Epwin Group — Business resilience and appropriate actions

Epwin reported headline FY19 financial metrics of revenue, EBIT and net debt in line with its 25 March update. On flat revenues, pre-IFRS 16 operating profit saw a small improvement. PBT benefited from a £10m sale and leaseback property profit but excluding this was effectively flat year-on-year on a like-for-like basis. (At group level, the adoption of IFRS 16 benefited EBIT by £2.1m with a £0.6m adverse impact on PBT.) At the year end, core bank net debt (excluding IFRS 16 lease liabilities) had reduced to £16.4m, or 0.6x pre-IFRS 16 EBITDA.

IFRS 16 Leases1: The adoption of this accounting standard from 1 January 2019 had the effect of boosting FY EBIT by £2.1m (£1.1m at the interim stage) and reduced FY PBT by £0.6m (£0.2m in H1). At the end of FY19, Epwin had £71m lease liabilities recorded on the balance sheet, split £9m short term and £62m long term. Just over three-quarters of the corresponding £51.4m right of use assets related to leasehold land and buildings, the remainder to plant, equipment and motor vehicles. During the course of the year, Epwin acquired a second Telford site and, after converting and developing it, undertook a sale and leaseback transaction, which is included in these year-end figures.

Extrusion & Moulding (E&M): Primarily PVC-based window profile systems, roofline and rainwater goods extrusion activities with wood composite decking products and glass reinforced plastic building products also in the portfolio. Aluminium lines (Stellar, window systems and Adeck, decking) have been developed internally and launched in the last 12 months.

Overall, this division was flat on the prior year in both revenue and EBIT terms (pre IFRS 16). H1 trading conditions were relatively benign (though there was a relatively minor year-on-year revenue headwind in H1 arising from the acquisition of Amicus2 in March 2018) with firmer selling prices aiding input cost recovery and profitability. The trading environment deteriorated in H2 amid UK Brexit and general election uncertainties and although higher revenues were generated year-on-year, markets were competitive and some margin tightening was apparent. Site inefficiencies relating to relocating certain lines may also have contributed to margin leakage.

During the year, PVCu window systems extrusion operations became fully consolidated into the existing Telford facilities. Profile foiling (relocated, capacity and capabilities expanded) and aluminium window profile production (new) were established in an existing building on the new Telford site. On full completion – now expected in H220 – the newbuild warehouse at this site will be the main distribution centre for window systems and related hardware. While like-for-like facility costs may not be too dissimilar to previous arrangements, this model should improve service efficiency and be able to accommodate higher sales volumes.

Epwin has traditionally been the leading supplier of cellular roofline products though sales in this sub-segment have been buffeted by the sale of an important customer to a competing supplier (ie SIG’s disposal of its Building Plastics and Windows businesses to privately owned GAP Plastics in August 2017). The indications are that the associated impact had effectively washed through in 2019 and sales volumes stabilised in generally competitive markets, gaining market share.

For certain other business lines, issues following the 2017 Grenfell Tower fire continued to impinge on trading in two ways, directly through updated fire testing requirements disrupting door demand and sales but also indirectly via a re-channelling of funds by the social housing sector into related priority areas requiring remedial action. To some extent, decking is thought to be affected by this at the margin (ie where used as balcony products in taller multi-occupancy buildings); core Ecodek3 volumes were lower year-on-year and more so in H2 we believe as general market conditions weakened. This effect was partly offset by the introduction of the complementary Dekboard range during 2019, which supplied an increasing proportion of internally produced lines to sister company PVS (acquired February 2019, external revenues reported in the Fabrication & Distribution division). A further range extension product, Adek, has since been launched in 2020, partly to address taller multi-occupancy residential and commercial buildings.

No comment was made on other product lines within the portfolio (eg drainage, Stormking entrance canopies) so we assume that their year-on-year impact on revenues and profitability was not material.

Fabrication & Distribution (F&D): Downstream manufacture of finished windows and doors (using profiles from E&M) and multi-channel (including own branches) B2B distribution of these and other group finished products. Supply and installation of low maintenance decking and ancillary products.

Indications are that actions taken in recent years to improve performance are starting to deliver a sustained improvement in divisional profitability. There was a marked step up in EBIT year-on-year in H1, while profit in the seasonally stronger H2 trading period sustained the improved level seen in H218 (on unchanged and higher sales, respectively). Overall, the divisional EBIT margin for the year rose by 70bp to 3.5%.

Having sold the non-core glass sealed unit manufacturing operations at the beginning of 2019, this division now comprises three fabrication facilities,4 c 86 owned specialist plastic building products distribution branches (and a backbone of various warehousing sites to service this network and other independent distributors) and a decking/ancillary product installation business.

Distribution operations are typically groups of regional, locally branded outlets, which together in a broad sense provide national coverage overall. Stock ranges include finished products from the company’s E&M division as well as complementary third-party lines. Where opportunities exist, this division seeks to build out the network with infill acquisitions where they are not in conflict with existing or third-party customer branches. Amicus (acquired in March 2018, 15 branches) provided some annualised benefit in H119. In underlying terms, our E&M observations regarding cellular roofline also feed in here; Epwin appears to be regaining share here in the specified new housebuilding segment serviced directly through its own branch network.

Epwin entered the decking installation subsector through the acquisition of PVS (February 2019), providing a further outlet and a degree of vertical integration with E&M’s decking products. We estimate that this business directly added c £3m external revenue and c £0.3m EBIT during the c 10 months of ownership by Epwin, weighted towards H1. The 2019 results statement made no explicit references to the F&D’s window fabrication operating performance. Given that F&D revenue was flat year-on-year and EBIT improved on a comparable basis together with the above commentary on other elements of the division, we infer that window fabrication revenues were flat to slightly down, while profitability was probably similar or better in FY19 compared to FY18.

Epwin ended FY19 with core bank net debt of £16.4m, a reduction of £8.4m y-o-y. This outturn was significantly influenced by net flows relating to the new Telford E&M facility. Excluding this, underlying cash flow was broadly neutral overall and similar to the prior year. For the purposes of comparability in the following analysis we split out cash flows relating to IFRS 16 leases and comment separately, though the overall group net cash flow movement is not affected by this.

Pre-IFRS 16 EBITDA in FY19 was comparable to the prior year at c £27m. Net working capital excluding provisions saw an outflow of £2.4m versus an inflow (of £5.1m) in 2018; around one-third of this year-on-year difference was due to a swing to a small incremental inventory investment position but the larger component was a c £5m absorption into receivables. A large proportion of the latter movement was seen in H1 but a smaller additional outflow in H2 – as opposed to an inflow in prior years – suggests that the trade debtor position was unlikely to have been squeezed at year-end. There were non-underlying cash outflows in both FY19 and FY18 concerning site moves/related staff changes (and also discontinued operations and reorganisation costs in FY18); we believe that some of these were netted off as part of the Telford development (see below) in FY19. Taken altogether, pre-IFRS 16 operating cash flow was c £23m, c £3m lower than in FY18.

Cash flows associated with the site acquisition, development and then sale and leaseback of the new Telford facility brought a net £10.1m inflow into the group for the year.5 (NB remaining fit-out and access work is expected to complete during H220; a further receipt from the new owner will cover the c £5m cost to complete leaving c £2m tax payable as the net cash outflow in FY20.) Other group capex spend approached £9m in the year and included some new equipment for the new Telford site and investment in foiling line items.

Cash outflows relating to bank interest and taxation were in the same ballpark as their P&L equivalents and totalled £4.2m. Excluding the Telford net sale and leaseback proceeds but including all of the above other items, underlying, pre IFRS 16 free cash flow was c £10m in FY19, marginally ahead of the prior year. Discretionary M&A spend and dividend payments were just over £2m (largely for PVS) and c £7m respectively. A small increase in loans explained the residual difference between the net cash and net debt movements.

IFRS 16 effects: the cash flow statement presentation relating to leased assets is changed by the adoption of IFRS 16, but overall cash movement is not affected. (For example, EBIT increased by £2.1m, as seen in Exhibit 1 and a £9.4m depreciation charge attributable to leased assets is now visible.) For the record, cash payments regarding lease liabilities were £12.3m in FY18.

Banking facilities: Epwin has in place a £65m RCF (initially to June 2022, with two annual options, each to extend for a further year) and a £10m overdraft facility (subject to annual renewal). At the year-end therefore, the implied headroom under existing facilities was c £58m.

Epwin had previously notified the market (on 25 March) that cost reduction and cash preservation measures are being undertaken including a temporary shutdown of operations and an intention not to declare an FY19 final dividend. These points – together with the withdrawal of forward financial guidance – were all reiterated in the 2019 results release. This statement also provided an update on the group financing position as at the end of March; at this point group headroom under existing banking facilities was said to be over £45m headroom, £10m+ below the FY19 year-end level.

As seen elsewhere, as part of the going concern and audit sign off process for the FY19 financial statements and annual report. Epwin was required to provide additional cash flow modelling under a number of scenarios. Two of these along with high-level banking implications were included within the results announcement, as follows:

While the UK’s government’s full lockdown apart from essential services is still in place until the next scheduled review date of 7 May, the business community is already openly airing plans to restart operations. Commercial pressures will build and where government guidelines can be adhered to, a gradual and selective resumption of operations is currently the most likely scenario in our view. In this light, Epwin’s worst case scenario would not be realised, meaning that existing bank facility headroom would be sufficient. That said, having initially left our estimates beyond FY19 in place – heavily caveated that they were likely to be reduced – in the absence of greater business environment clarity we are now formally withdrawing forecasts.

Business model considerations: Epwin’s FY19 reported gross margin was 31.5%. Within cost of goods sold, between 85% and 90% is accounted for by substantially variable costs including materials/consumables, production staff and energy. With a significant proportion of staff (both direct and indirect) currently under furlough arrangements, Epwin anticipates a payroll cost support cash run rate of c £3.3m per month. (As a benchmark aggregate group payroll costs in FY18 were £69.6m.) While more discretionary items such as sales and marketing spend and timing of new product launch costs could be stepped down for a period, other items (eg property-related, insurances) are more fixed in nature.

Following a re-shaping of Epwin’s business portfolio in recent years – including acquisitions, disposals and site consolidation activity – the company is better positioned to withstand the current period of uncertainty. Medium- and longer-term business drivers of UK residential repair, maintain and improvement (RMI) spending (including ageing housing stock, housing transactions and population growth) are intact as is the demand for faster rates of new house building and management remains positive on the business outlook in this context.