Some pressure on local South African profitability and transitory effects of disrupted China supply lead us to reduce our Norcros earnings estimates by 5–8% following a trading update. Management remains firmly in credit for achieving outperformance versus local markets and we expect this to be a recurring feature. The company’s share price has retraced to pre UK general election levels now and its P/Es remain in single digits on our revised estimates.
UK market conditions (domestic and export) appear to be similar to when H120 results were reported in mid-November. The Coronavirus is however affecting product sourcing; with a slower return to post-Chinese New Year full production by suppliers and a c six-week order lead time, Norcros has flagged some likely business impact around the end of this financial year and the beginning of the next. China is an important sourcing region – particularly so for some of the group’s UK companies – but we expect the impact to be short-lived and relatively small in financial terms. We have previously flagged challenges in South Africa (eg weak economic outlook and confidence, credit rating risk and power supply variability) and these are now being reflected in reduced economic growth expectations and competitive market conditions. Norcros notes slow construction sector activity at the start of its Q4, although management still expects local operations – including House of Plumbing – to deliver FY20 EBIT slightly ahead of the prior year. Reflecting the above, we have lowered our group earnings estimates by 7.7% for the current year (and by 7.0% and then 4.8% for the next two). This includes c £1.3m lower underlying profit contributions in all three years in South Africa (with a slightly adverse updating of ZAR/£ to 19.5, previously 18.5, for FY21 and FY22 also). We have also made a sub 5% reduction to our UK EBIT projection for FY20 and around half of this for FY21 (with no change to FY22).
The Norcros share price has performed well over the last 12 months. It also participated in the post-UK general election market rally, although the trading update, estimated short term Coronoavirus impacts and weaker equity markets generally have led to a return to pre-election levels now. On our revised estimates, the current year P/E of 8.2x and EV/EBITDA (adjusted for pensions cash) of 5.7x reduce to 7.3x and 4.7x respectively by FY22. South African exposure may dilute short-term investor sentiment, but underlying UK momentum will become a more important influence on the share price, in our view.