Norcros — Explicit growth aspirations

Norcros (LSE: NXR)

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Market capitalisation

GBP166m

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Research: Industrials

Norcros — Explicit growth aspirations

Variable underlying markets did not prevent Norcros from delivering both organic and acquired progress in FY18. Moreover, a new target of almost doubling revenue by 2023 has been set with ROCE sustained above 15%+. Share price movements suggest that the market is starting to give credit for management’s achievements. Performance will be measured against the strategic plan and we believe that a further re-rating is likely.

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Industrials

Norcros

Explicit growth aspirations

FY18 results and

capital markets event

Construction & materials

29 June 2018

Price

220.0p

Market cap

£176m

£/ZAR18.0

Net debt (£m) at end-March 2018

47.1

Shares in issue

80.2m

Free float

98%

Code

NXR

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

8.9

18.6

22.7

Rel (local)

10.6

10.0

18.4

52-week high/low

230.0p

165.4p

Business description

Norcros is a leading supplier of showers, enclosures and trays, tiles, taps and related fittings and accessories for bathrooms, kitchens, washrooms and other commercial environments. It has operations in the UK and South Africa, with some export activity from both countries.

Next event

AGM

23 July 2018

Analysts

Toby Thorrington

+44 (0)20 3077 5721

Norcros is a research client of Edison Investment Research Limited

Variable underlying markets did not prevent Norcros from delivering both organic and acquired progress in FY18. Moreover, a new target of almost doubling revenue by 2023 has been set with ROCE sustained above 15%+. Share price movements suggest that the market is starting to give credit for management’s achievements. Performance will be measured against the strategic plan and we believe that a further re-rating is likely.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

03/17

271.2

20.7

24.4

7.2

9.0

3.3

03/18

300.1

24.4

26.8

7.8

8.2

3.5

03/19e

328.7

30.9

29.3

8.4

7.5

3.8

03/20e

338.0

32.9

31.0

9.0

7.1

4.1

Note: *PBT and EPS FD are normalised, excluding amortisation of acquired intangibles, exceptional items and change in fair value of derivatives.

Good progress seen in FY18

FY18 showed good y-o-y progress driven primarily by a strong trading performance in South Africa and a first time contribution from Merlyn (acquired on 23 November 2017). Within the mix, South Africa did better than we had anticipated, partly contributing to a PBT outturn £0.6m above our estimate. Most of the UK operations traded well throughout the year, the primary exception being Johnson Tiles where a second cost-cutting programme to eliminate losses is underway. A turnaround here, a full year contribution from Merlyn and further organic progress elsewhere supports management’s confidence in the FY19 outlook and reflected in an 8.3% FY18 DPS uplift. Our estimates are substantially unchanged save for a slightly higher tax charge.

Setting out financial targets to 2023

Norcros’s management has set new 2023 financial targets for the group: to attain £600m revenue with a balanced UK/overseas split and to sustain a ROCE of 15%+. Acquisitions are expected to contribute to this near-doubling of annualised revenue (including a pro forma full year Merlyn contribution) and the company has a good track record in this area. Recent presentations at a capital markets event outlined key characteristics across existing subsidiary operations and a coherent aggregated business model that provides a clear framework for investors to evaluate both organic and inorganic investment decisions going forward.

Valuation: Growth ambitions suggest further re-rating

The announcement of the Merlyn acquisition in November had a positive share price effect and the FY18 results have also been well received, contributing to a c 58% uplift over the last year. Nevertheless, the FY19e P/E and EV/EBITDA (adjusted for pension recovery cash) still only stand at 7.5x and 5.4x respectively. Management has ambitious stated growth targets and these multiples are yet to factor in, if achieved, what would certainly be above growth rates in addressed market segments.

FY18 results overview

As flagged in a year-end trading update, FY18 trading was in line with management expectations and PBT c £0.6m higher than we had anticipated. Both reporting regions achieved constant currency l-f-l revenue growth over the year with a mix slightly more in favour of South Africa rather than the UK than we had anticipated. Year-end net debt came in below our expectations at c £47m, largely due to a better working capital performance and was c £7m better than we had expected. Save for a slightly higher tax charge going forward (100bp higher than we had previously modelled), our estimates are substantially unchanged.

Exhibit 1: Norcros divisional and interim splits

£m

H1

H2

2017

H1

H2

2018

% chg Actual

% chg Actual

% chg CER LFL*

% chg CER LFL*

H118

FY18

H118

FY18

Group Revenue

128.8

142.4

271.2

145.0

155.1

300.1

12.6%

8.9%

7.2%

4.4%

UK

86.9

95.4

182.3

94.3

106.3

200.6

8.5%

11.4%

8.5%

3.6%

South Africa

41.9

47.0

88.9

50.7

48.8

99.5

21.1%

3.8%

4.8%

5.9%

Group Optg Profit (post SBP)

11.0

12.8

23.8

11.7

15.7

27.4

6.2%

22.3%

1.9%

4.6%

UK

8.0

9.4

17.4

7.4

11.2

18.6

-7.7%

19.4%

-7.5%

-4.6%

South Africa

3.0

3.4

6.4

4.3

4.5

8.8

43.6%

30.2%

26.7%

29.6%

£/ZAR average rate

19.69

20.50

17.11

17.32

15%

18%

Source: Company, Edison Investment Research. Note: *CER LFL operating profit % change = Edison estimates.

UK: Good performances outside the retail segment

The majority of the UK operating companies performed very well; l-f-ls excluding Johnson Tiles (JT) were: H1 +11.4%, H2 +8.4% and FY +9.8%. This was well ahead of the underlying repair, maintain and/or improve (RMI) market, which was flat at best according to most commentators (eg Travis Perkins in general merchanting). Those with a higher trade/lower retail (including DIY) channel mix and export exposure were the better portfolio performers in FY18. There will also have been some positive pricing effect on revenues given rising metals price indices passed through during Q4. After a flat couple of years, Triton progressed in all of its market segments, achieving high single digit revenue growth and improved profitability. This also applied to the smaller Abode business which was even more strongly ahead (sales +20.8%). Both Triton and Abode benefited from new product launches. Vado was also very active in this regard, driving a 15.3% sales uplift and while profitability was held back by supporting business development investment this lays the ground for further progress. Croydex was hindered by its retail exposure but did advance in its trade and export channels. Merlyn’s maiden (c 18-week) revenue contribution for the year was £11.7m with above average margins for the division. JT revenue fell by 11.5% y-o-y to c £47m; H2 was lower sequentially compared to H1 and c -23% y-o-y reflecting sharply lower demand from the large DIY sheds. Consequently, its H1 trading loss widened for the full year. Having reconfigured production during FY18 (mothballing one kiln, converting another to small-format tiles), a more wide-ranging business restructuring is underway; a £2.1m exceptional charge (cash outflow in H119) is expected to generate annualised savings of at least £2m. With some benefit to flow in FY19 and with possibly lower CrystalGrip support costs, we would expect this action to result in a break even or better run rate by the year-end. Excluding Merlyn, we believe that underlying divisional profitability was marginally lower chiefly due to JT and, to a lesser extent, business development activity in a number of companies as outlined above.

South Africa: Broadly-based organic growth

The achieved growth rate was all organic and equated to +5.9% in constant currency terms (comprising H1 +4.8%, H2 +7.2%) in still sluggish local economic conditions. We note an acceleration in growth in H2 which came from faster rates of progress from manufacturing businesses TAL Adhesives and Johnson Tiles SA (JTSA) both of which cited improved operational performance. A project to increase capacity at JTSA by c 10% got underway in October and is expected to conclude during H119. This should result in improved factory yields and allow a higher volume of sales of higher-margin, own-manufactured product both independently and through sister company Tile Africa’s stores. Retailer Tile Africa broadly maintained a mid-single digit revenue growth rate throughout the year, including some benefit from two new store openings in FY18 and from accessing the group sourcing supply chain in certain product lines.

Overall, a very good outturn from South Africa with all three operating companies increasing both revenues, profitability and, we believe, margins and there was no discernible impact from widely reported regional drought conditions. This underlying performance was amplified by favourable FX translation which contributed £5.1m to revenue and £0.3m to divisional operating profit. Lastly, we note that business confidence improved towards the year end compared to H217 following political change in February 2018.

Merlyn lifts net debt after positive underlying cash flow

Net debt came in almost £7m better than we had anticipated at £47.1m which was a c £23m increase y-o-y, being the net effect of positive cash generation more than offset by the acquisition consideration paid for Merlyn in H2.

Operating cash characteristics were similar to the prior year including a small working capital investment to support growth (a £2.8m outflow versus £1.8m in FY17). Hence, in underlying terms, the operating profit increase substantially flowed through into a c £32m operating cash inflow. We had expected a larger working capital outflow and this explained most of the difference between our projected year-end net debt and the actual position. Net interest and tax both rose (to £1.1m and £4.9m respectively) reflecting acquisition activity and rising profitability and a reduced tax loss benefit compared to FY17. Capex was broadly flat y-o-y at just under £8m with no major items of spend highlighted; new stores and manufacturing improvements in South Africa and new Vado distribution facilities in the Middle East were some of the areas that featured we believe. Before the effect of non-trading items, underlying free cash flow was above £18m. Non-trading cash outflow was in excess of £8m with pension cash outflow of £2.5m (in line with FY17) and the remainder split broadly equally between Merlyn acquisition expenses and JT restructuring costs. Merlyn consideration was c £59m which was part funded by c £30m new equity raised, giving a net £29m cash flow/net debt impact. Finally, increased cash dividends – due to rising DPS and increased shares in issue – of £5m completed the group cash flow picture.

We currently anticipate a net debt reduction of c £9m in FY19 followed by £13m+ in each of the following two years. Note that the FY19 calculation includes some further cash restructuring and a deferred consideration payment (both c £2m) and a flagged step-up in capex to £10m. Otherwise, the annualised effects of owning Merlyn for a full year together with underlying progress is expected to drive increases in profitability and some of the other line items highlighted above.

Robust underlying profitability outlook

In headline terms, we have made only modest changes to our earnings projections for FY19 and FY20. We have made small adjustments to the mix of revenue (lower overall due to JT) and operating profit (no net change) following the reported FY18 performance. A slightly higher expected tax rate (ie 22% against 21% previously) nudges down our EPS estimates with no change to expected DPS. We have added FY21 forecasts for the first time. Overall, our three year EPS CAGR to FY21 is now 6.4% and 7.7% for the DPS equivalent (with cover reducing slightly to 3.3x by FY21). Updated group strategy (see below) suggests that management is targeting a run rate ahead of this. M&A forms part of the growth aspirations and we will factor in any transactions as and when they are announced.

Strategy update and platform for growth

A capital markets day (12 April) followed the trading update and included presentations from CEO Nick Kelsall and five business MDs representing almost 90% of annualised group revenues. As well as highlighting business breadth, common core characteristics and collaboration-driven synergies across the portfolio, this event was used to set out management’s medium-term aspirations, as follows:

Group revenue of £600m by 2023 targeted. This is equivalent to a c 13% CAGR; underlying market growth alone is unlikely to be sufficient to deliver this near-doubling of the top line in five years (versus FY18 £320–330m, including Merlyn for a full year) in our view. So acquisitions continue to form part of the strategic thinking and, of course, progress is unlikely to be linear.

Broadly even UK/overseas revenue split. For context, overseas sales were c 45% of reported FY18 revenue. The intention is to broadly retain this balance during the next growth phase and this may include exposure to faster-growing overseas markets and UK subsegments and acquisitions which could have an export bias or be located outside the UK.

Sustainable underlying ROCE in excess of 15%. The previous strategic target was to sustain this metric in the 12–15% range (and £420m FY18 revenue, including potential acquisitions). Norcros attained 18% ROCE in FY18 and clearly maintained a focus on quality rather than quantity regarding acquisitions made. We estimate that underlying profitability (ex-acquisitions) increased between FY13 and FY17, driven by South Africa, but there is also scope to improve UK returns over time. In a wider context, this premise and an 18% starting point provides some latitude to take on acquisitions on lower initial returns. We believe the company has a good acquisition track record and the raised through the cycle ROCE aspiration suggests that any dilution from the current level would be considered, but still allows for a significant margin over the group WACC of c 9%.

In our view, the overall strategic thrust and direction outlined above is unchanged from before. These updated targets indicate that the management team intends to build on the current platform and has significant ambition to grow revenue and profits.

Some regional perspective: the capital markets day provided information on the group’s current primary markets, which are most obviously the UK (c £2.3bn annual market value in the widely defined bathroom and kitchen products sector at manufacturer’s selling prices), South Africa (c £0.9bn), as well as the Middle East (specifically UAE and Qatar, c £1.1bn). As a broad illustration, based on the information presented, Norcros’s current portfolio addresses sectors that make up roughly three-quarters of these markets.

The UK market has the most balanced spread of subsectors (the largest – mixers, taps and controls – being c 20%), while South Africa has a more significant tile bias (around one-third, the remainder spread) and the specified Middle Eastern markets more so (60%+). In these overseas markets, we think it reasonable to expect an increasing demand for improved specification fittings, etc, over time, broadening beyond the high-end residential and commercial (hotels, apartments, offices) customer sectors. We also note that the two overseas markets both have a significant local player with a diversified portfolio: Italtile1 in South Africa and RAK Ceramics2 in the Middle East. As a reminder, Norcros has strong, branded number one or number two positions in its sectors in both the UK and South African markets. It has also sold into the Middle East for a number of years and, following 2016 distributor changes, now has a regional sales office and stocking capability centred around the Vado and Norcros Adhesives offerings.

  Listed on the Johannesburg Stock Exchange: www.italtile.co.za

  Listed on the Abu Dhabi Stock Exchange: www.rakceramics.com

Identifying commonalities across a diverse business portfolio

We highlight below some of the characteristics that we feel each of the individual businesses that presented at the CMD have in common; together, they provide the essence of the group business model.

Strong portfolio of brands

Our perception is that portfolio companies typically have leading market positions – usually with a single brand used by each company across the sectors it serves – and a mid/upper end bias, although not exclusively so. (We understand that some white-label manufacturing takes place to varying degrees around group companies, but this is not thought to be material in aggregate.) Pulling together provided data, market shares are:

Triton: UK 34% total (51% electric, 11% mixers) and 69% in the Republic of Ireland

Merlyn: UK 15%, 35% Republic of Ireland

Johnson Tiles: UK total 12%, wall tiles 21% (one of only two scale UK producers)

South Africa: retail 10% (number two), JTSA (number two), adhesives (number one)

Embedded innovation culture

In support of their market-leading positions, each company is clearly mandated to be active in new product development (NPD) and for this activity to make a material contribution to revenue. In largely established market segments this includes adding new features, updating appearance, range extensions, enhancing user experience and improving installer convenience. Regularly moving the product offering forward represents a constant challenge to competitors but also provides opportunities for margin consolidation/expansion from both cost (through design-for-manufacture and parts/sourcing commonalities) and pricing perspectives. We understand that in aggregate c 2-3% of annual group revenues are expensed or capitalised as NPD.

The following examples illustrate the significance of NPD at individual company level, noting percentage of revenue derived from products introduced in a specified time period (number of years in brackets):

South Africa 47% (three years); own-branded tap range (EVOX), adhesives formulations, Tile Africa range expansion

Triton 34% (three years); Fast Fit showers, digital controllers and mixers

Johnson Tiles 19% (two years) – exclusive customer ranges, smaller-format tiles

In overall terms, the equivalent figure for all existing UK operations is c 25% (three years). Merlyn, while being below this at the point of acquisition, already had new product momentum and is moving towards this UK average. Across the portfolio, there are examples of inter-company product development (eg Triton/Vado electric showers range, Vado/South Africa tap range), which further highlights the potential benefits from shared group expertise. Apart from the product portfolio fit, an ability to innovate and refresh the product range and potential to collaborate are clearly important considerations in making acquisitions.

Group sourcing synergies

Norcros’s operating companies have a range of different business models. Four of the seven UK businesses (ie Vado, Croydex, Abode and Merlyn) supply products that are internally designed and effectively externally sourced, except for some light assembly activity. Triton undertakes full final product assembly of its proprietary shower designs, for which the cover, sub-assemblies and components are bought-in. Consequently, supply-chain management is a critical discipline and Norcros has an extensive Chinese sourcing network including 35 locally based employees across a number of locations. Even if they were entirely independent, there would still be economies of scale in collective transportation and shipping arrangements. In fact, there are a number of product group overlaps such that group purchasing synergies can also be achieved. Some of the major product groups include:

brassware: valves, taps, fittings (Vado, Abode, Triton)

plastic injection moulded components: covers, shower heads (Triton, Croydex)

chrome-finish components: accessories, hoses, rails (Triton, Vado, Croydex, Merlyn)

Clearly, where acquisitions also fit this model, this brings opportunities to improve supply terms for the acquired company and potentially for the wider group. Glass panels and shower trays form the largest value elements of Merlyn’s offering sourced from China; while there is limited overlap with the rest of the group in these areas, we would expect some group sourcing benefit to be extracted.

JT and JTSA both have significant tile manufacturing facilities but, to broaden their offering, also source and import a significant proportion of revenues from third-party products and are able to share market intelligence and supply contacts (eg in Turkey, Spain, eastern Europe). Only the surface preparation product companies (ie Norcros Adhesives, UK and TAL Adhesives, South Africa) are pure manufacturing operations, largely for their local markets. Tile Africa is the only group retail business; it obviously relies heavily on JTSA and TAL for tiles and adhesives, respectively, but also accesses group supply chain capabilities in sourcing its brassware and fittings requirements.

Norcros typically hedges its expected FX cost exposure on a rolling nine-month basis. As a result, exchange rate fluctuations should have limited impact on in-year estimates; although, of course, as existing covers rolls off, prevailing rates become more relevant to future period forecasts. We are not aware of any hedging relating to underlying commodity pricing (eg metals) and believe that customer pricing is adjusted periodically – albeit with a lag – to take account of such movements. Imports form a significant proportion of the products sold in Norcros’s market segments in both the UK and South Africa, and competing suppliers are likely to face similar challenges, we believe.

Breadth of distribution channel expertise

Exhibit 2 summarises Norcros’s business portfolio together with the subsector focus of each constituent company.

Exhibit 2: Norcros business portfolio

Source: Norcros, Edison Investment Research. Note: *Merlyn revenue £30.7m (year to March 2017, pre-acquisition) – although Merlyn is based in the Republic of Ireland, the UK is its largest sales territory and we have classified this as ‘Domestic’ here for interpretation consistency with the other UK based companies.

From FY13 to FY17, through relative subsector performance and portfolio additions, the UK FY17 revenue split (as reported) by distribution channel evolved as follows:

UK domestic 85%, export 15% (FY13 89:11)

Triton has traditionally had a good export presence (especially in the Republic of Ireland) with Johnson Tiles and Norcros Adhesives also having some exposure. At the point of acquisition, Vado had c 40% revenue generated overseas, but this has since been diluted to some extent by strong UK growth as part of the group.

Within the UK portion of revenue, specific routes to market in this year were (figures rounded) Trade 49%, DIY retail 24%, specialist/independent retail 11%, other 2% (FY13 41:42:3:2).

The most notable swing during this period was into the other categories and away from DIY retail. Soft markets and sourcing changes by larger customers have affected JT especially, but also Triton and Croydex in this subsector. More positively, greater penetration of specialist retail and the new housebuilding (served through trade) segments – partly through acquisition and partly through NPD – have more than offset DIY pressures. The inclusion of Merlyn, (acquired in November 2017), further boosts exposure to these two channels, which continue to offer better growth prospects in the near term.

As things stand, there is less complexity in Norcros’s channels in South Africa. Most obviously, Tile Africa is essentially a pure, domestic market retailer, although some smaller contract work is also conducted through its stores. JTSA and TAL Adhesives both supply product into Tile Africa but also to other independent retailers and wholesalers, commercially specified projects and export to sub-Saharan markets. In aggregate, exports – chiefly to contiguous countries – accounted for 19% of JTSA and TAL’s reported FY17 revenue. We estimate that domestic sales in South Africa have risen by a c 12–13% CAGR in the last five years and all three businesses have achieved growth rates around these levels, while export growth of manufactured products to third parties have seen a 19% CAGR. It is important to note that these growth rates have all been achieved organically.

Norcros’s UK distribution channel presence is clearly illustrated by listing the multiple formats belonging to three quoted building materials supply-chain customers supplied by the group, ie

Travis Perkins – general merchanting, trade (Benchmarx), DIY (Wickes), retail (Tile Giant)

Kingfisher – DIY (B&Q), trade (Screwfix)

Grafton – general (Buildbase) and specialist (Plumbase) merchanting

The detail is more nuanced than this, with both channel depth (multiple suppliers to each segment) and diversity (more than one segment served by each individual company). This provides access to a wide range of end-customer types within both residential (directly through DIY/specialist retail, indirectly through trade) and non-residential (trade, commercial projects/specification sales) sectors. Some other examples of customers in each segment who are all served by more than one group company are shown below.

Trade – other general merchants (Jewson) plumbers’ merchants (eg Wolseley, Graham)

Specification – Material Lab is the London-based showcase for Norcros group products (and complementary third-party ones, eg paint, floorcoverings) addressing the project segment. Typically fulfilled through merchant chains, although not exclusively, and includes housebuilders (eg Berkeley, Redrow) and hotel chains (eg Hilton, Holiday Inn)

Retail – general (Argos, Dunelm), specialist (Topps Tiles), DIY (Homebase/Bunnings), online (Soakology, Victorian Plumbing)

In-depth channel knowledge aids the identification of new market opportunities such as product gaps and cross-referral of group companies. NPD activity and associated investment decisions are advantaged by the scale brought by these established market positions.

A collective consideration of the common attribute discussions above brings a useful perspective on the Norcros group business model, which we summarise in Exhibit 3. It operates in established and competitive markets; constantly evolving the product offer avoids commoditisation, and sustains brand differentiation and relative pricing power. Underpinned by co-ordinated supply chain and cost management, this forms the basis for healthy profit generation.

Exhibit 3: Norcros business model

Source: Edison Investment Research

It is clear that the company has a strong and broadly based platform from which to address its new 2023 targets. Business fit is a key criteria and this provides a framework with which we can appraise potential future expansion.

Some thoughts on acquisitions: having referenced acquisitions in a couple of places above, we now make a few observations on potential fit with the existing portfolio and include some examples pictured in the capital markets day presentation. (We took these to be illustrative rather than definitive.) We categorise the opportunities as follows:

Infills – close synergistic fit with the existing portfolio; waste, drainage fittings (to co-ordinate with taps, showers, shower trays), range extensions (eg specialist adhesives/surface preparation formulations, screens). Sanitaryware is the most obvious portfolio gap, although there are some significant international players and recognised brands in this space.

Adjacent products – additional discrete product lines for the same bathroom and kitchen target markets that could use existing channel expertise or add new specialist ones; lighting (higher reg rating), furniture/cabinets/storage, panel products.

Adjacent other – with increasing attention being given to modular construction methods, by having a wide range of products the group is well positioned to service a potentially new market segment. Depending on how this evolves, adding a service package or even light fabrication capability could reinforce the product offer.

Regions – South Africa has a relatively underdeveloped own product offer compared to the UK, though inter-trade is increasing (eg Vado). Subject to local market requirements, Norcros could broaden its range organically or via acquisition. This also applies to market development, where we understand the commercial/trade channel is relatively immature. Norcros has a modest local sales representation in the Middle East currently (through Adhesives and Vado in Dubai, now including some local stocking) and building a more significant channel presence would seem to be a logical step. Elsewhere, Brazil has been highlighted as a large low-pressure market where the group has undertaken market and product soundings.

Valuation revisited: Robust low-risk platform for growth

A year ago, we commented on the potential for re-rating at Norcros based on a low rating starting point, our conservative estimates and a perception that pension risk fears were overdone. We now return to address each of these points.

Partial re-rating seen: As noted on the first page of this note, the current year P/E and EV/EBITDA (adjusted for pension recovery cash) for Norcros are still only 7.5x and 5.4x respectively even after a 58% share price uplift over the last twelve months. A year ago, the then equivalents for FY19 were 6.2x and 3.6x, so an initial re-rating phase has taken place.

Solid delivery against estimates: Underlying group profitability has been solid to modestly better overall in our forecasts with a higher expected South Africa contribution largely matched by a UK reduction. This has been enhanced by the acquisition of Merlyn which has performed well so far and, hence, Norcros now has a higher earnings base.

Earnings outlook: Our earnings estimates generate a three year EPS CAGR of 6.4% to FY21 (versus 5.5% a year ago to FY20) with DPS on the same basis of +7.7% (previously +5.3%). The underlying CAGR drivers are:

UK revenue +1.6%, EBIT +7.1% - modest market growth, profit recovery at JT and some benefits from recent P&L investment. Including Merlyn, these CAGRs rise to 6% and 15.5% respectively (partly offset further down the P&L by higher interest costs vs FY18).

SA revenue +2.7%, EBIT +3.7% - some growth but moderated by capacity constraints at JTSA, and modest overall margin progression.

We note that a 2019e PEG ratio of 1.3x – which can be interpreted as anticipating faster earnings growth – is in line with the level a year earlier. It also fits the strategic theme of driving forward top-line progress although, of course, we do not factor in any future M&A activity that may contribute to this. At the end of our forecast period, the core valuation multiples reduce to 7.0x on a P/E basis and 4.4x for EV/EBITDA adjusted.

Low financial risk: Net debt to pro forma EBITDA (annualising Merlyn’s contribution) was c 1.2x at the end of FY18 and, as noted earlier, we anticipate positive cash generation/net debt reduction in each of our forecast years. Bank interest cover in the P&L is at least 17x in FY19 and rising. Consequently, we consider that Norcros is carrying a very manageable level of debt and low financial risk.

Pensions note: Norcros reported an IAS 19R deficit of £48m on its UK pension scheme at the end of March 2018, equivalent to just over 10% of scheme liabilities. The corporate covenant has improved since the last triennial valuation (in 2016) given:

higher profits: FY16 EBITDA £28m, FY18 pro forma (Merlyn contribution annualised) c £40m; and

reduced deficit: asset growth has exceeded that for liabilities resulting in an £8m deficit reduction since FY16 despite a lower discount rate (ie 2.65% vs 3.55% at end FY16).

While group net debt is higher than at March 2016, the ability to service this is at very healthy levels, as noted above. The company currently pays in annual pensions recovery cash of £2.5m+ CPI, or approximately 6% of FY18 annualised EBITDA, which we do not consider to be onerous and adjust for in our EV/EBITDA calculation. The latest triennial valuation review (dated 1 April 2018) is underway and a new recovery plan is to be agreed.

Summary: Our current estimates could not expect to attract strong, high growth-oriented P/E multiples. However, we consider that a solid earnings outlook, track record of delivery and conservative financing position all point to a robust platform from which management can drive towards the new strategic 2023 targets, which implicitly require higher rates of growth to achieve.

Exhibit 4: Financial summary

£m

2012

2013

2014

2015

2016

2017

2018

2019e

2020e

2021e

March

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

 

 

 

 

 

Cont.

Cont.

Cont.

Cont.

Cont.

Cont.

Cont.

Revenue

 

 

200.3

210.7

218.7

222.1

235.9

271.2

300.1

328.7

338.0

345.7

Cost of Sales

 

 

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

Gross Profit

 

 

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

EBITDA

 

 

18.6

19.9

22.9

24.3

28.0

31.6

34.7

42.3

44.5

46.1

Operating Profit (before SBP)

 

 

12.3

13.7

17.0

18.3

22.5

25.2

28.3

35.6

37.6

39.2

Net Interest

 

 

(1.4)

(1.3)

(1.5)

(1.2)

(0.9)

(0.9)

(1.1)

(2.0)

(2.0)

(1.9)

Other financial - norm

 

 

(0.9)

(2.4)

(2.6)

(3.1)

(3.1)

(3.6)

(2.8)

(2.7)

(2.7)

(2.7)

Other financial

 

 

0.6

(0.2)

(5.2)

2.1

(0.2)

(4.2)

(4.5)

(1.4)

(1.4)

(1.4)

Intangible Amortisation

 

 

0.0

0.0

(0.4)

(0.3)

(0.9)

(1.2)

(2.2)

(3.5)

(3.5)

(3.5)

Exceptionals

 

 

(1.2)

(4.4)

(1.5)

(4.8)

(2.0)

(3.8)

(4.2)

(1.0)

(1.0)

(1.0)

Profit Before Tax (norm)

 

 

10.0

10.0

12.9

14.0

18.5

20.7

24.4

30.9

32.9

34.6

Profit Before Tax (company norm)

 

10.7

11.7

14.6

15.8

20.4

22.9

26.3

32.7

34.7

36.4

Profit Before Tax (FRS 3)

 

 

9.4

5.4

5.8

11.0

15.4

11.5

13.5

25.0

27.0

28.7

Tax

 

 

0.0

0.2

4.3

(3.0)

(2.4)

(3.0)

(3.6)

(6.1)

(6.5)

(6.9)

Other

 

 

0.0

0.0

(1.4)

0.1

0.0

0.0

0.0

0.0

0.0

0.0

Profit After Tax (norm)

 

 

10.4

9.3

13.9

11.1

16.1

17.7

20.8

24.8

26.4

27.7

Profit After Tax (FRS 3)

 

 

9.4

5.6

8.7

8.1

13.0

8.5

9.9

18.9

20.5

21.8

 

 

 

 

 

 

 

 

 

 

 

 

 

Average Number of Shares Outstanding (m)

 

57.7

58.0

58.4

59.2

60.6

61.1

68.0

80.5

81.2

81.9

Average Number of Shares Outstanding FD (m)

58.0

58.9

60.8

61.5

62.2

63.1

69.8

82.2

82.9

83.6

EPS FD - normalised (p)

 

 

17.9

15.8

22.8

18.0

24.7

24.4

26.8

29.3

31.0

32.3

EPS FD - company normalised (p)

 

 

19.2

18.7

27.9

21.1

27.7

27.8

29.5

31.5

33.1

34.5

EPS - FRS 3 (p)

 

 

16.2

9.5

14.3

13.2

19.7

9.8

11.2

22.1

23.9

25.3

Dividend per share (p)

 

 

4.2

4.6

5.1

5.6

6.6

7.2

7.8

8.4

9.0

9.8

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Margin (%)

 

 

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

N/A

EBITDA Margin (%)

 

 

9.3

9.4

10.5

10.9

11.9

11.7

11.6

12.9

13.2

13.3

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

6.1

6.5

7.8

8.2

9.5

9.3

9.4

10.8

11.1

11.3

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE SHEET

 

 

 

 

 

 

 

 

 

 

 

 

Fixed Assets

 

 

80.0

86.7

80.0

78.3

93.4

98.8

147.9

149.7

149.3

148.9

Intangible Assets

 

 

23.4

27.6

27.1

26.9

44.7

44.8

98.9

97.4

93.9

90.4

Tangible Assets

 

 

44.8

43.5

36.9

37.6

38.2

43.0

45.0

48.3

51.4

54.5

Investments

 

 

11.8

15.6

16.0

13.8

10.5

11.0

4.0

4.0

4.0

4.0

Current Assets

 

 

89.7

104.6

102.2

100.4

119.4

165.3

165.1

170.0

187.4

205.1

Stocks

 

 

45.5

52.8

50.2

52.2

60.1

70.3

74.9

75.0

77.2

78.9

Debtors

 

 

34.5

36.3

48.1

42.6

53.4

57.5

64.4

68.8

70.8

72.5

Cash

 

 

2.9

6.8

3.9

5.6

5.9

37.5

25.8

26.1

39.4

53.7

Current Liabilities

 

 

(52.5)

(54.0)

(58.1)

(60.0)

(67.6)

(105.7)

(89.8)

(85.2)

(89.9)

(94.4)

Creditors

 

 

(52.1)

(53.5)

(57.3)

(58.6)

(64.8)

(74.8)

(81.3)

(85.2)

(89.9)

(94.4)

Short term borrowings

 

 

(0.4)

(0.5)

(0.8)

(1.4)

(2.8)

(30.9)

(8.5)

0.0

0.0

0.0

Long Term Liabilities

 

 

(46.1)

(75.7)

(58.6)

(67.4)

(97.6)

(101.8)

(118.6)

(117.5)

(116.2)

(115.0)

Long term borrowings

 

 

(20.3)

(37.0)

(30.5)

(18.4)

(35.6)

(29.8)

(64.4)

(64.4)

(64.4)

(64.4)

Other long term liabilities

 

 

(25.8)

(38.7)

(28.1)

(49.0)

(62.0)

(72.0)

(54.2)

(53.1)

(51.8)

(50.6)

Net Assets

 

 

71.1

61.6

65.5

51.3

47.6

56.6

104.6

117.0

130.5

144.7

 

 

 

 

 

 

 

 

 

 

 

 

 

CASH FLOW

 

 

 

 

 

 

 

 

 

 

 

 

Operating Cash Flow

 

 

6.0

6.6

13.6

16.2

18.5

25.5

23.5

35.3

38.4

40.4

Net Interest

 

 

(1.6)

(1.3)

(1.6)

(1.3)

(0.9)

(0.9)

(1.1)

(2.0)

(2.0)

(1.9)

Tax

 

 

(0.6)

(1.0)

(1.7)

(0.5)

(1.0)

(1.9)

(4.9)

(6.0)

(6.1)

(6.5)

Capex

 

 

(6.7)

(4.2)

(2.8)

(1.4)

(6.6)

(8.0)

(7.7)

(10.0)

(10.0)

(10.0)

Acquisitions/disposals

 

 

0.0

(10.6)

0.1

3.3

(23.6)

(2.7)

(59.1)

(2.0)

0.0

0.0

Financing

 

 

0.2

0.3

0.4

0.2

0.1

0.0

30.1

0.0

0.0

0.0

Dividends

 

 

(2.2)

(2.5)

(2.8)

(3.1)

(3.6)

(4.2)

(5.0)

(6.5)

(7.0)

(7.7)

Net Cash Flow

 

 

(4.9)

(12.7)

5.2

13.4

(17.1)

7.9

(24.2)

8.8

13.3

14.3

Opening net debt/(cash)

 

 

10.6

17.8

30.7

27.4

14.2

32.5

23.2

47.1

38.3

25.0

HP finance leases initiated

 

 

(0.8)

(0.1)

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Other

 

 

(1.5)

(0.1)

(1.9)

(0.2)

(1.2)

1.5

0.3

0.0

0.0

0.0

Closing net debt/(cash)

 

 

17.8

30.7

27.4

14.2

32.5

23.1

47.1

38.3

25.0

10.7

Source: Company, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Norcros and prepared and issued by Edison for publication globally. 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. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Limited (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US 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. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and 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 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. This document is provided 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.
Edison has a restrictive policy relating to personal dealing. 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. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. 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. 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 (ie 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. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “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.

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, 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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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