Thrace Group — Demonstrable core growth as COVID-19 subsides

Thrace Plastics was established in Northern Greece in 1977 and listed on the Athens Stock Exchange in 1995. The company operates in two main business divisions, Technical Fabrics and Packaging Solutions, using various manufacturing processes to produce a wide range of products from polymer materials in each case. Its third division, Hydroponic Agriculture, is at a more embryonic stage, offering a range of low carbon footprint vegetables, packaged in 100% recyclable materials. Thrace’s products and solutions meet the demands of 25 different market segments, with a sales network in 80 countries. This geographical and end-market diversification bolsters its strategic growth strategy. Since 2015 Thrace has undertaken an extensive capex plan of €237m to enhance capacity and improve operational efficiency to serve an international customer base (over 80% of sales are outside of Greece) and now stands to generate the benefits of that investment.

Thrace has a visible track record of profit generation, although its current valuation is perhaps influenced by the lower profitability being achieved since its record-high FY21 results, which were inflated by a surge in COVID-19-related PPE sales. As the market considers a return to more normalised and sustainable profitability, the single-digit and declining P/E multiple for FY24e looks undemanding. The market appears to be disinclined to accept improved profitability levels and/or growth rates that should be delivered as the benefits of the investment in efficiency and capacity are increasingly realised. Using peer-based EV/EBITDA multiples, which assumes the margin improvements can be retained, we value the company at €8.59/share (an average of our 2023e and 2024e values), implying substantial upside potential to the current share price. That potential opportunity is also supported by our 10-year, three-stage tapered DCF calculation, which returns a more conservative value of €7.86/share with room for growth if markets recover. As management progressively delivers the growth plan, these values should look increasingly achievable.

For the nine months ending September 2022 (9M22), Thrace demonstrated a robust financial performance despite the challenging macroeconomic environment. Revenue was €316.1m, 7.5% lower than the same period in 2021. PBT fell to €32.2m from €81.0m, reflecting the sharp fall in sales of higher-margin COVID-19-related products. Traditional products accounted for €22.3m of total PBT, which represented growth of 89% compared to 9M19 (pre-pandemic). The growth was achieved despite higher raw materials, energy and transportation costs, through effective cost pass-through mechanisms. Thrace boasts a strong balance sheet, ending the period with net debt of €25.6m, providing a healthy leverage ratio of 0.5x using our FY22e EBITDA. This is a significant improvement following historical high net debt in 2019, which exceeded €80m.

Thrace has an international manufacturing footprint and an end-market sales profile with a diverse spread of subsectors. Capacity utilisation is a critical profit driver and, having made significant investment in its asset base, volume growth is one of the crucial requirements for Thrace’s future profit growth. The spread between input price movements and selling prices can be affected in the short term by lags in passing through polymer price changes (particularly polypropylene), driven by movements in feedstock oil prices. Over time, widening this spread by growing volumes in higher value-added products is one of management’s objectives. Thrace has operations in nine countries and sells into 80, so is exposed to exchange rate fluctuations, albeit these are adequately hedged using forward contracts.

Thrace is a Greece-based international producer and distributor of polymer-based technical fabrics and packaging products and materials, and processes more than 110,000 metric tonnes of polypropylene each year. The business is diversified geographically, by end-market sector and manufacturing process. Its extensive capex plan of €237m (as described below) undertaken during the last eight years, in addition to its strong balance sheet with largely reduced debt levels, leaves the company well-placed to deliver increased volumes and grow profitability through increased capacity.

The front end of all Thrace’s processes involves the blending of polymer grades and additive materials, which are heated and extruded, formed or processed into finished products (eg fabrics, containers) or intermediate products (eg fibres, yarns, filaments). Formulations, in particular polypropylene and polyethylene, are application-specific and products are valued for their functional performance characteristics such as strength, weight or barrier properties and their compatibility with customers’ own usage. The sensitivity of the end demand for its products is dependent on favourable GDP growth in its markets and the ability to introduce new products and/or win market share supported by investment in capacity and new product development. The company divides itself into three operational units:

2021 was an important year for Thrace as additional and unexpected income generated by PPE sales allowed it to accelerate strategic implementation plans. In particular, progress was made in the following areas:

In addition to the growth strategy shown in Exhibit 2, a core part of the group’s corporate approach remains sustainable development, reflected in the implementation of its robust sustainability plan in accordance with United Nations goals and in line with the move towards a circular economy. Thrace is currently focusing on reducing its own environmental footprint in the following ways:

It is also making a contribution to the idea of a ‘circular economy’, that is, one where raw material use is reduced as more plastic product is recycled and reused. To this end, Thrace has submitted a pledge to the European Union to substitute more than 8,500 tonnes pa of virgin raw material with recycled material by 2025. In 2021, Thrace processed just over 110,000 metric tonnes of total product.

Thrace is also investing in research and development to develop thinner, lighter and more durable products that by definition use less material. Furthermore, it has created a pioneering platform designed to help its customers, suppliers and partners collect, recycle and reuse plastic material for the production of new products. The logo and a summary of how the ‘In the Loop’ platform is expected to work are shown in Exhibit 3.

By the end of 2022, Thrace expects to have invested €237m in capital expenditure since the start of 2015, with c 20% allocated to maintenance and infrastructure projects and c 80% to capacity and efficiency increases. The initial phase between 2015 and 2019 resulted in total investment of €135m, mainly in developing new non-woven capacity in Technical Fabrics and some additional capacity in Packaging Solutions.

The second phase of an additional €102m was invested between 2020 and 2022. This phase was principally concerned with increasing efficiency and developing value-added technologies. The €42m gross spend in 2022 was primarily concerned with a €25.5m plan to increase capacity and improve operating efficiency in Greece (€21.4m) and in its Scottish subsidiary, Don & Low (€4.1m). Gross capex over the last three years is broadly in line with cash generation from PPE sales, enabling Thrace to exploit the benefits of this short-lived performance boost to maximise future growth. In the short to medium term, the company is looking to invest in capex broadly in line with depreciation levels at c €23m in 2023.

Although some of the capex relates to capacity increases, it also includes investment in initiatives that fit with the group’s progressive ESG strategy. These include investment in mechanical recycling equipment, photovoltaic power generation and efficiency gains. As depicted in Exhibit 4, Thrace’s capex has been consistently in excess of its depreciation, which is indicative of its high future growth capabilities and the company’s desire to expand capacity.

Thrace’s Technical Fabrics division is consistently the largest in terms of sales, profitability and gross margins, being the exclusive focus of the company at its embryonic stage. The temporary effect of PPE sales had a huge impact in 2020 and 2021 (see Exhibit 5), particularly in this division, where PPE profits in both years accounted for more than half of the total, materially so in the latter year.

However, despite pressure on profits from higher costs of raw materials, energy and transport, our 2022 revenue forecast of €273m for this division compares very favourably with FY19, the appropriate pre-pandemic comparator year, representing growth of 29%. We anticipate gross profit to increase by 39% in this period, representing a relatively stable gross profit margin due to significantly higher input costs, seen across the sector. Overall, compared to 2019 Thrace has demonstrated increased demand for the company’s traditional products, which we expect to continue in the foreseeable future as the effects of capex and operational efficiencies feed through.

Market conditions in Thrace’s end-use markets were not overly strong at the end of 2022, so we are factoring in a slower Q4 for volumes, which is unlikely to be offset by product prices. We forecast a 14% decrease in revenue in this division, to €273m, compared to FY21. However, we anticipate volumes in FY23 to return to a similar level to that in 2021, with further growth of 7% projected in 2024 and prices remaining relatively stable.

Much like the Technical Fabrics division, Packaging has experienced double-digit year-on-year revenue growth from 2019 to 2021, albeit it is at a somewhat earlier stage. Despite year-on-year capacity additions (capex is always in much smaller increments than in Technical Fabrics, reflecting the scale and nature of the injection moulding processes employed versus non-woven fabrics, for example), we anticipate a volume decline of 6.5% in 2022, reflecting the notable impact of macroeconomic headwinds on the manufacturing industry, in particular plastics. However, we expect higher selling prices, driven by input cost pressures, to marginally offset the anticipated reduction in volumes. There were additional PPE sales in 2020 and 2021 in this division, but they were modest compared to Technical Fabrics, hence compared to FY21 we expect FY22 to appear less skewed; we anticipate revenue growth of 8.5% in this period, to €130m, with FY22 gross margin lagging slightly due to substantially higher input costs. This represents growth of 37% versus FY19, highlighting the strength in the division’s core underlying products.

Following government regulatory and incentive initiatives, Thrace established Thrace Greenhouses, which since 2013 has been cultivating the basic vegetables that comprise traditional Mediterranean nutrition. Not only does it have the largest hydroponic greenhouses in South East Europe, but they are also among the very few globally that rely solely on geothermal energy for heating and cooling. The hydroponic vegetables are produced with virtually zero carbon dioxide emissions. This unit contributes less than 2% of revenue to the group year-on-year and, although we anticipate growth in the division in the foreseeable future, from a revenue perspective it will remain a minor part of the business.

For 9M22, Thrace demonstrated the strength in its core, traditional products despite the challenging macroeconomic environment, albeit this was somewhat masked by the declining PPE sales. Revenue dropped 7.5% compared to the same period in the previous year, to €316.1m, and PBT fell from €81.0m to €32.2m, reflecting the sharp fall in higher-margin PPE products. Nonetheless, if we strip out PBT from PPE-related products and extraordinary gains (9M22: €9.9m, 9M21: €50.7m) to give PBT for the traditional portfolio, 9M22 suffered a much more modest c 26% decrease in PBT. Traditional products accounted for €22.3m of the total of €32.2m, which compares very favourably with 9M19 (pre-pandemic), representing growth of 89%. PBT from traditional products in Technical Fabrics and Packaging increased by 122% and 31%, respectively, relative to 9M19.

FY22 was a year of consolidating the core parts of the business; the boost in sales from PPE in 2020 and 2021 provided the company with strong cash flows and enabled a focus on strategic capex to grow the underlying business and develop its higher-value technology and product range. It has also strengthened Thrace’s balance sheet with the company ending the period with net debt of €25.6m, generating a healthy leverage ratio of 0.5x using our FY22e EBITDA. This is a significant improvement following historical high net debt at end 2019 of €83.5m.

Fundamentally, 9M22 was a period affected by a combination of high input prices, largely due to the knock-on effects of the war in Ukraine, increasing economic uncertainty and periodic outbreaks of COVID-19; none of these was helpful for a business already driving significant changes.

Q222 was a tougher period than the previous quarter as PPE revenue dropped off. In total, revenue declined 13.4% to €106.5m. The loss of the higher-margin PPE business therefore had a disproportionate impact on profitability, with gross profits declining 49%, EBITDA reducing 61% and PBT falling 71% to €9.3m. It is worth pointing out that the comparable PBT figure for Q219 was €4.0m, which again highlights the strategic progress of the group over the last three years.

In Q222, more than 96% of PBT was generated by traditional products as COVID-19-related product sales fell away as expected. Increased demand was seen from the construction sector and steady demand was seen from infrastructure and large-scale construction projects, as well as from the packaging sector. Demand from the agricultural sector lagged somewhat. As expected, costs of raw materials remained elevated and energy costs continued to rise significantly. Packaging and transport costs also rose and the group suffered long delays on specific routes, all of which added to the underlying pressures.

These trends continued into the next quarter, although Q322 PBT was positively skewed due to €4.6m from extraordinary profits. This was attributable to a one-off gain from a provision from the OAED, which is the Manpower Employment Organisation of Greece; €2m is still outstanding, and we expect the majority of it to be recognised in the next 18 months. PBT from PPE-related profits remained relatively low at €0.6m, and traditional product PBT reduced 23% to €7.0m compared to Q222. This could be explained by a spike in inflation rates in Greece during Q322, hitting 12%, in addition to a time lag between polypropylene reaching peak prices in Q222 of c €2,250/tonne and Thrace increasing its sales prices to offset this.

It is important to note that in the last three pre-COVID-19 years (2017–19) gross margins remained relatively stable, ranging from 19.6% to 21.0%, highlighting the company’s robust pricing power and ability to offset input price volatility; this is also true for the first three quarters of 2022, with no material margin volatility.

Thrace utilises a number of raw materials in the production of its fabrics and packaging, the main primary and secondary commodities being polypropylene and polyethylene. In FY21, the company processed more than 110k tonnes of polypropylene/polyethylene, which accounted for 52% of COGS. The price of polypropylene was fairly static through 2019, and then dropped in Q220 as demand fell with the spread of the pandemic. However, as economies opened up in 2021, demand increased and the price rose by over 50%, from an average of €1,189/tonne in 2020 to €1,826/tonne in 2021. In 2022, the price rose further to c €2,230/tonne in May, but it has since fallen back below levels seen for much of 2021. Notably polypropylene prices are largely driven by movements in feedstock oil prices (Exhibit 11), with a 90% correlation having been observed between the two.

Polypropylene is a pass-through cost in the long run for Thrace, but short-term volatility can lead to mismatches in timing between raw materials and final product pricing, which can affect quarterly results (both positively and negatively). The group is pushing through price rises to reflect the increase in the cost base. However, the decline in demand resulting in reduced volumes will likely offset this, hence our slightly depressed adjusted EBITDA and PBT forecasts for FY22. In addition, due to the seasonality of both the Technical Fabrics and Packaging business units, Q4 is often more subdued and slower in terms of volume so we do not expect much recovery in this period, in line with the wider industry. We assume broadly flat polypropylene prices in 2023 and 2024 relative to selling prices, and in line with the movement of oil prices, expected to average c €84/barrel in 2023 based on publicly available market sources.

Exhibits 12 and 13 clearly illustrate two factors that have positively affected Thrace’s profitability: one temporary and the other of a more permanent nature.

First, the temporary effect of PPE sales had a huge impact in 2020 and 2021, especially in the Technical Fabrics division, where PPE profits in both years accounted for more than half of the total, materially so in the latter year. There were some additional PPE sales in the Packaging division, but these were far more modest.

Second, the underlying profitability of the group had a step change in 2020 as additional capacity came on stream and operating efficiencies came into effect. This type of income stream is of a more permanent nature, assuming demand and an improved macroeconomic situation are maintained.

Looking ahead, we believe PPE sales will dwindle to c €5.0m in FY22 and further drop to c €0.75m in 2023 as the COVID-19 pandemic further recedes and demand for PPE dries up. Management has indicated that all existing contracts for PPE products expired in Q122, albeit there might be an ongoing de minimis profit contribution from face masks.

We expect Q422 to experience a sharp slowdown in PBT to around break even. The drop is due to the seasonality of the operating segments alongside the underlying challenges facing the industry, including the impact of customer destocking as well as higher costs of raw materials, energy and distribution. Nonetheless, in FY22 we predict group revenue, adjusted EBITDA (reported, pre-exceptional) and normalised EPS to be 31%, 54% and 159% higher, respectively, compared to FY19. We also forecast DPS of €0.18 based on a cover target of 3.5x, in line with pre-COVID-19 levels; this implies a 4.3% dividend yield with the current share price of €4.20, in line with the average yield of its dividend paying peers (3.2%).

Our forecasts for 2023 are indicative of the current macroeconomic uncertainty and continued challenges in terms of subdued demand and higher input costs. We expect core product revenues to remain relatively static compared to FY22e with no incremental contribution from PPE. At the PBT level, the contribution from core products (excluding €4.56m non-recurring OAED item and €5.0m PPE contribution in FY22) increases modestly to €22.1m. Our FY23e normalised EPS shows a 14% decline compared to FY22e (due to OAED and PPE). However, FY23e still shows significant upside to pre-pandemic 2019, with anticipated normalised PBT and EPS increases of 84% and 124% to €22.1m and €0.38/share, respectively.

We see the benefits of past and current investments providing the base for accelerating growth and positive cash flows as Thrace moves into FY24, which includes increased capacity from the company’s finalised new non-woven fibre line. On the back of that we predict 6.7% year-on-year revenue growth in 2024e, with continuing PBT and normalised EPS increasing 15% and 16%, respectively. This is further bolstered by increased demand emerging from higher-margin secondary processing products, which combine two or more of the company’s proprietary technologies.

Thrace has a visible track record of strong positive operating cash flows, which we expect to increase in 2023 and 2024, coinciding with anticipated tax payable reductions and more favourable working capital movements with lower capex investments (c €22m for both years) compared to the previously higher investment period (2020–22). Although our 2022 forecast post-interest operating cash flow of €21.8m represents a decrease of 75% compared to 2021, we expect this to increase by 77% and a further 7% in 2023 and 2024, respectively, implying values of €38.7m and €41.2m, both c 2x the operating cash flow in 2019. We anticipate a larger cash outflow from investing activities in 2022e of €39.9m compared to a €25.0m outflow in 2021 due to the substantially higher capex investment of €42m. As capex returns to an anticipated more normalised value of €20–25m in 2023 and 2024, cash outflow from investing should improve to c €20.0m in both years, in line with the pre-pandemic 2019 outflow of €21.1m.

The company boasts a strong balance sheet, with substantial net debt recovery from €83.5m in 2019 to an estimated €22.3m in 2022, an implied leverage ratio of 0.47x. We expect this to decline by 23% and a further 36% in 2023 and 2024 respectively to €10.9m, underpinned by top-line growth and increased profitability. The company also demonstrates a positive sustained net asset position with expected continued growth. Net assets in 2021 stood at €252.3m. We expect this to increase consistently year-on-year, reaching €286.0m in 2024.

Critical to the investment case, Thrace as it stood in 2019 was a €30m recurring EBITDA company; we now see c €50m as achievable and sustainable, with stabilised 3–5% long-term growth, in line with the industry. In 2022, 2023 and 2024 we forecast continuing EBITDA to be €42.5m (before PPE contribution), €46.2m and €49.4m, respectively, representing a more than 35% increase compared to 2019 in each case, to a large extent driven by operating leverage.

We use a DCF-based method to value Thrace’s shares, now that cash flows are normalising post COVID-19, and value the shares on a sustainable growth basis. We can also now add a peer multiple EV/EBITDA calculation, as the pandemic distortions have eased for most similar companies. Using the average of these values provides a fair value of €8.23/share.

We believe that FY23 is likely to be a year when more, if not all, of the ‘excess’ COVID-19-related revenue will fall away, and perhaps leave a modest residual legacy income as some organisations either retain the use of PPE or stockpile some, with a marginal contribution from surgical face masks expected. In valuing Thrace, we have used our estimated EBITDA for both 2023 and 2024.

By using an average of the FY23 and FY24 peer group multiples we derive a value of €8.59/share. If markets recover, we expect that the accelerating growth and positive cash flows from current and past investments should start to be reflected from 2024, with increased demand from higher-margin products, and increased capacity from the new fibre lines. This could lead to a re-rating of Thrace, with more upside potential.

Our DCF model gives a value of €7.86/share, 8.5% below our multiples-based valuation of €8.59, but still indicates substantial upside potential. Our key assumptions in the DCF model include:

The current share price of €4.20 implies a WACC of over 15%, which in our view looks unreasonably high considering the company’s sustainable growth prospects. While the history of financial markets in Greece undoubtedly has some bearing on the rating, we believe time has moved on and we consider our assumption of a cost of equity of 10% and a subsequent WACC of 8.9% to be more appropriate given the normalisation of the operating environment.

The sensitivity of our assumptions is reflected in the table below, indicating differing terminal value (TV) growth rates and WACCs. For example, raising our TV growth rate from 2% to 3% gives a value of €8.56/share, representing 104% upside to the current share price of €4.20.

Thrace operates in well-established industries that function on a local and global scale. The selection of an appropriate valuation peer group is, however, compromised by a significant number of private/family-owned players and the diversified nature of the listed ones. With this in mind, Exhibit 17 shows seven quoted companies active in at least one of Thrace’s market areas. It includes several who are among the largest non-woven fibre manufacturers in the world, albeit that represents only part of their activity. In this table we include larger US peers such as Berry Global and DuPont because they are more diversified in terms of products and end-markets and largely trade on a premium to the other companies. That provides a target rating for competitors, albeit smaller or pure plays such as Thrace.

None of these companies are true peers in the sense that they have similar business profiles, although we acknowledge some process and market overlap. Thrace currently sits at the bottom end of the range on most metrics, trading on a discount of 18% on a P/E basis and 52% on an EV/EBITDA basis versus the peer group average for FY24.

2022 has been a year of relatively subdued profitability compared to the preceding two financial years, which is likely a significant factor behind current valuation levels. As stated elsewhere, the prospect of Thrace converting its extensive capex programme into sustainable growth and higher profitability represents the key proposition to attract investors and enhance the company’s rating.

Thrace is an international manufacturer of a wide range of products that are used in a variety of sectors, ranging from construction/infrastructure to horticulture and food packaging. Hence, there is diversity across its production base and the end-markets that it serves.

Capital efficiency and growth: as with all capital-intensive industries, equipment utilisation is a significant driver of profitability. Thrace has several primary extrusion processes and downstream secondary conversion processes, which may or may not be directly integrated. The company has to balance these lines, aiming to achieve high levels of utilisation in extrusion as capital costs are significant, ideally including long runs, limited changeovers and a focus on higher value-added markets. New capacity can have short-term impacts on profitability (eg in utilisation rates and/or mix), but obviously contributes to business growth in the medium term. That said, some sectors (eg food packaging using injection moulding) are able to add capacity in smaller increments. Thrace’s evolution is highly dependent on favourable GDP growth in its markets and the ability to introduce new products and/or win market share supported by investment in capacity and capability, which can be negatively affected in the short and long term. The nature of competition varies by market; the packaging sector is typically relatively localised, and while technical fabrics can be required to meet local specifications there may be a number of international suppliers that are able to do this.

Importance of input costs and operational gearing: most obviously, higher (or lower) revenue per tonne sold – through pricing strategy or mix evolution – can have a significant positive (or adverse) operational gearing impact on profit. Underlying polymer costs (in particular for polypropylene) are a key driver; selling prices that recover input cost increases maintain the profit per tonne spread though dilute margins. Polypropylene is an oil by-product and thus its price is strongly correlated to oil price fluctuations. There is typically a lag before prices fully adjust, which can provide a short-term boost or dampening effect on profit. According to the latest annual report, Thrace processed c 110k tonnes of polypropylene/polyethylene in FY21, which accounted for c 52% of COGS in the year. At the margin, the re-use of process waste can help to lower input costs for some applications; this is an area of focus for the company and by 2025 Thrace aims to replace 8,500 tonnes of virgin raw material with recycled plastic.

Foreign exchange risk: Thrace has manufacturing operations in nine countries, selling to a total of 80 countries and is therefore exposed to foreign exchange risk. The company uses local borrowings as a natural hedge. A sensitivity analysis of the effect of exchange rate changes in FY20 and FY21 is shown below:

Financial considerations: Thrace strives to maintain ‘an ideal capital structure so as to ensure a low cost of capital’. The group has significantly reduced its net debt since its historically high levels of €84m in 2019 following its extensive capex programme. Despite capex of €102m in 2020–22, we estimate the company’s net debt/EBITDA ratio stood at a healthy c 0.47x at end FY22.

Single-use plastic legislation: in particular, Thrace’s Packaging division includes single-use plastics such as thermoforming cups, garbage bags and pallet covering, which are exposed to a minor regulatory risk from EU legislation. This is largely in the past however, as the company states that it has fully committed to the 2015 ‘EU strategy for plastics in a circular economy’, pledging to substitute virgin raw material with recycled materials and adapt its market offering towards recyclable, reusable and lighter weight solutions (the ‘In the Loop’ platform).

Founding family interests: account for c 64% of the outstanding equity. We understand that this has been a stable unchanged position for a number of years and have no reason to believe that this is likely to change. However, investors should recognise that Thrace has a sizeable minority free float of 35%.