Avon Rubber — Continuing to deliver

Reported FY18 orders of £173.3m (FY17 £166.0m restated) were ahead of reported FY18 revenues of £165.5m (FY17 £159.2m restated). This equated to 8.7% revenue growth at constant currency and against our estimate of £160.8m. Reported adjusted operating profit was £27.3m (FY17 £26.1m restated), up 11.8% at constant currency. FY18 adjusted EPS was 77.1p (FY17 83.8p) and the final dividend 10.68p gave a total dividend per share for FY18 16.02p (FY17 12.32p).

Avon Protection reported FY18 revenue of £115.7m (FY17 £109.8m restated), up 10.6% at constant currency. Orders received of £124.6m (FY17 £116.0m restated) resulted in a book to bill of 1.08x. The division reported FY18 adjusted EBITDA of £26.6m (FY17 £26.8m restated), representing growth in constant currency of 5.3%. The adjusted EBITDA margin actually decreased by 140bp, reflecting product mix with higher M50 mask system volumes versus FY17.

The Military division reported FY18 revenues of £66.1m (FY17 £64.2m), up 8.0% at constant currency. US Department of Defense revenues increased to £52.7m (FY17 £50.5m), reflecting higher M50 mask system deliveries plus higher aftermarket sales. The initial 10-year M50 contract concluded in July and the M50 order book for FY19 stands at 89,000 systems. The company is in discussions for a follow-on contract for the M50 mask systems. In addition, the company has invested in the M69 aircrew mask and M53A1 mask and powered air system. Closer to home, Avon has re-established its role with the UK Ministry of Defence through the General Service Mask contract. This contract has allowed Avon to demonstrate its technical capability and the company believes that this could drive further domestic contracts. Globally, Avon recognises the demand for defence agencies to address CBRN threats with its broad product portfolio.

The Law Enforcement division reported FY18 revenues of £35.4m (FY17 £29.0m), up 28.1% at constant currency. The division benefited from higher sales of filters and spares, plus initial sales of the powered air range boosted the year-end progress. Looking forward, Avon believes that it will increase its market penetration into law enforcement agencies in the US and elsewhere.

The Fire division reported FY18 revenues of £14.2m (FY17 £16.6m), down 10.0% at constant currency. As we have discussed before, the market has been challenged by delays in introducing the 2019 National Fire Protection Association (NFPA) standards, which, in turn, has delayed product purchases. Avon believes that these delays will start to be reversed from FY19, as it launches its Magnum Self-Contained Breathing Apparatus (SCBA) range in H219. Avon has also introduced the argus Mi-TEC E L camera to the US market and it is already NFPA-approved. Overall, while the fire market has had its challenges, Avon has addressed its strategy and product portfolio to deliver growth going forward.

We believe Avon Protection has invested in its product portfolio to ensure it is well-placed to leverage growth in defence and law enforcement budgets globally. We believe that the delays experienced in the fire protection markets will reverse and support growth. Meanwhile, Avon has taken action to tidy up its business portfolio, with the sale of the Avon Engineered Fabrics business in FY18. In addition, the business has also relocated the West Palm Beach electronics assembly, acquired with the Hudstar deal in FY15, to the Cadillac site in Michigan, which is Avon’s main US manufacturing facility. In addition to a production assembly line in Kazakhstan, the company will continue to explore flexible production solutions to align with customer requirements. We also believe that the company will seek to bolster organic growth with selective bolt-on acquisitions.

milkrite | InterPuls reported FY18 revenue of £49.8m (FY17 £49.4m), up 4.3% at constant currency. Orders received of £48.7m (FY17 £50.0m) resulted in a book to bill of 0.98x. The division reported FY18 adjusted EBITDA of £10.9m (FY17 £10.9m), representing growth at constant currency of 5.2% and a 20bp step-up in margin.

Interface reported FY18 revenues of £35.6m (FY17 £35.9m), up 2.9% at constant currency. While sales in North America were weaker than expected in H118, there was a notable pick-up in H218, supported by the Merrick’s calf nurser product line acquisition. So although FY18 North American revenues declined by 1.7% at constant currency, H218 performance grew 3.9% on the same basis. FY18 revenue growth at constant currency in Europe was 7.2%, while liner revenue grew in Asia Pacific and Latin America by 8.2% and 11.5%, respectively. Going forward, the business will focus on expanding its dealer network and product innovation to drive growth.

Precision, Control & Intelligence reported FY18 revenues of £9.0m (FY17 £9.0m), up 1.9% at constant currency. Growth was visible in Europe and the Middle East., We anticipate that the business will leverage the Interface platform in North America through the sales specialists it has already added. The business has also boosted its technical support capability.

Farm Services reported FY18 revenues of £5.2m (FY17 £4.5m), up 19.8% at constant currency. Cluster Exchange is at the heart of the growth here, boosting cluster points from 35,000 (624,000 cows over 1,900 farms) in FY17 to 40,000 in FY18 (637,000 cows, over 2,100 farms). Growth has been visible in both North America and Europe.

While the overall dairy market is not without its current challenges, Avon has innovated its product portfolio to ensure it is providing an attractive solution to the global market. The growth in Farm Services is continuing to build intelligence from usage data as well as adding greater revenue predictability. We believe the division will deliver organic growth while looking to bolster this through bolt-on acquisitions.

The table below reflects our estimate revisions and introduce our FY20 estimates.

Our cash-based capped DCF valuation is, in our view, a conservative basis for estimating cash flow values as it does not assume any growth in the terminal value. While we do normalise working capital to zero and capex to equal depreciation, it still eliminates some element of the potential tail value. The DCF on a calculated WACC of 8.0% currently delivers a value of 1,532p, previously 1,499p. Our sum-of-the-parts valuation is shown 1,878p. Taking an average of our DCF valuation and our sum-of-the-parts valuation gives a fair value price of 1,705p, which would imply a FY19e P/E of 21.7x.

On our updated forecasts, Avon Rubber is currently trading on 16.4x FY19e P/E, which we feel is undemanding versus the UK aerospace and defence peer group. Avon’s position to address the heightened CBRN threat in the UK and overseas underpins the higher than average margin performance and future growth in our forecasts. Hence, we believe a valuation premium is justified.