to UK engineering peers

After taking into account the £15m cash consideration paid for Lambert in May, analyst Paul Hill at Equity Development believes that Mpac will end this year with net cash of £9.5m, a sum worth 47p a share based on 20.17m shares in issue.

This means that not only are Mpac’s shares trading on a miserly current year price/earnings (PE) ratio of 8, and on a cash-adjusted basis the PE ratio is only 6. That’s an incredibly low earnings multiple to pay for  a company that is on course to lift EPS by 42 per cent from 23.6p in 2019 to 33.7p in 2021 based on Mpac delivering £7.7m of pre-tax profit on revenues of £101m in 2021, according to analyst Sanjay Jha at Panmure. In fact, Mpac’s forward PE ratio for 2019 is half the UK engineering sector average.

Furthermore, I wouldn’t rule out further earnings upgrades emerging in due course given that ongoing demand from Mpac’s blue-chip client base for the high-speed, cutting-edge packaging machinery and equipment that the company supplies is being underpinned by underlying market growth of 5 per cent, and a need for large original equipment (OEM) customers to improve efficiency and lower costs and wastage in their production lines. I would also flag up that Mpac earns more than 80 per cent of annual revenues outside the UK, so its revenue stream offers a natural hedge against further sterling weakness.

So, having suggested buying Mpac’s shares, at 156p, in my market-beating 2018 Bargain Shares portfolio, and after taking into account the pension deficit, I feel that shares have strong potential to surpass my previous target price of 225p as more investors cotton on to the strong earnings upgrade momentum that is unfolding. In fact, I have upgraded my target price to 250p. I am not the only one as Panmure have raised their target this morning from 259p to 300p and Equity Development have upgraded their target from 245p to 260p. Strong buy.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.