Carclo — Update 27 October 2016

On 14 October, Carclo acquired Precision Tool & Die (PTD), which provides high-precision mould tooling, injection moulding and assembly for the medical device industry. Approximately 90% of PTD’s business is for the medical device industry. PTD generated $1.6m (c £1.3m) profit before tax on revenues of $6.9m (c £5.7m) for the year ended December 2015. It is based close to Boston in the US and employs around 45 people.

The acquisition is central to management’s stated strategy of expanding the capabilities offered by Carclo’s Technical Plastics division to include micro-moulding and prototyping. PTD is focused on toolmaking and production prototyping of lower-volume medical products including direct experience of manufacturing tools for micro-moulding. In addition PTD has very strong technical relationships with a number of major medical companies with technical centres in Boston. PTD brings relationships with three of the global Top 20 medical devices companies that are not currently Carclo customers. Management intends that in the longer term these customers will be encouraged to place orders for volume production with other parts of the Technical Plastics division. Conversely, Carclo will now be able to offer prototyping services to those customers it currently provides volume manufacturing services to. Management hopes that being able to provide prototyping services will involve Carclo at an earlier stage of product development, making it more likely that it will receive follow-on orders for volume production.

The initial consideration is $5.5m (c £4.5m), payable in cash, with a performance-related deferred consideration of up to $1.0m (c £0.8m) over a three-year period, also payable in cash. The completion consideration includes a working capital adjustment of up to $0.75m (c £0.6m), of which an initial payment of $0.26m (c £0.2m) was paid on completion of the acquisition on 14 October.

The acquisition has been funded through a placing raising £7.7m (net) at 120p/share. The remainder of the funds raised will be used to fund the group’s investment plans and reduce debt. We expect that part of the funds will be used to support the increase in debtors associated with the mid-volume vehicle programme at Wipac, where payment will not be received until the start of the tooling phase.

Trading performance for the first six months of FY17 remains in line with management expectations. The board continues to look forward to a year of strong trading and good growth in both of its main divisions. Technical Plastics delivered a good first half performance, with growing net margins. The Wipac luxury and supercar lighting business performed well, with all of its current projects on track. The Aerospace division experienced stable demand and is expected to trade in line with management expectations for the full year.

Noting that the existing businesses are performing in line with management expectations, we do not make any adjustments to the underlying estimates, only making modifications to the P&L to reflect the PTD acquisition and fund-raising. Our revisions assume that post-acquisition revenue and profit generation from PTD will continue at the run rate achieved for the 12 months ending December 2015. As we are not modelling any performance improvement post-acquisition, we are not modelling any deferred consideration payments. Given the dilutive impact of the placing, the acquisition is EPS neutral on the historical run rate. We ignore any potential benefit from cross-selling opportunities. We also raise capex by £1.5m in FY17 and £4.0m in FY18 to reflect investments at the Technical Plastics Mitcham site, primarily to support a project win, and at Wipac to support the medium-volume project win.

Since around two-thirds of group revenue is derived from outside the UK, movements in foreign exchange rates will potentially have an impact on the estimates. This was limited during H117 by foreign exchange contracts. We treat any benefit from retranslation of overseas profits during H217 as upside to our estimates.

Given that Carclo has discontinued both its touchscreen and healthcare diagnostic test activities, we have changed our sample set of comparators so that it is more closely aligned to the sectors served by the remaining three divisions. Examination of the comparators (Exhibit 2) shows that Carclo is trading on multiples that are substantially lower than those for healthcare companies.

We therefore run a sum-of-the-parts calculation to determine an indicative FY17e P/E multiple for Carclo, as this methodology acknowledges that half of its divisional operating profit is attributable to the sale of products to the global healthcare industry. Where available, the P/E multiple applied to each division is the mean for each sector, as shown in Exhibit 3. There are a number of companies manufacturing high-volume medical products but the key one of relevance, which we use in the sum-of-the-parts calculation, is Gerresheimer, as its products are primarily for use in the medical/pharmaceutical test facilities, rather than for patient care (Ambu, Coloplast and Straumann). As can be seen from Exhibit 2, the latter trade on much higher multiples. This sample is therefore not used in the sum-of-the-parts calculation.

Applying a blended P/E multiple of 14.8x to Carclo’s FY17 EPS adjusted as though PTD was part of the group for the full 12 months gives a preliminary indicative valuation of 169p. We think that Carclo’s relatively small market capitalisation merits some discount. However, the implied discount (27%) to this preliminary indicative valuation with a current share price of 123.5p is, in our opinion, too severe given the stability provided by long-term customer relationships combined with potential for growth in Carclo’s two main divisions. Applying discounts of 10-15% gives an indicative valuation range of 144-152p (see Exhibit 3). To cross-check, we apply the same methodology to calculate a blended sum-of-the-parts using the year 2 EV/EBITDA multiple from our sample of peers in the three segments and apply a discount of 10-15%. This gives an EV/EBITDA range of 7.0-6.6x, which is similar to the FY18e EV/EBIDTDA range of 6.6-6.9x for Carclo resulting from our indicative valuation range of 144-152p.

The share price has not yet recovered from the adverse impact of the suspension of dividend payments at the end of August. Once investors have recognised that the withdrawal of dividend payments does not signal an imminent problem with underlying trading performance and profits, we see potential for share price to progress towards our indicative valuation range.