Epwin Group Plc (LON:EPWN) interim results had been well flagged in the pre-close trading update (16thAugust) but importantly today’s announcement provides detail with regards the issues with the two largest customers. Both situations are on-going but developments, particularly with entu, offer the opportunity to assess the likely impact in more detail. This leads to cuts in pre-tax profit of c.7%, c.19% and c.13% in FY17, FY18 and FY19, respectively. New forecasts are a best estimate of the potential impact and ZC feel this is a robust and realistic assessment of the situation. A better outcome might be forthcoming should entu trade well under new ownership and the impact from the new owner of SIG’s distribution network is less than expected. Valuation post today’s downgrade is 5.9x FY17 earnings increasing to 6.7x in FY18, the trough year for earnings. The shares yield 9.1% with free cash flow cover of 1.1x in the current year increasing to 1.5x in FY18.
Scale of customer risk beginning to be quantified – Today’s statement provides more information with regards the potential fallout from the issues with Epwin’s two largest customers. FY18 sees the material impact and should be viewed as a transitional year before a solid recovery in profitability in FY19, predicated on cost savings. In FY18 we cut revenue by 8% to £279.1m (prev. £303.8m) leading to a 19% cut to profit before tax. This assumes the benefit from additional restructuring due to the potential loss of volume does not start coming through until FY19. Despite the difficult trading environment, the interim dividend increases by 1.4%. The FY17 assumption is pared back to 1.5% growth followed by 1% in both FY19 and FY20, previously 3% growth had been assumed in each year.
Cashflow remains strong – After today’s cut to forecasts Epwin will generate c. £10.0m of free cash flow increasing to £14.0m in FY19. This is against cash dividend payments, on the new lowered growth, of c. £9.5m offering 1.1x to 1.5x cover in both years. With estimated finance costs of c.£1.0m the cash generation provides confidence in the financial strength of the business.
Results and current trading – Revenue growth of 4.6% was underpinned by the National Plastics acquisition last year. Organically, the higher margin extrusion business saw small growth. We estimate that the Fabrication division was marginally down yoy. Management had alluded to cost pressures, particularly in resin and hardware, acting as a headwind to profitability earlier in the year and this has manifested itself in operating margins declining 80bps to 7.4%. The operating environment remains difficult and competitive making it difficult to attain price increases to offset cost input pressures.
Valuation – The shares look to be discounting a great deal of the customer risk having declined to 72.75p since the initial announcement. Trading on 5.9x FY18 earnings and yielding 9%.
