Interactive Investor

Stockwatch: an emerging stock mostly resilient to Covid-19

8th January 2021 12:26

Edmond Jackson from interactive investor

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Machine maker is a quality cyclical company, although vaccine delays might spell trouble.

It tends to pay to be alert to companies guiding ahead of expectations, especially in this challenging environment. Not only does it imply well-honed operations, but also such stocks have scarcity value. 

AIM-listed Mpac (LSE:MPAC), a specialist provider of high-speed packaging machines, has issued a pre-close update in respect of its 2020 results. This suggests higher profit as a result of better-than-expected margins in the fourth quarter.

Revenues are also resilient given “Mpac serves essential healthcare, food and beverage markets, deploying digital technology to mitigate travel restrictions despite the continued headwinds from the pandemic”.

Be aware of a long history

This is the old Molins group, which originally made cigarette machines in the early 20th century. Then, as the tobacco industry matured, from the 1980s it diversified into packaging machinery in the hope of raising its price-to-earnings (PE) ratio. This was typically 8x, as tobacco was in decline.

Sentiment shifts and operational issues meant the stock had volatile times, and it was possible occasionally to lock in exceptional yields. But it was a chequered history, and after disposal of its tobacco machinery side the group was re-named Mpac in early 2018. 

On fundamentals, the stock could be described as a quality cyclical based on Mpac serving major multinationals such as 3M (NYSE:MMM), Nestle (SIX:NESN), GlaxoSmithKline (LSE:GSK), AstraZeneca (LSE:AZN), Unilever (LSE:ULVR), and Kellogg's (NYSE:K)’s – to name just a few. Yet the financial track record (see table) suggests there is much yet to be proven. Capital equipment demand is also essentially geared to the business cycle.  

If hopes persist that vaccines will effectively scotch Covid-19 by springtime – as seen on Wall Street this week - then investors will continue to dig out perceived cyclicals as an alternative to the highly-valued growth plays that benefited last year.

The spoiler would be if vaccines’ roll-out proves less effective versus new strains. This sentiment party can easily halt, and another economic downturn could still damage Mpac’s prospects.  

Yet new aspects of identity may tempt buyers   

On a chart view, the stock’s identity depends on timeline. Over four years, there is actually a growth trend – with some volatility – from 50p. You could say this is the market respecting a better-honed operation taking shape, as well as its potential. That the stock’s attaining a 475p high in response to the update is justified by momentum taking shape. 

Whereas looking back nearly 20 years, it traded up to 400p and de-rated - especially in 2004, with a circa 40p low around the 2009 crisis. I can recall hopes for the packaging side gaining traction as long ago as the early 1990s, so you might say it is no great track record how nearly 30 years later, at a 475p high, Mpac is capitalised only at £83 million. 

Yet 2019 was quite a transformational year, when the £15 million acquisition of Lambert Automation – supplying the medical and consumer healthcare markets – was made and integrated, which alters the group’s substance. It enables delivery of complete solutions including design and integration of packaging systems – such as for factory automation and process innovation. 

The 2020 numbers are set to benefit from last September’s acquisition of Switchback Group, a US supplier of packaging to the food, drink and healthcare markets – where trading has been ahead of expectations “and the first commercial synergies with other businesses within the group have been secured”. 

There is also a time-honoured lesson how smaller companies with well-established positions, whose equity is rated modestly by the market, become takeover targets.  

Modestly rated

It is possible to view this stock as having an attractive price/earnings to growth – or PEG – ratio, given expectations are for strong performance in 2021 as the acquisitions boost performance.  

I am cautious to assume one consensus forecast I have seen – of a circa 50%+ advance in normalised 2021 earnings per share (EPS) to 37.4p based on £7.6 million net profit. But unless vaccines fail and there is another global down-dip then I would pencil in a base-case 20% earnings growth scenario this year – to the low 30p area for normalised EPS.

The update sounds as if we can anticipate operating margin growth from about 6% to at least 7%, hardly exciting, but decent. 

The 2021 order book edges up to £55.5 million 

Relative to £55.4 million at end-2019 it is proverbially described as “strong,” but obviously lacks growth. I also wonder at the like-for-like comparison after September’s circa $15 million (£11 million) acquisition of Switchback, which achieved $14.2 million revenue in 2019. It is as if some of Mpac’s operations have seen a comparative decline in their order books. 

As to the effects of the pandemic, the firm says: “Our customers remain active and we continue to win original equipment and service orders with robust demand, particularly in healthcare and the Americas.” 

With more than 80% of revenue generated outside the UK, the stock offers currency diversification for the post-Brexit era. This may continue to weigh on sterling until there is better proof. 

Management says it has invested to ensure agility and positioning to exploit higher market activity when it resumes – for example brand development, virtual exhibitions for customers, investment in senior commercial leadership and digital solutions.  

So, despite the order book hardly looking exciting, there are reasons to be positive. Possibly the food packaging side can benefit from the shift to more home working (away from canteens and buying from outlets). Other boosts could be healthcare packaging for Covid-19 test kits and vaccines.  

Mpac Group - financial summary
Year end 31 Dec

  2014 2015 2016 2017 2018 2019
Turnover (£ million) 87.4 87.0 41.5 53.4 58.3 88.8
Operating margin (%) 4.8 3.3 -7.0 8.6 -13.0 6.0
Operating profit (£m) 4.2 2.9 -2.9 4.6 -7.6 5.3
Net profit (£m) -0.3 -4.1 -0.6 1.6 -6.0 5.9
EPS - reported (p) 16.9 8.7 -12.1 12.1 -30.1 29.3
EPS - normalised (p) 21.5 11.2 -2.0 -12.6 24.6 37.7
Price/earnings ratio (x)           11.1
Return on equity (%)   5.4 -6.7 6.1 -14.4 13.4
Operating cashflow/share (p) -2.6 18.4 31.4 -10.5 -4.5 25.3
Capital expenditure/share (p) 26.7 16.3 7.1 8.5 7.0 11.4
Free cashflow/share (p) -29.2 2.0 24.3 -19.1 -11.5 13.9
Dividend/share (p) 5.5 4.0 1.3 0.0 0.0 1.5
Cash (£m) 9.8 10.4 9.0 30.3 27.9 18.9
Net debt (£m) 2.1 3.2 -0.8 -29.4 -27.0 -13.2
Net assets (£m) 25.9 36.6 35.4 42.8 40.6 47.5
Net assets per share (p) 128 181 175 212 205 239

Source: historic company REFS and company accounts

Cash reserves lend scope for further development 

One estimate I have seen is for tight working capital control, such as lower debtor days, implying net cash is up from £10 million at end-September to about £14.5 million at the year-end.

The historic record on free cash flow has been volatile, but last September’s interim results showed £5.8 million net cash generated from operations versus £0.8 million investment needs and £0.4 million lease repayments. There was only £0.9 million bank debt and £4.6 million lease liabilities, in the context of £50.2 million net assets, of which 34% constituted goodwill. 

The balance sheet therefore encourages ongoing corporate development, both organically and through further acquisitions. 

Net tangible assets per share were 167p as of last June. 

Do you trust in a 2021 recovery? 

This is likely the nub issue for investment rating. Having followed the Molins to Mpac evolution over decades, yes, the group does look better honed than ever before – justifying a relative high on its stock chart.

Despite some prospective projects having become delayed due to the pandemic, no orders have been cancelled. Management reckons 75% of its prospects relate to essential consumer products, implying a decent underlying risk/reward profile. 

At the interim stage however, the board baulked at paying a dividend. The charitable view is that this is what many other companies are doing in exceptional circumstances, which does not rule out a payment on consideration of the full year results. The latest update gives no hint though. 

I tilt positively on the stock, assuming vaccination roll-out at least enables further draconian lockdowns to be avoided, and a search for decent cyclical stocks extends to small cap ones. ‘Buy’. 

  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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