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Cash in on Bunzl weakness

The group offers steady cash conversion and a growing dividend
November 8, 2018

Bunzl is a solid business that generates strong levels of cash from its diversified portfolio of businesses. Its performance and track record tend to be reflected in the share price, but recent weakness has created a buying opportunity.

IC TIP: Buy at 2267p
Tip style
Income
Risk rating
Low
Timescale
Long Term
Bull points

Cheap against history

Strong cash conversion

Track record of organic growth

Strong acquisition pipeline

Bear points

Potential threat from Amazon business

Recent margin reductions

The group is a distribution and outsourcing business that offers a wide range of products, such as cleaning materials, bandages, personal protection equipment and food packaging and labelling. It operates across many markets, including healthcare, retail and safety, but food service and grocery are the two largest, accounting for a combined 56 per cent of 2017 revenues. North America is by far its largest geography and was the source of 59 per cent of revenues last year.

Margin pressure and the existential threat of Amazon have been a cause of dull recent share price performance. And investors' concerns have not been helped by currency movements that analysts expect to weaken results by about 4 per cent this year.

On the margin front, a grocery customer in North America substantially increased its business with Bunzl in 2017, but on keener terms. This added to cost pressures associated with rising US wages and customer consolidation, which have put downward pressure on profitability. In the UK, political and economic uncertainty related to Brexit has weighed on margins. What's more, the rising oil price means input costs need to be carefully managed. In response, the company has been taking steps to reduce costs, such as moving US food service operations into a newer, more efficient warehouse. Margins have yet to turn around, with underlying operating margins flat in the first half of 2018 and unadjusted operating margins slightly lower. However, some of the pressures on profitability look temporary and the group's scale should aid it in mitigating other pressures.

The other challenge weighing on investor sentiment is the threat from Amazon Business, the internet giant’s foray into business supplies. Shares in Bunzl dropped sharply last November after a note from Morgan Stanley said the group was “vulnerable”. However, Amazon’s offering looks more likely to apply to smaller customers, and third parties fulfil 80 per cent of sales. Bunzl, on the other hand, focuses more on larger, complex customers who require a range of items across a number of sites. Taken from this perspective, Bunzl looks well-placed to defend its business.

We think concerns about prospects are overstated and have resulted in investors ignoring the crux of Bunzl’s appeal – its steady growth and cash generation. Management targets a minimum cash conversion – calculated using operating cash flow as a percentage of adjusted operating profit – of 90 per cent. It has comfortably met this target every year since 2004, with an average of 97 per cent.

The company uses its cash for paying dividends and making acquisitions. Here, too, the track record speaks for itself. Dividends have risen every year for the past 25 years, with a compound annual growth rate exceeding 10 per cent, while maintaining dividend cover around 2.5 times adjusted earnings per share (EPS).

The group’s growth strategy focuses on a combination of organic and acquisitive growth and investment in efficiency savings. Many of the companies in the group’s sectors are family-owned and so rely on an event such as a retirement to trigger sale discussions. Management usually declines to offer a target figure for acquisitions for this reason, but it has become more acquisitive in recent years, with the average number of deals per year more than doubling to 14.6 for the years 2011-17, from seven between 2004 and 2010.

BUNZL (BNZL)   
ORD PRICE:2,267pMARKET VALUE:£7.63bn
TOUCH:2,265-2,267p12M HIGH / LOW:2,442p1,918p
FORWARD DIVIDEND YIELD:2.3%FORWARD PE RATIO:17
NET ASSET VALUE:437p*NET DEBT:100%
Year to 31 DecTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20156.4941191.038.0
20167.4347810642.0
20178.5854311946.0
2018**9.0555812849.0
2019**9.1557713052.0
% change+1+3+2+6
Normal market size:1,000   
Matched bargain trading    
Beta:0.65   

*Includes intangible assets of £2.37bn, or 703p a share

**Shore Capital forecasts, adjusted PTP and EPS figures