Cash out of De La Rue

De La Rue is made up of three businesses, the largest of which is banknotes. Sales here tend to be lumpy and profitability can be significantly affected by changes in raw material prices. In the first half, for instance, an increase in the cotton price – a key ingredient in 'paper' bank notes – was a major contributor to a fall in the division's operating margin from 10.5 per cent to 9 per cent. That said, the 'lumpy' nature of orders saw a 36 per cent surge in the division's revenue to £185m, leaving operating profit up 16 per cent to £16.6m. The second half is expected to be in line with last year.

Such trading vicissitudes, along with the capital intensity of note printing, helps explain the company's desire to reduce its reliance on this part of the business while slimming down the asset base. Investors concerned about the potential emergence of cashless societies may also welcome the move. There has been noteworthy progress, with the company closing two printing lines yet still producing 7 per cent more notes during its first half. Meanwhile, in February a 90 per cent share in two paper mills was sold for £61m. However, the disposal has come at a cost to the bottom line, with broker Investec downgrading its 2019 EPS forecasts by 14 per cent as a result of the sale.

The question for shareholders is how quickly these profits can be replaced, and the failure of the re-bid for the UK passport contract, at a £4m cost, highlights the challenges in De La Rue's niche, but still competitive, marketplace. And while investment in innovation, such as polymer note printing and the group's DLR analytics product, holds promise, the required research and development spending is holding back margins. Indeed, in the first half operating profits at identity solutions – the manufacture of passports and other identity products – were flat at £5.4m despite 3 per cent growth in sales to £39.4m. Meanwhile, a 20 per cent sales surge to £20.2m at product authentication – anti-counterfeiting features and labels – produced a relatively muted 7 per cent rise in operating profit to £4.6m.

Faith in the group's ability to deliver growth has also been knocked by management's guidance in March that full-year profit will be at the lower end of expectations, and the surprise announcement in March of the departure of the finance director Jitesh Sodha later this year. 

Balance sheet improvements should help underpin expectations that the attractive dividend will be maintained. Proceeds from the recent disposal reduces net debt to about £55m and a change to the inflation rate associated with the pension scheme is shaving about £70m from a deficit that previously stood at £157m at the half-year stage.