Mpac shares have rallied – but it's still on a 35% discount

Mpac (MPAC:325p), a specialist provider of automated packaging systems, rebuilt margins and doubled annual profits in the second half of 2023.

True, the first-half operating margin of 4.2 per cent would have been materially higher if Mpac had capitalised its work on the Norwegian battery cell production line of Freyr Battery (US:FREY) rather than expensing it ahead of the second-half delivery. Freyr is a major developer of clean, next-generation battery cell production capacity. The delivery of that contract is well worth noting given that other blue-chip clean energy customers have been monitoring Mpac’s progress. It would be surprising if the group doesn’t land further clean energy/battery contracts in due course.

Furthermore, the directors are guiding investors to expect a doubling of pre-tax profit to £7mn when the group reports results in mid-March 2024, in line with market expectations. It means that second-half operating margin will have more than doubled to 9.6 per cent on slightly higher revenue of £54mn to deliver pre-tax profit of £5.1mn, materially higher than the £1.9mn first-half pre-tax profit. On this basis, analysts at both Shore Capital and Equity Development pencil in earnings per share (EPS) of 26p.

A key driver behind the improved margin performance has been strong order intake from the growth sectors in which Mpac operates (healthcare, food and beverage, and energy). Contract wins have driven up the closing order book by 11 per cent to £75mn, a high percentage of which is higher-margin healthcare work such as automated packaging equipment for contact lenses, intraocular lenses that are surgically implanted and glucose management products. The strong order intake provides good coverage for another year of growth, with consensus estimates suggesting 11 per cent higher revenue in 2024 (£116mn to £120mn range).

Smart technologies drive service revenue

Mpac is also benefiting from a rebound in higher-margin service revenue, which accounts for a third of group revenue. The group has an impressive installed base of around 4,000 machines across 80 countries and boasts a blue-chip client base, with the top five customers generating around 35 per cent of group revenue. The increasing contribution from the service side of the business reflects management’s proactive approach to delivering customer upgrades and retrofits on equipment, effectively carrying out health checks that generate new business. It’s a win-win situation for all parties.

That’s because by introducing smart technologies into their legacy equipment, customers benefit from improved efficiency and far less costly downtime of their equipment, thus reducing their operating costs and enhancing return on investment. According to Deloitte, manufacturers using predictive maintenance (rather than preventative and reactive) can increase machine life by 25-40 per cent, reduce downtime by 30-50 per cent and slash maintenance costs by 25 per cent.

Analysts at brokerage Shore Capital believe this area presents a growing opportunity for Mpac as a core service provider and manufacturing partner, noting that research and advisory company Forrester estimates that less than half of global manufacturers currently use predictive maintenance technologies to reduce operational costs. Given that the marginal benefits of a smart technology equipment upgrade far outweigh the marginal cost, it is only reasonable to expect even more companies to retrofit their equipment with data-driven technology. Mpac is well placed to benefit.

Deep value opportunity

The group’s progress has not been lost on investors, hence why Mpac’s share price has rallied 71 per cent since I reiterated my buy call at the interim results (‘Mpac’s CEO is bullish and rightly so’, 8 September 2023). However, prospects of the group delivering 50 per cent higher current year pre-tax profit and EPS of £10.5mn and 38.7p, respectively, are still being underrated with the shares trading on a forward PE ratio of 8.4, a discount of 35 per cent to Liberum’s median rating of peers. Importantly, given past disappointments, the bumper order book and a robust service business de-risk the earnings risk.

Admittedly, it’s been a rollercoaster ride since I included the shares, at 156p, in my market-beating 2018 Bargain Shares portfolio, albeit a 105 per cent total return (TR) in a six-year holding period compares favourably with the 24 per cent loss on the FTSE Aim All-Share TR index. More importantly, with margins set to continue rebounding, and order intake de-risking revenue forecasts, the ongoing share price rally has potential to achieve analysts' target prices of 500p (Liberum), 485p (Equity Development) and 490p (Shore Capital). Buy.

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