Mpac (MPAC:210p), a small-cap niche packaging engineering business supplying customers in the pharmaceutical, healthcare, nutrition and beverage industries, has prompted analysts to push through material earnings upgrades for the fourth time since the company released its 2018 annual results in early March ('Mpac’s massive earnings upgrades', 5 March 2019).
In the six months to 30 June 2019, Mpac reported a 10 per cent operating margin on revenue up 62 per cent to £45.8m and delivered a pre-tax profit of £4.5m against break-even in the same six month period last year. The key drivers behind the dramatic improvement in the company’s operational performance were stronger than expected Original Equipment Manufacturer (OEM) demand, mainly in the US healthcare market, driven by contracts won in late 2018 and early 2019 which led to a 200 per cent rise in OEM sales in the region to £27.2m; improved product mix and operational efficiencies after shipping more repeat orders; and successful delivery on value contracts won last year against prudent contingencies.
Mpac also benefited from improved margins from the extended service model offered to customers, and a healthy rise in sales, too. Indeed, service order intake was up by 75 per cent, leading to a 50 per cent-plus rise in revenue. On the OEM side, order intake was up 42 per cent, and analysts estimate Mpac’s closing order book was around £35m at the end of the first half.
The directors also flagged up that the integration of the earnings-enhancing acquisition of Tadcaster-based Lambert Automation, a provider of automation solutions, is bang on track. Lambert was acquired by Mpac for £15m in May 2019 and has offered the company entry into the medical and healthcare product assembly and packaging market, as well as exposure to demand for wellness products.
To put the scale of the post-results upgrades into perspective, analyst Sanjay Jha at brokerage Panmure Gordon lifted his 2019 pre-tax profit estimate by 28 per cent to £6.8m and his earnings per share (EPS) forecast by a third to 31.2p, while analyst Paul Hill at Equity Development is even more bullish, pencilling in a five-fold rise in annual pre-tax profits to £7m on revenue up by half to £87m. This implies the shares are rated on a prospective price/earnings ratio of 7, a hefty discount to peers, and a valuation that can no longer be justified by Mpac’s legacy pension scheme liabilities.
The directors confirm that the UK’s pension scheme’s actuarial deficit halved to £35m in the triennial valuation at 30 June 2018, and is now expected to be eliminated by July 2024, five years earlier than previous forecast. Please note that the IAS 19 valuation of the UK pension scheme shows a surplus of £29.3m at 30 June 2019, and the US scheme has a £6.2m deficit. There are no financial concerns either as Mpac’s net cash position of £9.6m is set to surge to £14m (69p a share) by the end of 2019, according to Mr Jha at Panmure, thus opening up added potential for bolt-on acquisitions.
True, general market uncertainty has increased with global FMCG companies under pressure to eliminate plastic in consumer products which has led to investment delays while they develop new solutions. Order intake is also variable and sensitive to political events. But there is clearly still demand coming through from Mpac’s blue-chip client base for the high-speed, cutting-edge packaging machinery and equipment that the company supplies, underpinned by market growth of 4 to 6 per cent, and a need for large OEM customers to improve efficiency and lower costs and wastage in their production lines. I would also point out 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 upgraded my target price to 250p earlier in the summer (‘Mpac delivers third major earnings upgrade since March’, 16 July 2019), I continue to rate them a buy on a cash-adjusted PE ratio of 4.5. Mr Hill and Mr Jha have target prices of 275p (upgraded from 260p) and 300p, respectively. Buy.
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