Interactive Investor

Stockwatch: is there value in this small company with a big pension?

16th June 2023 10:35

Edmond Jackson from interactive investor

If this business can muddle through the adjustment period to higher interest rates, then the stock represents good value, argues analyst Edmond Jackson.

Have you heard the adage: “pension fund with a company attached”? It typically applies to BT Group (LSE:BT.A) but I suspect also Norcros (LSE:NXR) – a near £160 million supplier of bathroom and kitchen products, operating in South Africa besides the UK. 

Norcros has just posted record annual results to 31 March, with numbers at the top end of expectations and the chair asserting: “the group’s business model and strategy have proven to be highly effective through a sustained period of macroeconomic uncertainty.” 

It is known for brands such as Triton showers, Vado taps, Croydex bathroom accessories and Johnson Tiles – the leading UK maker of ceramic tiles. A year ago, Norcros acquired Grant Westfield – a leading maker of waterproof bathroom panels – for £80 million, which has aided latest strong numbers. 

Yet its stock barely managed a 1% rise to 178p, where it trades on a price/earnings (PE) multiple below five times - based on normalised earnings per share (EPS) of 37.4p. That is before subtracting acquisition and other costs, and consensus expects 32p normalised EPS this year, then 30p in March 2024.  

Some easing back of underlying performance seems inevitable given the era of ultra-low interest rates is over – given its upshot for discretionary spending on home interiors.

A 10.2p total dividend is covered 3.6 times and well-backed by cash flow. Consensus expects a similar easing as EPS, to about 9.6p, hence a 5.4% prospective yield.   

Going back over 20 years, I recall Norcros appealing similarly on a modest valuation; yet after all this time it remains a sub-£200 million small-cap company.

Norcros - financial summary
Year end 31 Mar

Turnover (£ million)222236271300331342324396441
Operating margin (%)
Operating profit (£m)10.216.716.819.625.117.824.936.227.5
Net profit (£m)
EPS - reported (p)13.020.713.314.223.913.518.631.218.8
EPS - normalised (p)18.823.517.718.628.021.822.438.237.4
Operating cashflow/share (p)23.226.435.625.135.632.166.017.727.4
Capital expenditure/share (p)11.310.512.511.
Free cashflow/share (p)11.915.923.114.028.726.262.511.120.7
Dividend/share (p)
Earnings cover (x)
Cash (£m)5.65.937.525.827.247.328.327.429.0
Net debt (£m)14.232.523.
Net assets (£m)52.747.656.6105126104148200210
Net assets per share (p)87.477.391.5130156130184247235

Source: Historic company REFS and company accounts.

What exactly is the catch here? 

Around the millennium or earlier, the excuse appeared to be South Africa being politically high risk. Business there nowadays constitute a third of group revenue. 

Since I have wrestled with BT’s liabilities and also gained better awareness of pension fund accounting, I suspect the real drag here is £285 million of pension liabilities. 

The results proclaim a £15 million pension surplus, but that is an accounting valuation, whereas a more vital actuarial reckoning in 2021 required “deficit repair contributions” of £3.8 million from April 2022 to March 2027. These are also to rise with inflation, if capped at 5%. 

It is not hugely burdensome in a good year. Net cash generated from operations has soared 68% to £24.5 million. But if a recession ensues after Norcros bought Grant Westfield with debt, such liabilities become more awkward. 

The nub of the problem here seems the pension fund being required to support a 7.5% annual return from its near £380 million assets. While members will die off and reduce demands on the scheme, it could continue to absorb cash flow after 2027. This is all highly conjectural given the murkiness of assumptions behind pension valuation, which is a pity because Norcros’ businesses are good. 

I suspect this is why it looks a sitting duck for takeover – but has done so for years. 

Howden shows this sector doing well in challenged times 

Yes, home refurbishment items (or indeed in new-build) are interest rate-sensitive. The Bank of England has hinted at rates going higher, similarly the Federal Reserve guided for another two 25 basis-point moves by year-end at its meeting last Wednesday. 

But I recall in the wake of the 2008 crisis, Howden Joinery (LSE:HWDN) was a surprise out-performer. This kitchen supplier (to the trade than retail customers) was assumed to face tough times and its stock traded at a 13p low in January 2009. But people decided to spend on improving their homes rather than take on the extra financial challenge of moving house. That helped Howden equity rise to over 500p by end-2015. It even reached 940p by August 2021 after home improvements were buoyed by Covid. 

Like Norcros, Howden equity has recently been hit by the sea-change in interest rates, currently around 680p on a forward PE of 13 times and a near 3% yield.  

Yet it is not necessary for Norcros to emulate such progress in years ahead. If it can simply muddle through this adjustment period to higher interest rates, then superficially at 178p its stock represents value. 

Mind, the pension fund is an elephant in the room; hard to quantify in the overall value equation. You do not get a sense for this when initially reading the latest results. 

Grant Westfield has helped prop annual numbers 

Norcros benefits from 10 months post-acquisition revenue from Grant Westfield, which is ahead of Grant’s equivalent prior year period. 

Without this, however, reported revenue would not be 11% higher (or 1.5% at constant currency), it would only be up 1%, hence failing to match inflation. 

Group operating profit numbers vary – up 13% over £47 million on an underlying basis, albeit down 24% below £28 million – due to acquisition and other exceptional costs. Grant Westfield’s profit contribution is not specified, either within group accounts or the operating review, which simply cites “an underlying profit performance in line with expectations”. 

However, the business is deemed “a compelling fit with our existing portfolio of businesses, with opportunities for sustainable growth.”  

That Triton and Merlyn – the leading supplier of shower enclosures to the UK and Ireland – have “particularly strong performances” may endorse a housing market slowdown as not altogether a bad thing. It recalls Howden’s out-performance from 14 years ago. 

A 2018 strategic target was to raise group revenue to £600 million by 2023, extended to 2025 due to Covid disruption. There is also an objective to sustain a pre-tax return on underlying capital employed over 15%, where nearly 19% was achieved last year and 24% to March 2022. 

Yet a stock price that has traded volatile-sideways for years, effectively says the company has to run well simply to “stand still” in equity valuation terms – given the pension funding issue compromises growth in shareholder value. 

Gearing up at peak-cycle? 

The 31 March balance sheet shows financial debt all long-term, but is still a big jump from £19 million to £79 million, relative to (stable) £29 million cash. This will boost the net interest charge, which last year was £5.8 million relative to £27.5 million reported operating profit. There are also £85 million leases, albeit stable. 

It is not a big financial risk but is gearing up at what could be “peak cycle” if interest rates remain high for the next year or two, and consumer demand succumbs. 

Due to historic acquisitions, there is £108 million goodwill and £59 million intangible assets – both boosted by Grant Westfield – such that they constitute 79% of £210 million net assets. Perhaps you prefer to rely on net tangible assets of 48p a share. 

Recent trading compromised by South Africa 

Since the financial year-end, April and May have seen like-for-like revenue edge up 1.3% on a reported basis, albeit down 3.6% at constant currency. While the UK is slightly ahead, South Africa has been impacted by electricity supply interruptions, which are being actively managed. 

Norcros’ valuation does reflect its hindrances and may offer value while currently low on its chart. It is hard to marshal conviction given pension actuarial valuations will vary. You could, however, make a similar objection to holding BT. I think risk/reward favours upside for Norcros at 178p but keep my stance tempered at “hold”.  

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

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