Purchase of 3M’s ballistic protection business

Avon Rubber 9 August 2019 Update
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Avon Rubber

Purchase of 3M’s ballistic protection business

Acquisition and
trading update

Aerospace & defence

9 August 2019

Price

1,562p

Market cap

£484m

US$1.22/£

Net cash (£m) at 31 March 2019

46.8

Shares in issue

31.0m

Free float

96%

Code

AVON

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

15.7

10.9

9.2

Rel (local)

19.6

11.2

17.0

52-week high/low

1,572p

1,180p

Business description

Avon Rubber designs, develops and manufactures products in the protection (70% of 2018 sales) and dairy (30%) sectors. Its major contracts are with national security organisations such as the US DOD. Over 70% of 2018 sales were from the US.

Next events

Pre-close statement

16 September 2019

FY19 prelims

13 November 2019

Analyst

Andy Chambers

+44 (0)20 3681 2525

Avon Rubber is a research client of Edison Investment Research Limited

In its largest acquisition to date, Avon Rubber is buying the ballistic protection assets of 3M, a market leader in the US. The purchase price of an initial $91m could increase by a further $25m depending on the outcome of tenders for legacy products. Subject to approvals, the deal should complete by fiscal Q220 and be immediately earnings enhancing, creating value in FY21, its first full year of ownership. Avon has also indicated that trading remains in line with management expectations, so our forecasts remain unchanged at present. We will update our forecasts for the acquisition when it completes in FY20.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

09/17

159.2

25.9**

83.3**

12.3

18.8

0.8

09/18

165.5

27.2

76.5

16.0

20.4

1.0

09/19e

176.3

29.8

78.6

20.8

19.9

1.3

09/20e

187.0

32.8

86.3

27.1

18.1

1.7

Note: *PBT and EPS are normalised, fully diluted and excluding amortisation of acquired intangibles, exceptional items and share-based payments. **Restated for AEF disposal.

US leader in helmets and body armour

Avon is buying the assets of 3M’s ballistic protection business including the Ceradyne brand helmets and body armour activity. The acquisition is in line with one of the group’s strategic goals of creating value through targeted acquisitions to complement the existing product portfolio and add growth opportunities. It has strong positions with the US Department of Defense (DOD) supported by excellent R&D capabilities. It has just started fielding the low rate initial production (LRIP) volumes of helmets and body armour for the US DOD Soldier Protection System (SPS) programme, which should provide growth as it moves into full production. Of its $85.4m of revenues in 2018, 93% are for US customers, so Avon Protection sees further potential from leveraging its international sales network.

Compelling financial case

Subject to approvals the deal should complete in Avon’s Q220. The business generates EBIT margins of around 10% currently. Avon management believes it can generate $5m of annual cost synergies by FY21 for an upfront cost of $10m, which should leave ROIC in double digits and well ahead of WACC, creating shareholder value. The initial consideration is being funded from cash resources and an increased three-year revolving credit facility (RCF) of $85m. Group net debt to EBITDA is expected to not exceed 1.0x.

Valuation: Significant EPS enhancement expected

We maintain our estimates at present, in line with the trading comment, as we do not incorporate acquisitions into our estimates until a deal completes. However, we would expect an enhancement to earnings in the region of 20% in a full year post cost synergies. As the acquisition and business case is executed, we would expect Avon’s valuation to respond accordingly.

Record acquisition progresses growth strategy

Avon has been exploring targeted M&A opportunities as an element of its three-pronged growth strategy. These are designed to augment organic growth from the existing product portfolio while maximising operational efficiency, enhanced by selective product development to maintain its cutting-edge technology and leadership in innovation. The business employs 280 people and operates from three well invested sites in the US; the main site is Irvine in California, with additional ceramic plate production in Lexington, Kentucky, and additional assembly and production capacity at Salem in New Hampshire, where the R&D centre for the business is located.

Rationale for the deal

The agreed purchase of 3M’s ballistic protection assets maintains Avon’s financial discipline in M&A deals. It has secure, organically growing and profitable revenue streams, expands the technology range of the group with leading market positions and brands and brings a strong management team with it. It should enhance earnings, create value and augment cash flows, allowing Avon to maintain a strong post-deal balance sheet.

The business has a leading position in the US supplying helmets and body armour. Its products appear to be almost entirely complementary to Avon Protection’s existing mask systems operations in the US. Both supply critical personal protection products to the US military and law enforcement agencies.

Extending the critical personal protection product range

The operations to be acquired are:

Ballistic Helmets – lightweight and customisable for military and law enforcement customers

Body Armour Plates – with both ceramic and composite solutions

Flat Armour – helicopter and rotary wing protections systems for side and seat protection

The company supplies the Advanced Combat Helmet (ACH) and Enhanced Combat Helmet (ECH) for the US Armed Forces. Its excellent product development has provided the next generation Integrated Head Protection System (IHPS) for the SPS programme, which has just commenced the sole sourced LRIP. The contracts for full rate production (FRP) are expected to be awarded by 2021, the transition to which should organically grow revenues,

Exhibit 1: Revenues split by product (2018 $85.4m)

Exhibit 2: 2018 revenues split by customer location

Source: Avon Rubber

Source: Avon Rubber

Exhibit 1: Revenues split by product (2018 $85.4m)

Source: Avon Rubber

Exhibit 2: 2018 revenues split by customer location

Source: Avon Rubber

In body armour, the business is the sole source LRIP supplier of Vital Torso Protection (VTP) body armour under the SPS programme. Together with two other suppliers, an FRP contract worth a combined maximum of $704m over four years has been awarded. Deliveries are expected to commence in late 2020, further boosting organic growth in both 2020 and 2021.

Opportunity to generate both cost and revenue synergies

Management believes there are $5m of costs to be extracted as the back office and central head office operations of the new business are transitioned to and integrated with Avon’s systems. The company is expecting one off costs of $10m to achieve these benefits by FY21.

In its business case value creation is not contingent on sales synergies, but there is clear potential for these to be achieved as well. At present most of the US sales go to the DOD, around 90% of the total, meaning only around 3% of sales go to law enforcement agencies. Avon Protection clearly believes it has the potential to extend penetration of the law enforcement and other domestic US markets. In addition, only 7% of sales went to overseas markets, and with Avon Protection’s international sales network there is clearly potential for that to increase subject to any export licence restrictions.

The transformational increase in scale of Avon Protection should also further enhance its overall reputation and brand around the globe, hopefully providing additional leads in both domestic and export markets.

Financial metrics appear compelling

Avon is paying an initial $91m subject to normal closing adjustments, for gross assets of $45.2m that generated FY18 revenues of $85.4m, EBITDA of $10.8m and PBT of $3.3m. Subject to the award of pending tenders for legacy products, a maximum of a further $25m would become payable, but we expect any awards to enhance the business case. The deal is subject to CFIUS and other US regulatory approvals, but given the complementary nature of the product ranges and Avon’s existing US presence, we do not see these as potential obstacles to completion, which is expected in fiscal Q220.

Avon has substantial cash resource and has renewed and increased its three-year RCF to $85m. These resources will be used to pay for the deal, adding around $1.0–1.5m per year of interest, peaking in the year of acquisition. The deal is immediately EPS enhancing and adding $5m of cost savings will make it value creating in FY21, further enhanced by organic development from the SPS programme.

Management expects the activity to have cash conversion consistent with the existing business, which is itself highly cash generative. Net debt to EBITDA is expected to be below 1.0x when the deal completes and, assuming all goes to plan, management expects to be in a net cash position by the end of FY21.


Exhibit 3: Financial summary

£000s

2017

2018

2019e

2020e

Year end 30 September

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

159,200

165,500

176,250

187,049

Cost of Sales

(97,600)

(99,900)

(106,389)

(112,907)

Gross Profit

61,600

65,600

69,861

74,141

EBITDA

 

 

36,300

35,300

38,772

42,203

Operating Profit (before amort. and except.)

 

 

30,300

30,400

33,449

36,609

Intangible Amortisation

(4,200)

(3,100)

(3,718)

(4,075)

Operating profit (company definition)

26,100

27,300

29,732

32,534

Exceptionals

(7,000)

(5,700)

(4,300)

(4,300)

Other

(33)

(100)

(100)

(99)

Operating Profit

19,067

21,500

25,332

28,135

Net Interest

(200)

0

200

321

Profit Before Tax (norm)

 

 

25,867

27,200

29,832

32,756

Profit Before Tax (FRS 3)

 

 

18,867

21,500

25,532

28,456

Tax

2,900

(1,800)

(4,870)

(5,426)

Profit After Tax (norm)

25,502

23,500

24,164

26,532

Profit After Tax (FRS 3)

21,767

19,700

20,662

23,031

Average Number of Shares Outstanding (m)

30.4

30.5

30.5

30.5

EPS - normalised (p)

 

 

83.3

76.5

78.6

86.3

EPS - (IFRS) (p)

 

 

71.5

64.6

67.7

75.5

Dividend per share (p)

12.3

16.0

20.8

27.1

Gross Margin (%)

38.7

39.6

39.6

39.6

EBITDA Margin (%)

22.8

21.3

22.0

22.6

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

19.0

18.4

19.0

19.6

BALANCE SHEET

Fixed Assets

 

 

66,700

64,100

61,060

57,950

Intangible Assets

40,400

41,500

40,646

39,800

Tangible Assets

26,300

22,600

20,414

18,149

Investments

0

0

0

0

Current Assets

 

 

80,500

102,000

120,597

139,791

Stocks

21,800

23,000

24,739

26,517

Debtors

23,800

24,200

25,772

27,351

Cash

26,500

46,600

61,886

77,723

Other

8,400

8,200

8,200

8,200

Current Liabilities

 

 

(39,000)

(41,400)

(43,615)

(45,894)

Creditors

(37,200)

(41,300)

(43,615)

(45,901)

Short term borrowings

(1,800)

(100)

(0)

7

Long Term Liabilities

 

 

(52,600)

(39,900)

(39,838)

(39,777)

Long term borrowings

0

0

0

0

Other long term liabilities

(52,600)

(39,900)

(39,838)

(39,777)

Net Assets

 

 

55,600

84,800

98,205

112,071

CASH FLOW

Operating Cash Flow

 

 

29,754

33,400

35,776

38,721

Net Interest

(154)

(200)

0

200

Tax

2,900

(1,800)

(4,870)

(5,426)

Capex

(5,500)

(8,900)

(9,101)

(9,659)

Acquisitions/disposals

0

5,100

0

0

Financing

(1,000)

(1,100)

(1,000)

(1,000)

Dividends

(3,200)

(4,100)

(5,419)

(6,992)

Other

(96)

(600)

0

0

Net Cash Flow

22,704

21,800

15,386

15,844

Opening net debt/(cash)

 

 

(1,996)

(24,700)

(46,500)

(61,886)

HP finance leases initiated

0

0

0

0

Other

0

0

(0)

0

Closing net debt/(cash)

 

 

(24,700)

(46,500)

(61,886)

(77,731)

Source: Company reports, Edison Investment Research estimates


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 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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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The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. 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

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 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. 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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