The departure of its CEO is unusual, and another warning on profits unhelpful. Here’s what analyst Edmond Jackson thinks about the situation at this UK company.
While the stock market has rebounded in 2023, we must hope a latest profit warning and CEO departure relates more to classic issues with a cyclical small-cap than wider risks.
Uckfield-based industrial fastenings firm Trifast (LSE:TRI) is a well-established operation that floated in 1993. While it has only achieved a few hundred million pounds valuation, now only £85 million, it did achieve a phenomenal run from pretty much 0p after the 2008 crisis to over 250p by mid-2018. It’s now back in a 60-70p area following Monday’s warning.
Mind that industrial fastenings – things like nuts, bolts, screws and washers - are a long-standing bellwether on the economy.
A transient hit, or portent of a wider downturn ahead?
In recent months, the stock has followed wider market sentiment, rising from a 50p low last November to 92p only last Friday.
Yesterday, however, saw a plunge back to 50p then a steady recovery to around 65p currently, after an update cited: “We have continued to see macro-economic conditions contribute to some volatility in demand patterns, and in particular have, more recently, been impacted by significant de-stocking from one of our Asian manufacturing customers.”
This represents a classic risk for an industrial supplier, when those higher up the chain batten down the hatches.
While there has been “further year-on-year revenue growth, led by the European and North American businesses...a further £10 million new contract wins” the impact on profit is serious.
Despite some price rises agreed with customers, adjusted pre-tax profit for the year to 31 March will fall from previous expectations of just over £14 million to around £9 million.
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It marks a second profit warning for Trifast, following an update last October, which guided March 2023 profit down 10% below prevailing consensus.
Sudden departure of CEO is inconsistent with this context
What most likely caused a near-halving of the share price back to 50p, was news of how the CEO of eight years would leave the company he’d been with for 23 years with immediate effect. That hardly squares with a narrative that the profit fall is chiefly macro, nor how Trifast has implemented board policy to recover margin by way of price and cost-saving actions.
Trifast’s issues appear external, also reflecting a smaller supplier’s dilemma. The CEO’s actions looked as good as any.
I am possibly scarred from the early 1990s example of BM Group, an acquisitive plant hirer whose CEO surprisingly stepped down and its stock plunged from 250p to below 100p. It then recovered to over 150p, but recession exposed underlying flaws, debt weighed on the stock below 10p, and the re-named company ended up being acquired in a 20p range.
The hard lesson for investors when a CEO suddenly departs a cyclical acquisitive company with debts is waiting for a new boss to conduct their own review. Obviously, that means missing opportunities like Trifast’s 25% rebound to as high as 67p earlier today.
Rise in debt relates to necessary inventory management
Last November’s interims to 30 September had explained a 14% rise in net debt to over £40 million as “fundamentally due to an increase in our inventory” due to foreign exchange headwinds, commodity price increases and the need to ensure continuity of supply to customers...”
(Mind, this inventory aspect also hit the March 2022 annual cash flow statement, with a £34 million movement.)
Nearly £14 million of extra debt came from an existing facility and Trifast has no short-term debt. Gross debt had, however, doubled to over £84 million and there were also nearly £15 million lease liabilities, hence exposure to rising interest rates despite £29 million cash.
This was in context of £143 million net assets on the September 2022 balance sheet, of which 31% constituted intangibles. Yet the ratio of current assets to current liabilities was a very satisfactory 3.7 times. On the basis that such numbers were reasonably reliable, net tangible assets were 72.6p a share.
Yesterday’s update cited £44 million net debt as reducing, despite net interest charges for the March 2023 year being higher than previously expected. A fourth-quarter strategic review identified annualised savings of around £5 million in the 2024 financial year.
Again, none of this squares with the CEO’s immediate departure. If things were going broadly to plan with no disagreements, the board wouldn’t have taken such a drastic step. The incumbent would at least retain an advisory role, if not stay in place until succession.
Movements in the inventory position also explain a 2022 slump in operational cash flow which remained negative - after working capital changes - at last November’s interims. So, I do not initially see reason to suspect Trifast’s profit numbers, which can be the case where there is disparity from cash flow.
Trifast - financial summary
Year end 31 Mar
|Turnover (£ million)||187.0||198||209||200||188||219|
|Operating margin (%)||9.6||9.6||8.2||2.0||4.7||5.3|
|Operating profit (£m)||17.9||19.0||17.1||4.1||8.8||11.6|
|Net profit (£m)||12.7||15.1||12.2||-0.2||5.8||9.0|
|EPS - reported (p)||10.4||12.2||9.9||-0.2||4.3||6.6|
|EPS - normalised (p)||10.3||11.9||9.9||3.9||4.7||6.9|
|Operating cashflow/share (p)||14.5||8.2||8.0||12.7||17.4||-13.1|
|Capital expenditure/share (p)||2.4||2.9||3.4||3.8||2.3||3.8|
|Free cashflow/share (p)||12.1||5.3||4.6||8.9||15.1||-16.9|
|Covered by earnings (x)||3.0||3.2||2.3||-0.2||2.7||3.1|
|Return on total capital (%)||14.6||15.0||12.9||2.3||5.4||5.7|
|Net debt (£m)||6.5||7.4||14.2||30.3||-0.5||37.5|
|Net assets (£m)||102||110||121||116||132||139|
|Net assets per share (p)||84.5||90.9||99.3||94.9||96.9||102|
Source: historic company REFS and company accounts
The table also shows operating margins declining from high-single-digit percentages to mid-single digits (although it was nearer 5% going back to 2012). Yet given a recent context of cost-input inflation, I cannot see this justifies ditching the CEO.
Near-term forward PE around 12 times if latest outlook is fair
Around £9 million pre-tax profit implies £7.3 million net profit using a 19% corporation tax rate, albeit which rises to 25% from 1 April. This equates to earnings per share (EPS) of 5.4p – though mind that is a normalised measure – hence a forward price/earnings (PE) ratio of 12 times with the stock currently around 65p.
Unless there have already been changes within consensus numbers, the market had assumed EPS of 7.5p rising to 9.0p in March 2024.
The key point is whether March 2023 turns out to be trough earnings in whatever (extent of) downturn lies ahead, and the profit impact being essentially due to a transient issue of de-stocking, which does not portend significantly lower demand.
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If that is true and the CEO departure does not reflect underlying strains, then, yes, Trifast equity is in buying terrain after a long-term mean-reversion from its 265p high in April 2018.
For now, a non-executive director has stepped into the role of interim CEO and £44 million of net debt is declared “within both facility headroom and covenant levels” despite rising interest charges.
So, there are reasons why yesterday’s drop to 50p was an over-reaction. The macro trend will be key though, with a potential outcome being the global economy festers in stagflation then traders seize quick profits.
But if a scenario is fair where the global economy continues to grow, and central banks ditch their 2% inflation targets such than circa 5% inflation helps reduce global debt over time, then it is already opportune to buy hard-hit cyclicals.
A near-term fall in dividend pay-out seems likely
Trifast’s interim dividend had risen from 0.70p to 0.75p, with earnings cover targeted in a 3 times to 4 times range.
The implication for a total dividend based on EPS of 5.4p implies a final dividend similar to the interim – such that a 1.5p total dividend would equate to a 2.3% yield. But no way does that constitute support for the stock if its narrative deteriorates.
Given the extent of debt, I think 1.5p a share is more likely the prudent way forward, relative to past consensus for 2.4p rising to 2.7p in 2024.
Director share purchases might prop the stock for now
If busy trading reveals director share buying, it should lend support. Far more significantly though, is whether the global economy avoids a slowdown as China opens up, and what might lie behind the CEO’s abrupt departure. Unless there is any issue within last September’s £103 million inventories, net assets offer reassurance. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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