Respectable H1 trading has been partly overshadowed by ownership changes for two large customers triggering estimate reductions. Given the step down in expected earnings, investors may focus more on the 8.7% dividend yield and, based on the current financial position and our cash flow projections, we believe this level of payout to be sustainable.
First half revenue was up 4.6% including an increased National Plastics contribution and broadly flat for the existing businesses, with ongoing variability in market conditions and business unit performance. Higher input costs – affecting both divisions – were only partly recovered in the period, resulting in an 80bp EBIT margin reduction (to 7.4%) and a 5.9% group EBIT decline. Epwin’s cash profile was consistent with historic seasonal patterns with period-end debt at £28.2m. This said, the flagged bad debt provision (£3.9m for Entu) and expected costs of site rationalisation actions (c £2.5m) will restrict the usual H2 flowback to below normal levels in our view. Management confidence in the longer-term business outlook was reflected in a 1.4% dividend increase on what is already an attractive payout level.
The 16 August trading update (see our August update note) highlighted potential issues with Epwin’s two largest customers (both now under a change of ownership since Entu’s trade and assets were bought out of administration). How the trading relationships settle down remains to be seen, but we now assume a large reduction in revenue and profitability from these sources. Separate actions being taken to reduce the cost base and increase efficiency will partly mitigate the impact; our FY17 EPS FD is now c 7% lower than previously published levels, with annualised effects more apparent in the c 18% reductions in FY18 and FY19. Existing dividend expectations are largely unchanged, although we have tweaked down FY19. Our end-FY17 net debt projection is now c £26m (or 0.85x EBITDA for the year) and interest cover is in the order of 19x. We see net debt and its EBITDA multiple declining in FY18 with a similar interest cover, despite lower earnings.
P/E and EBITDA multiples are firmly in single-digit territory. With profitability set to step down temporarily, the 8.7% prospective dividend yield will be a key attraction. Unsurprisingly, cover ratios are lower (between 1.5x and 1.8x on an earnings basis) but the group’s financial position and future cash profile suggest to us that this level of payout can be sustained while the company rebuilds its earnings profile.