Trifast — Project Atlas helps map the future

Design, manufacture and distribution of industrial fasteners

Trifast is a leading specialist designer, manufacturer and distributor of industrial fasteners to major global assembly industries. 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 strengthening the product range, as with the acquisition on 4 April 2018 of UK-based Precision Technology Supplies (PTS), a key supplier and distributor of stainless steel fasteners with one of the broadest product ranges in Europe.

Trifast shares have outperformed the broader UK market over the last 12 months, rising by c 20%, or 5% year to date, as it continued to deliver consistent growth ahead of expectations. There is little change in the rating of the shares on a one-year forward P/E basis, and the 7% discount to its distributor peer group persists. A premium may be justified if the company delivers superior growth of earnings and free cash flow via Project Atlas, but this is likely to lag the initial investment phase.

In FY18, Trifast delivered another record year. Revenues rose 6.0% at actual exchange rates (AER) to £197.6m (FY17: £186.5m), or 4.0% at constant exchange rates (CER). Gross margin of 30.5% (FY17: 31.1%) remained above the 30% target rate despite anticipated input price inflation and the additional costs of investment in new manufacturing capacity. Underlying operating margins improved 20bps to an historic high of 11.5%, thanks to the increased sales and ongoing good cost control across the group. Underlying diluted EPS rose 7.5% to 13.78p (FY17: 12.82p). The full year dividend was increased 10% to 3.85p, with cover of 3.6x still within the target range of 3.0-4.0x. Net debt rose a modest £1.0m to £7.4m which, given the £1.2m tax payment last April that was deferred from FY17, essentially reflects a neutral net cash flow performance before the initial £8.5m purchase cost of PTS early in FY18. Trifast remains financially well positioned to pursue its invest and grow 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.

FY18 saw Trifast deliver another record year in terms of financial performance despite a moderation of growth in the second half of the year. Both the UK and Europe continued to make strong top-line progress, and overall the gross margin of 30.5% remained above the targeted level of 30% for the second year in succession. The Asian operations delivered a robust profit performance following a strong first half and the company continues to invest in the US, where profitability also experienced some one-time operational issues that should moderate this year.

As expected, the cash conversion rate from EBITDA to underlying operating cash fell to 68.1% (FY17: 97.3%). In addition to a £0.5m increase in capex to £3.6m, a £2.5m gross investment in stock levels was incurred during the year to normalise the abnormally low positions held at the prior year end. Excluding the inventory adjustment, the operating cash conversion would have been 78.2%. A number of one-off, non-operational factors also affected the net cash flow. These included the £1.2m tax and national insurance payment deferred from FY17 against the chairman’s exercise of share options on 17 February 2017, a £3.4m buyback of 1.5m shares by the Trifast EBT, property disposal proceeds of £1.6m in Malaysia and a £1.3m increase in net debt due to FX movements.

Underlying fully diluted EPS rose by 7.5% to 13.78p per share, which compares to our estimate following FY17 results of 12.56p, almost a 10% improvement. It has been achieved despite the anticipated input cost pressures and the one-off operational issues in the US.

In FY18 the UK grew revenues (including intra company sales) 5.4% to £73.0m at AER. As in the previous year growth was driven by the European distribution business, which grew 23.4% to £10.0m, or 14% of UK sales. In addition, there was a more broadly based increase in sales to core multinational OEMs across various sectors. The operational leverage over a semi-fixed cost base combined with good cost control led to a 220bp improvement in margin to 12.0%. We would not anticipate a further increase in margins as materials cost pressures persist even if relatively modest to date, Brexit concerns remain and the Project Atlas investment will start to generate some initially unrecovered incremental costs across the group.

Europe experienced a sharp contraction in operating margins split across three factors. As expected following the ending of a supply contract at the end of H117, there was a drop-through from gross profit of increased purchase costs, especially in the Italian operation. A similar impact on margin arose from higher fixed production costs from investment in additional manufacturing capacity. The third element was an overhead under absorption at the new TR Espana operation as it continues to build volumes. At the underlying operating level margins fell 210bp, although there was an improvement apparent during H218. The reported external revenue growth of 8.2% to £72.7m remained healthy despite the abnormally high domestic appliance sales volumes in Italy in FY17 due to a major global recall by a customer. The automotive sector in Holland (15.4% CER) and Sweden (13.6% CER) experienced the strongest growth.

Management expects the input cost levels to continue into FY19 as they have returned to more normal levels following the end of the favourable supply contract. We expect some improvement in overhead recovery in Spain as the new facility continues to grow.

Asia continued to perform well, with solid organic growth during the year across the key automotive and domestic appliance sectors. Although the growth moderated in Asia during the second half, this was expected. In part it was the result of management maintaining pricing discipline in the region, with some volume sacrificed as a result an e-bidding auction process. Trading nevertheless increased almost across the board in the full year, with China remaining the strongest region as the Shanghai-based operation grew by almost 10%, driven by strong automotive demand from domestic manufacturing operations and exports to Japan. The region broadly maintained its operating margin, with the benefit of higher volumes being largely offset by increased overhead expenses on newly opened facilities, as well as a higher balance sheet translation FX loss of $0.4m (FY17: £0.2m loss) incurred due to the weakening of the US$ later in H2.

We expect growth to continue in FY19 but at more muted levels.

The US broadly maintained sales volumes in the second half of the year compared to H118 using AER. However, in local currency terms, a soft first half with growth of 3.7% was followed by double-digit growth in the second half. Margins declined sharply due to product mix changes and the increasing focus on the lower-margin automotive sector, where temporary additional costs were incurred against a production start-up programme for a customer. As a result, underlying operating profit fell by £0.3m for the full year to close to break even. The decline was further exacerbated by the effects of Hurricane Harvey on electronics manufacturing customers. Trifast continues to invest in the region to stimulate future growth and, while some margin recovery is expected in the current year, additional overheads will be incurred as the operations moved into a new HQ in April.

The UK macroeconomic situation has continued to be resilient despite some well-publicised concerns and persistent domestic uncertainty, notably around Brexit. However, the impact of FX rates on input costs has so far been more muted than expected and exchange rates appear more stable. Management anticipate increased input cost pressures in FY19. Performance in the UK in FY19 will be enhanced as PTS will also make its initial contribution, effectively for a full year. We expect PTS to contribute £6m to revenues with a mid-teen operating margin, above the UK regional average.

We expect Europe to broadly maintain margins at the more normal levels seen in FY18, compared to an exceptional FY17, with growth in Spain and in other new capacities helping to mitigate any residual input price pressures.

Asia should benefit from the manufacturing capacity expansion in Singapore, which should lift margins with better overhead absorption. The new warehouse in Shanghai should also support continued automotive sector growth in China and Japan.

Management expects to see double-digit revenue growth and some margin recovery in the US assuming no repeat of the weather events in FY18, especially for the automotive operations. However, Trifast continues to build the team and invest in new facilities to support growth, including the new facility in Houston in April 2018.

Project Atlas has been launched. It is scoped to integrate and develop the IT infrastructure across the group to support the continuing growth, while improving the interface with customers. The associated investment of £15m will be spread over the next three years with around £5-6m anticipated in FY19.

Trifast’s core strategy remains unchanged. The focus is on developing business, with over 100 multinational OEM customers spanning the end-market sectors of automotive (33% of FY18 sales), domestic appliances (22%), electronics (16%) and other. These customers contribute more than 65% of revenues and delivered 5.6% organic growth last year. Trifast continues to increase both the number of products being sold to these companies and their manufacturing plants it supplies. New OEMs continue to be added and investment should now be accelerated into an integrated Management Information System (MIS) via Project Atlas, aligning customer-facing processes and systems with manufacturing. This is further supported by the five additional strategic pillars:

As the business has grown, Trifast has invested in the manufacturing footprint. However, the company has recognised the need to invest in its IT infrastructure and redesign its business processes to support further growth. A thorough investigation has prompted the company to introduce a new strategy in Project Atlas. Management views timely and effective information systems as integral to the future of the business and outlines four key drivers for the Project Atlas investment:

The direct costs incurred in FY18 were £0.4m, largely due to the project team and consultancy costs. While Project Atlas is a multi-year programme, the board has authorised a total budget of £15m, although this figure may evolve as the scope of the investment is refined. While the IT platform is expected to account for around a third of the budget, focus on improving business processes, including change management and training, will make up most of the investment. At the full point of benefit realisation (FY23), management estimates ROI on the project in excess of 25%, which is in turn above the company’s current ROCE of 20.1%.

We are once again modestly increasing our expectations for FY19 by around 1%. Margin pressures persist in some areas due to FX effects on input costs and additional fixed costs from capacity investment, and Project Atlas is likely to add further pressure in the near term, with its full enhancing benefits not expected until 2023. The acquisition of PTS further boosts current year performance, although our expectations for the business remain unaltered.

We introduce our FY20 estimates, with similar growth rates again reflecting the investments to be made under Project Atlas, and we expect to continue to look for appropriate opportunities to expand the business through additional M&A.