Interactive Investor

Stockwatch: a successful small-cap exporter defying Brexit fears

14th April 2023 11:16

by Edmond Jackson from interactive investor

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This company has a strong track record and, despite some downside risk in the months ahead, analyst Edmond Jackson believes its strengths will show through.

UK positivity

The small-cap shares in Churchill China (LSE:CHH), a £144 million ceramics manufacturer for hospitality and retail sectors, are a good example of how consumer-facing plays are twitching higher on hopes that a serious recession can be avoided. 

Yesterday, and in response to annual results for 2022, Churchill rose nearly 6% to 1,310p despite this representing nearly 20 times the adjusted earnings per share outcome, a 6% beat to expectations at 67p. Assuming the chairman’s pitch about how “we look forward to an improved performance in 2024” is accurate, and if, say, consensus for 75p earnings per share (EPS) this year turns out to be nearer 80p, the multiple drops to just over 16 times. 

I think this shows how market confidence that global economies will avoid much recession is building – possibly a mild downturn later this year in the UK if interest rates have to keep edging up to contain inflation. Small-caps are a relatively powerful indicator of change in confidence either way, due to less liquidity and the businesses often being quite sensitive to the economy. 

Not surprisingly, with its stock rising again, Churchill’s prospective dividend yield has slipped below 3% - hardly supportive if the story changes say from mid-year – with earnings cover of two times about as low as it probably should be. 

Chart view implies a sense of medium-term ‘buy’  

Churchill’s steadily accumulating, long-term chart since flotation at 280p in 1994 suggests a quality stock you should not be deterred from by high nominal price. It follows from just 11 million shares in issue, after all this time, signalling a successful cash-generative business that has not had to dilute holders. 

Having tested 200p in late 2019, there have since been two big swings – down in response to Covid, back up on expectations for spending on the home during lockdowns, then an exit from growth and small-cap stocks from September 2021 – that snowballed on fears for discretionary spending under higher interest rates.   

Churchill China chart April 2023

Source: TradingView. Past performance is not a guide to future performance.

Valuation parameters aside, if the economic narrative does prove more resilient than was feared later last year, the current chart uptick signals “buy”. 

Long-term success with strong export profile 

Churchill’s history of manufacturing fine ceramic tableware goes back to the late 18th century, its products earning a reputation for strength and durability, especially for hospitality markets.  

In retail, it has worked with varied licensing partners such as Jamie Oliver, Disney and the Royal Horticultural Society. 

Defying the Confederation of British Industry’s endless moaning about Brexit, here is a company that grew continental European sales by 32% last year, near £32 million or 39% of total group revenue. Export represented 60% of the overall total. 

Churchill says: “Good progress was made in all our major market sectors and Europe continues to be the market reporting the highest level of added value product sales, supporting our continued focus on that region. We expect to increase the level of new product launches in 2023.” 

The US being the next most important market, at 11% of group total, I similarly find it curious how we are told that the UK is in a commercial mess, with the US given “no trade the back of the queue,” yet Churchill grew US sales by 36%. 

A flippant observation is Churchill showing what can be achieved with determination versus the critics. More seriously, you wonder just how decisive international trade deals are for export success.    

Interestingly, also, is all geographic revenues having increased by mid 30% metrics – as if macro considerations of consumer and business demand are crucial. 

Succeeding to contain costs including energy 

An operating margin slightly over 11% is respectable, especially amid concerns generally as to rising costs. It was, however, in the mid-teens, pre-Covid (see table).  

Churchill says: “The early part of the year saw significant energy and material price rises alongside the existing issue of reduced availability. More recently we have seen some impact from uncertainty arising from the impact of higher costs of living in certain markets.” 

Labour availability also weighed over the year, but margins showed a normal rise in the second half, management also claiming better efficiency so far in 2023. Interestingly, while exceptional income benefited from £550,000 Covid rate relief rate, £415,000 of this was returned to employees by way of cost-of-living support (see note two to the accounts, exceptional net income). 

Energy input costs for ceramics manufacturing is an obvious concern. Management says:“Our hedging position continues to reduce volatility within energy pricing. While we will see some benefit from lower prices earlier in 2023, the principal benefit from this will be secured in the second half of the year.” 

It sounds reassuring and a help to operational gearing – another reason Churchill equity is rising despite looking superficially fully-valued. It is shown by group revenue up 36% near £83 million, yet profit measures advancing around 50% and EPS, also the dividend per share by around 77%. 

A slight niggle is operational cash flow down 54% below £5 million as capital expenditure rose 27% near a similar amount. This is explained by inventory investment to ensure supplies and enable longer production runs, both to the benefit of customer service. 

Looking back a few years, the table shows regular material capital spending – for example, ceramics groups need to keep evolving new designs – although this has not compromised a good record of free cash flow generation. 

Churchill China - financial summary
Year end 31 Dec

Turnover (£ million)51.153.557.567.536.460.882.5
Operating profit (£m)
Net profit (£m)
Operating margin (%)12.514.515.116.80.510.111.7
Reported earnings/share (p)47.858.
Normalised earnings/share (p)47.755.470.780.85.537.866.9
Operational cashflow/share (p)54.359.863.786.49.088.551.8
Capital expenditure/share (p)22.720.019.050.922.334.042.0
Free cashflow/share (p)31.639.844.735.5-13.354.59.8
Dividend per share (p)21.124.629.
Covered by earnings (x)
Return on total capital (%)16.819.219.723.40.311.813.8
Cash (£m)12.715.617.415.614.015.09.6
Net debt (£m)-12.7-15.6-17.4-15.2-13.6-18.6-9.1
Net assets (£m)28.633.938.041.837.142.756.6
Net assets per share (p)261309347381337387515

Source: historic company REFS and company accounts

A good start to 2023 accords with macroeconomic data 

First quarter targets have been met in a context of 1.2% UK retail growth during February. It suggests consumers at least are willing to spend despite double-digit inflation and rising interest rates working their way through the system.  

Mind, this may change in the UK (40% of group revenue) if inflation does not materially fall and there is at least one further rate rise.  

Also, how the bulk of Churchill’s revenues relate to capital spending decisions in the hospitality trade, rather than retail. It is hard to find this split specified – disclosure focuses on ceramics versus materials – but it was said retail sales fell 33% to represent less than 5% of ceramics revenues “albeit in line with prioritising hospitality products”. 

The group’s healthy start to 2022 may also be supported by UK gross domestic product edging up 0.1% in the three months to end-February, which abates recessionary fears – unless damage from strikes will manifest in April’s figures.  

A median view, also respecting the Bank of England’s narrative, is slightly higher interest rates causing mild recession later this year, in which case current optimism may abate. 

You therefore take your view on the economy as to stock timing. 

No financial debt just £477K leases 

Churchill is thus barely exposed to interest rate increases, if curious then how £148K interest costs appear at all. Note three of the accounts explains this as £113K of interest due to the pension scheme with leases of just £35K. 

Funding of the defined benefit pension scheme has, however, improved substantially over the year - swinging from a £7 million deficit to £7 million surplus.  

On a two-year view, I think Churchill’s strengths will show through hence – and despite some downside risk, sometime in months ahead – Buy.   

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

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