A lot of work has been done internally to rationalise this company, cut debt and resolve the pension deficit. Analyst Edmond Jackson thinks the shares are underrated.
A gently rising stock price at Morgan Advanced Materials (LSE:MGAM), a mid-cap manufacturer of advanced ceramic and carbon materials, may reflect awareness it should not be sensitive to recession.
At 275p, it is up from a mid-June 260p low, having fallen from 323p in the first half of this year. Yet its long-term context since 2011 has been a volatile-sideways trend of circa 200p to mid-300p levels, as if it’s perceived as lacking growth prospects.
Indeed, 2022 revenue was up only 10% on 2017 (see table below) and an early 2023 cyber security incident was unfortunate, compromising first-half revenue growth to 2%, with 2-4% targeted for 2023. Second-quarter 2023 sales rebounded 9% like-for-like.
Yet the broad context is a CEO since 2015 having rationalised the group, cut debt and resolved key aspects of a pension deficit. The stock has this year succumbed to recession fears, but 2009-10 underlying performance was resilient, hence a currently modest valuation that might tempt investors to accumulate.
Risk/reward in the financial mix is positive
This group used to be known as Morgan Crucible, selling materials, components and systems across many industries and end-markets. Some 80% of revenue is derived from industrial, metals and petrochemical sectors, the remaining 20% semiconductors and healthcare. Perhaps cyclicality is mitigated by around 50% of revenue supporting consumer products.
Another angle is that around 50% of revenue is from products that need regular replacement, especially carbon and ceramic components. The replacement period can range from less than a year to a few years.
“Green” credentials exist too. Morgan’s ceramic rollers are used to make thin-film solar panels, also carbon brushes which are integral to wind turbines and power generators, plus enabling electrified rail transport.
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The financial summary table shows double-digit operating margins and return on capital; also, fundamentally strong cash generation apart from last year when a one-off £67 million pension contribution slashed the deficit below £16 million.
Morgan Advanced Materials - financial summary
Year-end 31 Dec
|Turnover (£ million)||1,001||1,034||1,050||911||951||1,112|
|Operating margin (%)||15.9||10.4||12.0||-0.2||11.9||12.7|
|Operating profit (£m)||159||107||126||-1.8||113||141|
|Net profit (£m)||108||46.3||73.1||-22.5||73.8||88.0|
|EPS - reported (p)||36.4||19.9||25.0||-8.6||23.7||30.3|
|EPS - normalised (p)||22.3||22.6||25.0||26.8||26.1||32.6|
|Operating cashflow/share (p)||20.7||34.1||42.7||38.6||37.6||6.6|
|Capital expenditure/share (p)||12.0||18.5||19.7||10.5||11.0||20.2|
|Free cashflow/share (p)||8.7||15.6||23.0||28.0||25.7||-13.6|
|Dividends per share (p)||11.0||11.0||4.0||5.5||9.1||12.0|
|Return on total capital (%)||23.9||16.4||17.7||-0.3||16.5||19.1|
|Net debt (£m)||181||181||222||156||96.5||200|
|Net assets (£m)||195||232||270||202||311||389|
|Net assets per share (p)||68.4||81.4||94.7||70.9||109||136|
Source: historic company REFS and company accounts.
Valuation basics are modest, assuming a resilient 2024. Indeed, the outlook at the 2022 results in March was robust, and a first half- year update on 29 June cited investment in faster growing markets, “continuing at pace...we are well-placed to benefit from the substantial growth opportunities that these markets present.”
While consensus expects 2023 to see an 18% fall in earnings per share (EPS) to 26.7p based on £76 million net profit, a rebound near £96 million is anticipated for 2024, generating EPS of 33.3p and a 12.8p dividend. Much obviously rests on delivery, but with the stock currently at 275p, that implies a 2024 price/earnings (PE) ratio of 8.3 times and a material 4.7% yield covered 2.6 times.
An international business with under 5% UK revenue
Morgan offers comfort versus yesterday’s UK purchasing managers’ data that renewed domestic recession fears.
The US was last year Morgan’s majority revenue source at 36%, followed by Asia (excluding China) the Middle East and Africa at 17%; China itself representing 11%; Germany 8% and rest-of-Europe 16%; Canada 4% and South America 3%.
Five product segments totalled £1.1 billion: ceramics (38%), thermal & technical (27%), electrical carbon (17%), seals & bearings (13%) and molten metal systems (5%). Excepting seals & bearings, all the divisions posted strong profit growth and adjusted operating profit at constant currency rose nearly 15%.
With the adjusted operating margin edging up 0.5% to 13.6%, profit growth beat 11% for revenue. Inflation was offset by pricing and operational improvement.
Leading market positions tempt takeover interest
Morgan is leader in thermal ceramics with a 25% global share excluding China, which has lower-quality suppliers and local demand. Technical ceramics serves more varied sectors, hence market shares range from 5% to 40% in small niches. In electrical carbon and seals & bearings, Morgan is one of four global firms sharing 60% of the market. Lastly, it has a 25% share of the molten metal systems market.
With a wide range of end-markets, Morgan has very low customer concentration – 2% maximum – helped by some 80% of sales being direct, versus a modest 20% via distributors.
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Speculatively, if interest rates had not risen, these strong global positions plus a cash generative profile would make Morgan a target for private equity acquirers while its stock is modestly rated. More contentious is whether the price of an agreed deal – to reflect also, positioning and investment for growth – would reflect full rather than fair value.
Now would be an intelligent time to approach the company, before the benefits of recent years’ work manifest financially, and while investors are weary of volatility and recession fears.
Resilience over the last ‘great recession’
Historic annual reports show normalised 2009 operating profit down a modest 18% to £89 million, while revenue actually rose 13% to £943 million. A 4.5p dividend was sustained.
Then, in 2010, normalised operating profit rebounded 24% to £110 million on revenue up 8% to £1,017 million, and the dividend edged up to 5p.
It reinforces a sense that the group is not overtly cyclical; and helps explain a modest 11% revenue drop in 2020 when Covid struck, then a 10% rebound in 2021.
Regarding financial risk, should the effect of higher interest rates eventually bear on economies and firms, Morgan’s end-2022 balance sheet had £149 million net bank debt and £52 million lease liabilities generating a £9 million annual interest charge. This took only 6% of operating profit, but the charge will be higher this year given debt rose 53% to £266 million – for example in aid of £58 million spent on equipment and software – and it appears around 40% of the debt is sensitive to interest rate changes.
Even so, the five-year context has involved net debt falling nearly a fifth despite making a total £120 million dividends plus making the pension payments.
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Due to historic acquisitions, net assets constitute 46% intangibles, hence end-2022 net tangible assets per share of 84p.
In no way does the balance sheet represent a material risk liable to impact the stock should trading deteriorate.
Mind, there’s a likely exceptional cost of £35 million to deal with the cyber incident, which should partly reflect useful upgrading, hence may simply be bringing such cost forward.
Pension drain looks to have been resolved
This has probably been another factor behind a volatile-sideways stock trend. Over the last five years, some £160 million of pension deficit payments have been made, a £67 million lump sum last year being additional to around £17 million annually.
As of end-2022, this left a near £16 million deficit, with minimal payments expected going forwards.
It will support stronger free cash flow, hence more likely resilient dividends should revenue soften temporarily, while also retaining capability for acquisitions.
Notwithstanding recession risks, Morgan therefore offers a better platform for growing shareholder value. Revenues being adjusted towards growth markets, a higher margin despite recent inflation, broadly lower financial leverage and no pension cash drain.
In a cautious financial environment, the market is essentially treating Morgan as another industrial cyclical, which looks to underrate prospects. If consensus for 2024 is achieved and a 12 times PE applies, a 400p stock price target implies potentially 45% upside on a two-year investment view. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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