Cream rises to the top

Avon Rubber 3 July 2020 Update
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Avon Rubber

Cream rises to the top

Sale of dairy activities

Aerospace & defence

3 July 2020

Price

3,380p

Market cap

£1,031m

US$1.24/£

Net debt* (£m) at 31 March 2020
*Excluding leases

45.8

Shares in issue

30.5m

Free float

96.8%

Code

AVON

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

2.1

37.1

150.4

Rel (local)

1.9

19.1

199.1

52-week high/low

3,380p

1,252p

Business description

Avon Rubber designs, develops and manufactures products in the protection (77% of H120 sales) and dairy (23%) sectors. Its major contracts are with national security organisations such as the US DOD. Over 75% of H120 sales were from the US.

Next events

FY20 pre-close update

21 September 2020

Analyst

Andy Chambers

+44 (0)20 3681 2525

Avon Rubber is a research client of Edison Investment Research Limited

The announcement that Avon Rubber is to sell milkrite | InterPuls, its dairy division, to DeLaval Holding for £180m gross proceeds is strategically logical and financially compelling. The fit of dairy and defence has always looked slightly anomalous and the terms of the deal show that the opportunity to augment dairy through value-accretive deals is difficult given the scale of the business and opportunities. Management must now recycle the cash balances that will be created into Avon Protection, where there are a greater number of potential investments.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

09/18

165.5

27.2

76.6

16.0

44.1

0.5

09/19

179.3

31.4

90.9

20.8

37.2

0.6

09/20e

233.0

35.4

93.1

27.1

36.3

0.8

09/21e

288.4

49.2

129.5

35.2

26.1

1.0

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Disposal of dairy on compelling terms

After transaction costs and tax, Avon will receive £160m of net proceeds. The terms of the sale are financially compelling for a business with below group average, mid-teen adjusted EBIT margins where we expect only moderate growth. The dairy activities were expected to account for just under 20% of sales and adjusted EBIT based on our FY22 estimates, and the disposal terms suggest FY22 multiples for EV/Sales of 3.3x, EV/EBITDA of 14.7x and EV/EBIT of 20.5x. At face value, the disposal is EPS dilutive by around 15% in a full year, as cash returns would likely be minimal. However, as management recycles the substantial but low-return cash balances created, it should prove accretive compared to the dairy activities. We think it is refreshing to see a management selling well, when the opportunity to invest appears limited at value-accretive terms. The deal is subject to regulatory approvals and should close in Q121 (Q4 CY20). Our forecasts remain unchanged until the deal completes.

Reinvestment in a focused defence core

Management should be able to use the proceeds to continue the growth strategy. The deal focuses Avon Rubber on its Avon Protection business, will allow a £20m payment to the pension fund, and pay down the RCF drawings following the Helmets and Armor acquisition in January 2020. It should leave Avon with a healthy cash balance, we estimate of c £150m at the end of FY21, with which to pursue its continued organic development and M&A opportunities, and adjacencies in the personal protection market to enhance its portfolio.

Valuation: Growing into its rating

While Avon is well rated compared to its defence peers, the ability to increase growth and cash generation by recycling the proceeds is central. Assuming value-creating investments are achieved, earnings metrics and cash-based valuations should return to more directly comparable levels.

Avon Protection becomes the sole focus

We have indicated the fundamental parameters of the deal on the front page, but think it is worth briefly exploring the future of the more focused Avon Rubber without dairy.

If we assume that the disposal releases £140m and that management is able to reinvest in businesses that can create value, using a WACC of 7.5% and tax of 19% as per our model, then these would add adjusted operating profit of at least £13m. That is over 30% more than dairy contributes to our future estimates. Of course, we would hope that management delivers a significantly better return on capital employed than WACC on new investment.

In addition, the calculation takes no account of the reduction to the pension deficit through the £20m payment on completion and the likely reduction in future deficit contribution cash payments.

The track record of current management is so far encouraging in terms of M&A. The acquisition of the new Helmets and Armor division on 2 January 2020 already appears to be at least meeting best expectations, with several new and legacy multi-year body armour contracts already announced.

When combined with an excellent competitive position in mask systems for Military applications, the future for organic growth looks encouraging, especially if supply of systems for non-US markets increases. In addition to the newer systems in the US that have seen multi-year contracts awarded in the last two years, the long-awaited sustainment programme to replenish the installed base of 2m M50 mask systems has now commenced.

On 24 June, Avon announced a sole-source requirements contract for the US DOD for the supply of M50 mask systems, spares and accessories. It has an initial value of $50m over a five-year period on commercial terms. The immediate near term requirement for the programme was reflected in the receipt of the first supply order under the contract that was awarded on 29 June 2020, with a value of $16.3m. Deliveries are to commence in H220 to meet immediate needs and the scale of the initial contract could be increased in the future given the lifecycle expectation of the systems. Additional supplemental contracts are expected to be added for other specific spares and accessories including filters, taking expected annual medium-term order intake for the M50 to the £25–35m range previously indicated. The award was already included in expectations for FY20 and FY21, so our forecasts remain unchanged.

With the strength of the sole-source position in mask systems in the US and the ability to develop international markets, we feel the reinvestment is likely to be made in suitable adjacencies to the personal protection markets for Military and First Responders, where Avon is already established.

Exhibit 1: Financial summary

Year end 30 September

£m

2018

2019

2020e

2021e

PROFIT & LOSS

IFRS

IFRS

IFRS

IFRS

Revenue

 

 

165.5

179.3

233.0

288.4

Cost of Sales

(99.9)

(106.8)

(138.8)

(171.8)

Gross Profit

65.6

72.5

94.2

116.6

EBITDA

 

 

35.3

41.3

50.2

65.1

Operating Profit (before amort. and except.)

 

 

30.4

35.9

41.7

55.4

Intangible Amortisation

(3.1)

(3.9)

(4.4)

(4.9)

Operating profit (company definition)

27.3

32.0

37.3

50.4

Exceptionals

(5.6)

(17.7)

(8.0)

(6.3)

Other

(0.1)

(0.7)

(1.2)

(1.1)

Operating Profit

21.6

13.6

28.1

43.1

Net Interest

0.0

0.1

(0.7)

(0.2)

Profit Before Tax (norm)

 

 

27.2

31.4

35.4

49.2

Profit Before Tax (FRS 3)

 

 

21.6

13.7

27.4

42.9

Tax

(1.8)

0.6

(5.2)

(8.2)

Profit After Tax (norm)

23.5

28.0

28.6

39.9

Profit After Tax (FRS 3)

19.8

14.3

22.2

34.8

Average Number of Shares Outstanding (m)

30.5

30.5

30.5

30.5

EPS - normalised (p)

 

 

77.1

91.7

93.8

130.6

EPS - normalised & fully diluted (p)

 

 

76.6

90.9

93.1

129.5

EPS - (IFRS) (p)

 

 

64.9

46.9

72.6

113.9

Dividend per share (p)

16.0

20.8

27.1

35.2

Gross Margin (%)

39.6

40.4

40.4

40.4

EBITDA Margin (%)

21.3

23.0

21.6

22.6

Operating Margin (before GW and except.) (%)

18.4

20.0

17.9

19.2

BALANCE SHEET

Fixed Assets

 

 

64.1

64.4

148.6

144.2

Intangible Assets

41.5

35.3

59.2

56.0

Tangible Assets

22.6

21.4

72.8

73.9

Right of Use Asset

7.7

16.6

14.4

Investments

0.0

0.0

0.0

0.0

Current Assets

 

 

102.0

117.5

84.7

106.1

Stocks

23.0

20.7

27.2

34.0

Debtors

24.2

35.4

34.1

42.2

Cash

46.6

48.4

10.4

17.0

Other

8.2

13.0

13.0

13.0

Current Liabilities

 

 

(41.4)

(35.4)

(65.0)

(61.3)

Creditors

(41.3)

(35.3)

(45.8)

(56.5)

Short term borrowings

(0.1)

(0.1)

(19.2)

(4.8)

Long Term Liabilities

 

 

(39.9)

(62.0)

(70.8)

(68.6)

Long term borrowings

0.0

0.0

0.0

0.0

Lease Liabilities

(11.3)

(20.2)

(18.0)

Other long-term liabilities

(39.9)

(50.7)

(50.6)

(50.6)

Net Assets

 

 

84.8

84.5

97.4

120.4

CASH FLOW

Operating Cash Flow

 

 

33.4

15.2

48.0

57.6

Net Interest

(0.2)

0.0

(0.7)

(0.2)

Tax

(1.8)

0.6

(5.2)

(8.2)

Capex

(8.9)

(7.9)

(18.7)

(15.8)

Acquisitions/disposals

5.1

0.0

(72.4)

(2.4)

Financing

(1.1)

(1.3)

(1.0)

(1.0)

Dividends

(4.1)

(5.4)

(7.1)

(9.1)

Other

(0.6)

0.6

0.0

0.0

Net Cash Flow

21.8

1.8

(57.0)

20.9

Opening net debt/(cash)

 

 

(24.7)

(46.5)

(48.3)

8.7

HP finance leases initiated

0.0

0.0

0.0

0.0

Other

0.0

0.0

0.0

0.0

Closing net debt/(cash)

 

 

(46.5)

(48.3)

8.7

(12.1)

Total net financial liabilities

 

 

(46.5)

(37.0)

28.9

5.9

Source: Company reports, Edison Investment research


General disclaimer and copyright

This report has been commissioned by Avon Rubber and prepared and issued by Edison, in consideration of a fee payable by Avon Rubber. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Avon Rubber and prepared and issued by Edison, in consideration of a fee payable by Avon Rubber. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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