Trifast — Good momentum in fasteners

Design, manufacture and distribution of industrial fasteners

Trifast is a specialist designer, manufacturer and distributor of industrial fasteners. From its origins in the UK, the group continues to build a global presence, with sizeable operations in Asia and continental Europe, and a smaller activity in the US. Trifast differentiates itself from its global competitors by operating its own manufacturing plants, principally across Asia and in Italy, which enable the group to offer specialist design support as part of a high-quality, comprehensive and tailor-made supply chain management service. Management is constantly broadening the product range, while recent acquisitions have introduced businesses in Malaysia, Italy and Germany.

Trifast’s shares have risen by almost 60% over the last year and by 5% year to date. In large part the improvement has been the result of increased quantum of earnings, partially due to improved organic performance but also significantly enhanced by translation gains. There has been a re-rating of the stock of around 30% in one-year forward P/E terms, which has closed the discount on its peers to a degree. However, a discount of 10% to its distributor peers in CY18 remains, which may reduce further should management continue to execute the growth strategy successfully.

FY17 proved to be an extremely positive year for the group, with a strong organic performance in all regions enhanced by FX tailwinds. Revenues rose to £186.5m, a 7.0% increase at constant exchange rates (CER), or 15.6% as reported. Gross margin of 31.1% showed a 140bp improvement and exceeded 30% for the first time, with favourable mix effects in all regions except the smaller US. Investment in growth and efficiency continued across the group. This drove underlying operating margins up by 90bp to 11.3%. Adjusted diluted EPS increased by 28.3% and the full year dividend was increased by 25%. It remains covered 3.7x, well within the targeted range of 3.0-4.0x cover. Cash flow was exceptionally strong, reducing net debt to £6.4m, although benefiting from a £1.2m tax payment that fell into April. Nevertheless, the company has a strong balance sheet and banking facility headroom with which to pursue its growth strategy.

Distributors of industrial components bear the brunt of destocking and restocking, which tends to accentuate the impact of shifts in economic cycles. This is true for Trifast at extreme stages of the economic cycle, but the group’s operational flexibility and product development/design skills enable management to use strong relationships with its major customers to anticipate and respond early to these challenges. Similarly, management responds to the ongoing risks encountered by all distributors to the industrial sector, such as cost-down pressures, fluctuating raw material costs, exchange rate movements, stock obsolescence and the migration of global manufacturing capacity to lower-cost territories, as part of the day-to-day challenges of the business.

Progress in FY17 was significant and accelerated through the second half of the year, driven by substantial improvements in both Asia and the UK, which had reported reduced underlying operating profits during H117. The overall performance exceeded management expectations and a gross margin of 31.1% was not only a record but breached the 30% level for the first time. With a robust contribution from the smaller US business despite a lower gross margin, and Europe boosted by the Kuhlmann acquisition and translation gains, underlying operating profit rose by 25% to £21.0m.

Cash performance was exceptional despite the growth, with net debt falling to £6.4m (FY16 £16.0m). Although flattered by a timing discrepancy on a £1.2m tax and NI contribution relating to an option exercise by the chairman, which has subsequently been paid implying a normalised net debt figure of £7.6m, the cash conversion from EBITDA to underlying operating cash was 97.3%.

Diluted adjusted EPS rose by 28.3% to 12.82p per share, with underlying growth of 12.9% substantially exceeding the 5% growth expectations at the start of FY17. The improvement was further bolstered by favourable FX.

The UK operations experienced solid growth in FY17, with total revenues including intra-company rising 4.6% to £69.3m at CER. The improvement was largely driven by increased exports to European distributors, as well as a strong demand from major auto manufacturers in the UK, where production has remained buoyant again due to the export orientation of the sector. The company continues to reinvest the majority of gross margin gains (100bp in FY17) to support growth, but nevertheless underlying operating margins increased by 20bp to 9.8%. The company expects this mature market to increase only marginally in the current year, with margins expected to be squeezed by input cost inflation arising from the weakness of sterling over the last 12 months.

Europe enjoyed a very buoyant FY17 with the H117 performance benefiting from the domestic appliance product recall for VIC in Italy, which dissipated in H217. In addition, the new distribution centre in Barcelona is now fully operational and in Hungary demand from the electronics sector saw strong growth. Trifast is also increasing its penetration of the Swedish auto segment. Reported revenues rose by 24.4% with a significant translation benefit into sterling of 14.6%. Organic growth at CER of 4.6% matched the UK, but was further enhanced by a 5.2% growth contribution from M&A as Kuhlmann made a first full year contribution having been acquired in 2015. Now fully integrated, the company grew by 10% and delivered underlying operating profits of £1m on revenues of £5.4m, a margin of 18.5%. The overall underlying operating margin of 14.6% (FY16 12.7%) benefited from the increased new capacity in Italy combined with the volume from the recall, as well as Kuhlmann.

Management expects the region to experience stable growth in the current year, although again FX movements may undermine margins through higher input costs. Both VIC and Kuhlmann are expected to increase their auto segment business during the year, a brand new stream for the German company. There should be some further translation benefit from more favourable euro sterling exchange rates.

Top-line organic growth accelerated in the US to 12.3% (FY16 7%), including inter-company sales at average exchange rates, which was further boosted by significant translation benefits to 28.2% at the reported level. The increase in sales to £6.0m continues to benefit from the group’s strategic focus on key multinational customers, with steady growth in the electronic segment and strong growth now being experienced in the automotive sector. Gross margins fell by 410bp, partly due to the increase in lower-margin auto segment sales. The decline dropped through to lower operating margins of 5.7%, which also bore increased investment in sales and operations to enhance future growth through further segment and share gains. However, the contribution remained relatively robust and as the top line grows further we expect margins to improve as the incremental costs are better covered by increased sales. Automotive is expected to once again drive double-digit growth in FY18. While opportunities to expand in the US through M&A remain, achieving value-creating propositions and good regional coverage are key requirements.

FY17 saw a solid return to growth in Asian markets, with a 6.5% organic revenue development at CER and including inter-company sales for Singapore and China. This was boosted to 20.7% at the reported level by currency translation. Revenues of £46.6m generated fairly stable operating margins of 17.2% (17.4%), delivering an underlying operating profit of £8.0m (FY16 £6.7m).

Singapore continued its strong growth (+9.4%) with high levels of demand from both domestic appliance and electronics customers, and China (+9.8%) finally saw improving sales to the automotive segment as delayed projects moved into production. Even more encouraging was the return to growth for PSEP in Malaysia (+6.2% organic), with the bottoming out of demand in automotive combined with growth from domestic appliance OEMs.

The outlook for the current year is for these trends to persist, with Malaysia expected to see some recovery in automotive and increased exports through the TR network. Singapore and China should continue to grow and there is some prospect of greater Japanese automotive penetration due to the increased competitiveness of Trifast’s operations.

Trifast’s core strategy remains to focus on developing business with over 100 multinational OEM customers spanning the end-market sectors (automotive (31% of sales), electronics (18%), domestic appliances (21%), distributors (10%), and other (20%). These customers contribute more than 60% of revenues and where organic growth last year remained at around 10%. Trifast continues to increase the number of products and manufacturing plants of these companies it supplies. New OEMs are being added and investment is being made in key account management and CRM systems. This is further supported by the five additional strategic pillars:

We have modestly increased our expectations for FY18, largely reflecting the slightly better than expected base in FY17. We are now looking for 3% top-line growth compared to 2% previously, but are now expecting a slightly greater squeeze on gross margins as input cost increases are absorbed, especially in the UK. The slight increase in unallocated costs has led us to tweak our underlying margins, resulting in a £0.1m reduction in our adjusted operating profit forecast.

This is offset by a reduction in financing costs arising from the lower average debt levels and improved borrowing costs, leaving a marginal increase in PBT. We feel that our forecast errs on the side of caution, but given the limited visibility for sales and the uncertainties that exist in the world (Brexit negotiations, global trade policies, FX rates, geopolitics etc), we feel this is prudent. We have increased our underlying tax rate expectation to 25%, reducing forecast FY18 EPS by 2.6%.

We introduce our FY19 estimates with similar growth rates but a more stable margin expectation, which should lead to a slightly higher rate of earnings growth. We expect the strategy to continue to deliver consistent earnings growth in the absence of any adverse macro developments.