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Morgan Advanced targets 'slow burn' gains

The advanced materials group is pursuing a clearly defined strategy to build the most promising segments of the business – but it won't be achieved overnight
November 30, 2017

When we reviewed half-year figures for Morgan Advanced Materials (MGAM) in July, we ventured that “despite a sharply lower price/earnings ratio to peers such as Victrex”, it was difficult to judge whether the previous year’s business overhaul would soon feed through to improved sales and cash generation. Four months down the track and there are now signs that performance is at last starting to register incremental improvements on the back of rationalisation measures and a repositioning of the engineering group for long-term growth.

IC TIP: Buy at 328p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points

Completion of transition to global structure

Increased emphasis on R&D

Improved debt profile

Bear points

Near-term margin pressure

Increased contribution to pension

The group produces a range of high-tech, performance materials utilised across a range of industrial applications, including seals and bearings, insulating fibres, along with crucibles for metals processing and high-technology composites – to name but a few. Profits are split more or less evenly between its thermal products division and its carbon and technical ceramics divisions, while production takes place in approximately 85 manufacturing sites across more than 30 countries.

Following on from a somewhat drab, though promising, first-half showing, organic constant currency sales growth improved to 2.3 per cent in the third quarter from July to October, compared with the same period in 2016. That rate of increase won’t set the world on fire, and some investors might have been looking for a guidance upgrade on the back of the positive third-quarter performance, but we think that this organic growth needs to be set in context. It has been achieved while the group is both streamlining its operations and transitioning to a global structure.

On a divisional basis, third-quarter sales declines in Europe and North America weighed on performance at the thermal products division, but the carbon & technical ceramics division (the main destination for increased R&D spending) revealed 5.6 per cent year-on-year growth.

The reality is that Morgan Advanced will need to grow its top line to support earnings in the short term as the group is committed to reinvestment programmes designed to generate higher growth in targeted markets. This is reflected in its determination to increase R&D investment to around 4.0 per cent of sales from 3.2 per cent over the next three to four years. So while the group headline operating margin of 11.9 per cent is nearly in line with management’s 12.0 per cent medium-term target, margins are likely to come under pressure in the near term while the group waits for the benefit from increased R&D expenditure, and a general increase in raw material prices will also weigh on profitability. Likewise, the decision to offload the global rotary transfer systems and UK electro-ceramics businesses, though justifiable from a strategic perspective, could drag on performance as they were relatively high-margin affairs.

However, the group insists that the divestments “reduce complexity and strengthen the balance sheet”; more to the point, they brought the net debt/cash profit ratio down to 1.1 at the June half-year from 1.6 a year earlier. Movement on the debt front is to be welcomed given that the group has agreed to increase its annual contribution to the plugging of its £259m pension deficit from £5m to £12m. In terms of improvements to “operational execution”, the group has delivered £3.5m of the £6m full-year target at the half-year mark; the result of improvements in procurement, practical measures relating to material yield and utilised scrap, together with increased automation.

MORGAN ADVANCED MATERIALS (MGAM) 
ORD PRICE:328pMARKET VALUE:£936m
TOUCH:327.6-328.1p12M HIGH / LOW:338p277p
FORWARD DIVIDEND YIELD:3.4%FORWARD PE RATIO:14
NET ASSET VALUE:63p**NET DEBT:75%
Year toTurnoverPre-taxEarningsDividend
31 Dec(£bn)profit (£m)per share (p)per share (p)
20140.9292.022.110.9
20150.9195.020.811.0
20160.9910522.711.0
2017*1.0210421.511.0
2018*1.0211223.511.0
% change +8+9-
Normal market size:2,000   
Matched bargain trading    
Beta:0.64   
*JPMorgan Cazenove forecasts, adjusted PTP and EPS numbers **Includes intangible assets of £220m, or 77p a share.