While volume growth is being achieved in several divisions, some of the factors that affected H1 trading – most notably higher input costs – have not receded as quickly as anticipated. Underlying operational improvements are happening but have not been enough to offset these pressures to date. We have lowered FY18 earnings expectations sharply – slowing the rate of net debt reduction a little – with a flat DPS profile now.
We understand that volumes are growing modestly in all three core business units. Polymer costs account for almost two-thirds of COGS (or approaching half of revenue); they have risen further in H2 to date rather than fallen as expected and are +10% ytd. A lagged pass-through, including some competitive market effects, is providing a drag on profitability, as is mix, as seen in H1. We believe mix evolution has been due to relative subsector demand patterns rather than a trading-down effect. Internally, phased efficiency improvement at Coated Technical Textiles is progressing slowly and the Civil Engineering business unit disposal process is underway, although our sense is that neither will be complete by the year-end. More positively, the two largest profit generators (Building & Industrial and Interiors & Transportation) have been relatively resilient, although still affected by higher input costs. Lastly, management’s business improvement is gaining traction with both cost and inventory reductions noted.
EBIT was lower y-o-y in H1 and we now expect this to be the case in H2 also (having been flat in our previous estimates). This c £5.6m adjustment to FY18 PBT estimates (and smaller reductions subsequently) led to a c 24% EPS reduction (followed by c 13% and 5%, respectively). Our end-FY18 net debt projection is now c £133m (down c £5m y-o-y), which represents almost 3.1x trailing EBITDA. As things stand, any dividend increase is very unlikely now in our view – we have moved to a flat payout profile in all three years – and in our view the near-term outlook will depend on earnings momentum at the year-end.
The post-Q3 update share price move and earnings reduction for FY18 have been in step, leaving a current year P/E of 10.3x (6.7x EV/EBITDA). Even on our lower estimates, the P/E compresses to 6.4x by FY20 and if this trajectory can be achieved the current dividend payout (yielding 7.6%) could be sustained, but this is not a given. Absent any M&A related write-downs, our end-FY18 NAV is 50p.