Thrace Plastics — Investing for the future

Strong personal protective equipment (PPE) demand and robust sales into more traditional sectors continued into Q2, contributing to strong year-on-year increases in H121 group revenue (+ c 51%, including volume + c 9%) and EBIT (+ c 234%, or + c 245% on a continuing operations basis). Technical Fabrics saw the majority of the PPE benefit and substantially drove group progress, with volumes in other sectors understood to be stable overall at good levels. Another strong period for cash conversion saw a c €15m net cash position (pre IFRS 16) at the end of H1 and an increased capex budget in several areas has been flagged. We have raised our current year EPS estimate by c 18% with a marginal uplift in the following two years and expect to see further positive cash generation.

Technical Fabrics is an international developer, manufacturer and distributor of technical fabrics, industrial yarns, fibres and composite materials used in a wide range of applications (including construction, infrastructure, PPE, landscaping, floorcoverings and agri/horticulture) produced mainly from polypropylene (PP) using a wide variety of different processes.

Divisional revenues rose by 66% y-o-y in H121, which was slightly ahead of the reported rate of progress in Q121 indicating that demand conditions continued at high levels in Q2. We now consider that the significant wave of demand for PPE that developed in 2020 only really started to do so towards the end of Q220, so the scale of the Q2/H121 favourable comparator is partly explained by this. As well as mix, firm pricing due to rising input costs also boosted top-line progress though we are unable to quantify this effect at a divisional level.

Thrace started FY21 with a favourable inventory position, which – along with the enriched mix described above – facilitated a record gross margin performance in Q1 (ie 43.6%). The H1 achieved gross margin of 42.2% indicates Q2 was still strong but slightly below Q1; this may partly reflect higher raw material pricing and possibly the effects of ramping up production from two relocated non-woven manufacturing lines.1 We note that opex also saw a step up in Q2 but was stable as a percentage of sales compared to Q1 and both periods compared favourably to H120 in this regard, reflecting positive operational gearing effects from higher levels of activity.

The above features fed into a near fourfold (€44m) increase in divisional EBIT in H121. The company states that medical sector/PPE demand accounted for €40.4m in this division (and €40.9m in total). Although we do not have the H120 base figure – which would have included some pre-COVID-19 underlying revenue as well as initial COVID-19 generated demand – there appeared to be good year-on-year growth in profitability in non-medical sectors overall, in addition to the still very significant medical sector contribution.

The Packaging division is a European manufacturer of containers and packaging in both rigid and flexible form mainly using PP and polyethylene feedstock with injection moulding (including in mould labelling), blown film extrusion and thermoforming being the primary production processes.

This division again experienced double-digit year-on-year revenue growth in Q221 albeit not quite at the same level as the preceding quarter (Q1: +19.4%, Q2: +15.8%). In addition to higher selling prices driven by input cost pressures, we would expect there to have been some volume growth in this division also reflecting 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 understand that there were no major mix variations across the core food/non-food product categories and no particular new trends have been noted by management. We should state that volumes supplied to the medical sector have historically been very small though there was a short-term spike around the middle of 2020 which makes the comparative period in FY21 a little more challenging.

As seen in Technical Fabrics, divisional margins were slightly lower in Q2 compared to Q1, but still very respectable for the half as a whole including 24.1% at the gross level and 12.5% for EBIT. Firstly, we think that the Q2/Q1 pattern again reflected the progressive work through of better-priced inventory at the start of the year to purchasing raw materials at prevailing spot prices before the period end. Secondly, the 2020 medical sector contribution referenced earlier (actually €3.2m EBIT for the year as a whole of the €16.1m group total) is likely to have included some Q220 benefit though we are unable to quantify this. Although the Q221 gross margin was below its prior year equivalent (Q121 was slightly ahead), excellent opex control meant that Thrace was able to report divisional EBIT marginally ahead of H120 in the first six months of FY21.

As stated earlier, by the end of H1 Thrace had moved to a c €15m core net cash position (or c €11m on an IFRS 16 basis) compared to net debt of c €32m at the beginning of the year and c €6m at the end of Q1.

Operating cash flow throughout H121 was very strong at c €75m in total and this was almost double the level achieved in H120. Having discussed profitability earlier, the only additional point to note here is the working capital movement, which saw a c €1m Q1 inflow reverse in Q2 to a neutral position for H1 as a whole. These movements are consistent with the starting inventory position and the only material driver behind a slightly better operating cash flow outturn in Q1 versus Q2 overall.

As one would expect given the profit and cash generated over the last 12 months, net interest costs have tapered down while outflows relating to corporate taxation have increased accordingly. In underlying terms, gross capex was in line with the prior year at c €12m (and slightly lower in net terms after disposal proceeds), though H120 also benefited from the initial sale proceeds of the former Thrace Linq site in the United States (ie €9.4m), which did not recur. Dividends approaching c €7m were paid in H121 (H120: zero) following approval at the 21 May AGM. Other cash outflows of c €4m were dominated by IFRS 16 lease payments and we note that this was heavily skewed towards Q1, prior to a transfer to owned fixed assets.

Coming towards the end of a period of strategic investment in the wider business, net debt at the end of FY19 stood at c €74m. The sharp increase in profitability starting in FY20 boosted by unprecedented medical sector demand was sufficient to fund the end of the previous capex cycle and also start to lower group borrowings on hand. The latter trend has clearly continued in FY21 to date, and Thrace’s end H121 net cash position and ongoing cash generation credentials form the platform for the next strategic phase.

Cash flow outlook: Thrace management has outlined a planned incremental capex of c €26m, which we believe is likely to be spread over the next 18 months or so. This is in addition to normal existing business requirements, which we had previously modelled at €17.5m per annum, so this is a sizeable new commitment. Geographically, the lion’s share of the additional capex is to be made at group facilities at Xanthi in northern Greece (€21.4m) and the remainder at Don & Low in Scotland. Facilities in both locations are to benefit from investment in both land and building to improve factory layout and accommodate further growth as well as adding recycling capacity to accommodate both in-house and third-party post-use polymers. In addition, there are some site-specific differences, as follows:

Consistent with the strategy overview in our previous note (on page 2), Thrace is clearly targeting further sustainable growth in its traditional core sector areas and we see the respective investments in spunbond and needle-punch processes as logical follow-ons to the relocation of US production lines in the prior year and in higher value-added complementary areas. In addition, investments in solar power and recycling enhance the company’s environmental, social and governance (ESG) credentials and improve business resilience.

After factoring in this increased capex evenly across FY21 and FY22 in our model, the current year portion is partly funded by improved FY21 profitability (see section below). We have assumed a working capital outflow in H221, but this is more than covered by the Linq property final receipt (as reported on 18 August). A special interim dividend (of €0.1086/share) was declared on 30 September and we expect the associated €4.75m cash to flow out in H2. Taken overall we expect a c €7m cash outflow in H221 to result in a c €7m net cash position at the year-end (pre IFRS 16) with material net inflows of €20m+ in the following two years. This cash performance and the resulting balance sheet funding position raises the question of prospective dividend payments. Thrace has a track record of engaging in material investment programmes and, provided attractive returns are seen to be available, we would not be surprised to see further plans of this nature over and above what we currently have factored in. For now then, we have assumed that cash dividend payments revert to historical levels, though we consider there to be clear upside risk to this, especially going into FY22 when the latest capex programme should be well advanced.

As stated in the H121 report, management is anticipating a ‘gradual return of the traditional sales mix’ partly informed by ‘evidence of declining product demand for medical/PPE’ as well as increasing normalisation of trading in those sectors that were negatively affected by COVID-19 (eg hospitality, tourism). While we now expect a higher contribution from the medical/PPE sector in FY21 than before, we expect that it will start to tail down in the second half of the year compared to the levels seen in the first two quarters of the year. We have also trimmed Packaging profitability slightly in the current year only, acknowledging the expected temporary effect of higher input prices. There are no other material changes in our forecasts, save for lower interest cost expectations driven by the positive cash flow performance.