- First-half operating profit declines 75 per cent to £1.2mn due to supply chain issues and inflationary pressures
- Working capital build to mitigate impact and cost-saving measures put in place
- Prospects of large order from Freyr Battery
Half-year results from small-cap niche packaging engineering group Mpac (MPAC:255p) mirror the pre-close trading update over the summer which resulted in a savage profit warning (‘Bargain Shares: Recovery plays’, 19 July 2022).
The issue is not Mpac’s end markets, which remain in fine fettle, as highlighted by a slightly higher closing order book of £62.6mn and a 15 per cent increase in first-half revenue to £50.6mn. As a specialist provider of automated packaging systems, the group occupies a prominent position in the manufacturing and distribution chain, serving customers in healthcare (48 per cent of 2021 revenue), food & beverages (48 per cent) and pharmaceuticals (5 per cent). These industries need to meet regulatory requirements at high levels of volume output for sealed, packaged and packed product, and with an increasing focus on artificial intelligence and environmentally-friendly solutions.
The issues Mpac has faced are sourcing critical, customer-specified electronic components, and mitigating disruptions in supply chains, which have delayed client build times or deliveries, and led to inflationary pressures. This explains the decline in the group’s gross margin from 33.4 per cent to 21.1 per cent in the first half of 2022 and the resulting £4.1mn fall in gross profit, hence the 75 per cent reversal in operating profit to £1.2mn.
Although operational challenges are expected to continue for the remainder of 2022, before easing in 2023, Mpac’s management has been proactive in implementing mitigation measures. These include securing alternative sources of electronic component supply, and implementing price increase and cost-savings initiatives. There has been working capital build as a result, but with net cash of £9.5mn and £20mn of HSBC debt facilities to tap the group remains well funded.
It is also in advanced discussions regarding an exclusive commercial framework agreement with Freyr Battery (US:FREY), a major developer of clean, next-generation battery cell production capacity, for the supply of casting and unit cell assembly equipment to its battery cell production line in Norway. Bearing this in mind, Mpac has made good progress in the development of the customer qualification line, which is expected to be delivered in December 2022.
The key for investors is whether Mpac’s management can get its gross margin back above 29 per cent, the average for the previous six half years before last summer’s warning. If it can, then house broker Shore Capital’s forecasts, which suggest this year’s pre-tax profits will decline from £8.6mn to £3.5mn on flat revenue of £95mn before recovering to £7.1mn on revenue of £106mn in 2023, have mileage. On this basis, the forward price/earnings (PE) ratios are 18.6 (2022) and 9.3 (2023).
Equity Development is taking a more cautious stance, predicting a recovery in pre-tax profit to £5.8mn in 2023, but this still implies the shares are only trading on a forward PE ratio of 12. Either way, at such depressed levels, and trading 6 per cent above my last buy call, the shares still rate as a recovery buy.
Simon Thompson was named Journalist of the Year at the 2022 Small Cap Awards.
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