paragon — Radically improving the investment case

paragon (FRA: PGN)

Last close As at 20/06/2024

3.02

−0.02 (−0.66%)

Market capitalisation

14m

More on this equity

Research: Industrials

paragon — Radically improving the investment case

So far in 2023 paragon has sold its semvox subsidiary, fully redeemed its Swiss franc (CHF) bond and is preparing for the remainder of the accelerated €25m Eurobond partial redemption, while delivering positive Q123 results. Once the Eurobond payment is complete, investors’ focus should return to the equity investment case. Risk reduction of the business model and a clear growth strategy still appear underrated by the market.

Andy Chambers

Written by

Andy Chambers

Director, Industrials

Industrials

paragon

Q123 results and
bond redemptions

Automobiles and parts

21 June 2023

Price

€5.76

Market cap

€26m

Adjusted net debt (€m) at 31 March 2023 (excludes leases €15.2m)

88.1

Shares in issue

4.5m

Free float

50.7%

Code

PGN

Primary exchange

Frankfurt Xetra

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

1.1

8.3

21.8

Rel (local)

2.1

0.4

0.3

52-week high/low

€6.38

€3.65

Business description

Based in Delbrück, Germany, paragon designs and supplies automotive electronics and solutions, selling directly to OEMs, including sensors, interior, body kinematics and power. It has production facilities in Germany, Croatia and China.

Next events

H1 results

September 2023

Q3 results

November 2023

Analysts

Andy Chambers

+44 (0)20 3077 5700

Natalya Davies

+44 (0)20 3077 5700

paragonparagon is a research client of Edison Investment Research Limited

So far in 2023 paragon has sold its semvox subsidiary, fully redeemed its Swiss franc (CHF) bond and is preparing for the remainder of the accelerated €25m Eurobond partial redemption, while delivering positive Q123 results. Once the Eurobond payment is complete, investors’ focus should return to the equity investment case. Risk reduction of the business model and a clear growth strategy still appear underrated by the market.

Year

end

Revenue (€m)

PBT*
(€m)

EPS*
(€)

DPS
(€)

P/E
(x)

Yield
(%)

12/21**

135.4

(3.5)

0.72

0.0

8.0

N/A

12/22**

160.3

(7.9)

(1.15)

0.0

N/A

N/A

12/23e

173.7

6.5

1.14

0.0

5.1

N/A

12/24e

195.9

12.2

1.82

0.0

3.2

N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. **Continuing – restated for paragon semvox discontinued in FY21/FY22.

Q123 trading performance shows further progress

Q123 trading performance saw good revenue growth (+15%) with stable EBITDA and slightly negative net cash flow. Management has retained guidance for full year revenues of c €170m delivering EBITDA in the €20–25m range and we maintain our estimates. However, net interest should fall significantly from H223, enhancing our EPS estimates for both FY23 and FY24 by around 50%. With a 22% increase in the five-year booked business to €761m at the start of the year and subsequent additional order intake, paragon looks well set to deliver its growth strategy.

Semvox proceeds applied to bond redemptions

paragon received €34.5m of the proceeds from the semvox disposal to Volkswagen on completion on 12 May 2023 and expects the balance of at least €5.5m by early July. Management used the proceeds to repay the interim financing that facilitated the final CHF21m bond redemption, as well as the buyback of €4.8m nominal of the Eurobond in April. That leaves a further €20.2m nominal to be redeemed by January from the accelerated payments triggered by the deal. The successful rapid deleveraging of the balance sheet should immediately reduce interest payable, enhance EPS by c 50% and leave the company’s investment case in an increasingly positive place.

Valuation: Debt reduction yet to be reflected

While the shares and Eurobond have continued to trade at higher levels, we believe the equity rating does not reflect paragon’s substantial progress. With a leverage ratio of c 2x by the year end, paragon will, for the first time in a long time, be an equity investment story unencumbered by excess debt. Despite an increase in the weighted average cost of capital (WACC) due to the increased equity value, our discounted cash flow (DCF) valuation stands at €23.8/share (€26.6/share previously), although the equity risk premium of 10% should probably be reduced once the Eurobond redemption completes. The €23.8 value would represent a multiple of just 13.1x FY24e EPS.

Q123 continues positive momentum

paragon continued to display positive momentum in Q123, with semvox treated as discontinued ahead of its c €40m disposal, which was completed in May subject to final account adjustments. The proceeds facilitated the final redemption of the CHF bond and prepare the company for the remainder of the accelerated €25m repayments of the Eurobond that now fall due. The progress in the trading performance is confirmed by management’s unchanged guidance for revenue growth in FY23 to c €170m with EBITDA of between €20m and €25m. When combined with the continuing deleveraging, the investment proposition is being progressively de-risked. We expect the recent re-rating to receive further impetus as the growth plan is executed.

Trading performance in Q123

Once again, the continuing operations of both the Electronics and Mechanics divisions recorded growth in Q123. Both divisions grew revenues as the automotive market bounced back from the global shortage of semiconductors and the automotive supply chain disruption, caused by the war in Ukraine, that characterised Q122. Car registrations were up 17% in Europe and 8% in the United States, although China declined 7%. paragon’s operations continued to outperform the market. The key highlights of the Q123 results are:

Revenues grew 14.6% to €44.7m (Q122: €39.0m).

EBITDA was stable at €3.8m with an improvement in Electronics offsetting a decline in Mechanics. The EBITDA margin was 8.6% (Q122: 9.8%).

EBIT improved modestly to €0.5m but there was a significant increase in interest charges to €3.0m, reflecting the higher Eurobond interest rate and cost of interim finance used to secure the April 2023 final CHF bond redemption. As a result, the loss before tax increased to €2.5m (Q122 loss: €0.7m) and the net loss for the period was €2.3m (Q122 net loss: €0.9m).

Exhibit 1: Q123 financial summary

3 months to 31 March (€m)

Q122

Q123

– Sensors

12.6

12.2

-3.5%

– Interior

14.0

14.5

4.2%

– Power

0.5

1.5

300.0%

Electronics

26.9

28.2

4.6%

Body Kinematics

12.1

16.6

36.6%

Revenues

39.0

44.7

14.6%

Gross profit

19.3

20.3

5.3%

Gross margin

49.4%

45.4%

-8.1%

EBITDA

Electronics

2.8

3.8

38.1%

Body Kinematics

1.0

0.0

-99.0%

EBITDA

3.8

3.8

0.7%

EBITDA margin

9.8%

8.6%

EBIT

0.4

0.5

27.3%

PBT reported

(0.7)

(2.5)

237.0%

Net income

(0.9)

(2.3)

161.4%

EPS (€)

(0.20)

(0.51)

161.4%

Adjusted net cash/(debt) (excluding leases)

(86.0)*

(88.1)

2.4%

Source: Company reports. Note: *At 31 December 2022.

There was an operating cash outflow from the continuing operations of €2.3m (Q122: €6.0m inflow) largely driven by the drop in profits as well as the switch to twice-a-year payments of Eurobond interest.

Adjusted net debt (excluding leases) increased modestly by 2.4% during the quarter to €88.1m (FY22: €86.0m, Q122: €98.8m), as the €9.7m accelerated bond redemptions were initially paid for from cash balances. Cash and cash equivalents declined to €4.6m (FY22: €18.1m) and lease liabilities totalled €15.2m.

In Q123, the continuing Electronics segment activities’ third-party revenues grew by 4.6% to €28.2m (Q122: €26.9m), accounting for 63% of group sales. The increase reflected a 3.5% decline in Sensors revenues to €12.2m (Q122: €12.6m), more than offset by a 4.2% increase in Interior revenues to €14.5m (Q122: €14.0m). The still-nascent new Power business unit made excellent progress, increasing sales to €1.5m (Q122: €0.5m). The divisional EBITDA contribution increased to €3.8m (Q122: €2.8m), a margin of 13.6% (Q122: 10.6%).

The Mechanics division (Body Kinematics) increased sales by 36.6% to €16.6m (Q122: €12.1m), while the EBITDA contribution fell to just above break-even (Q122: €1.0m) as paragon movasys ramped up volumes on newer products, including seat adjusters, rear tables and adaptive spoilers, in China.

In terms of business development during the period, paragon’s Sensors business unit won a third order for its Sensoric anti-virus filter (DUSTDETECT) with an anticipated lifetime contract value of over €10m. In addition, Power won a contract to supply lithium-ion starter batteries to a premium segment car OEM. Production starts in Delbrück this summer, with an expected lifetime value of more than €40m.

Outlook

Increasing FY24 EPS by almost 50%

Management has maintained guidance for FY23, indicating sales of c €170m with an EBITDA of between €20m and €25m. paragon does not present an order backlog but does monitor booked business for the next five years, or the anticipated value of sales from contracts secured. It measures this at the year end. From the end of FY21 to FY22, the value of the five-year anticipated sales revenue had increased by 22% to €761m from €624m a year earlier. The expansion reflects the anticipated growth in China, where sales are expected to almost double to c €16m in FY23.

We have adjusted our earnings estimates to reflect the benefit of the continuing bond redemptions. While our revenues and profits before financing charges are essentially unchanged, the decrease in interest payable has a significant effect at the PBT and EPS levels. As a result, our EPS estimates increase by around 50% in both FY23 and FY24.

Exhibit 2: paragon estimates adjustments

Year to December (€m)

2023e

2023e

 

2024e

2024e

 

 

Prior

New

% change

Prior

New

% change

Electronics

118.7

118.7

0.0%

136.5

136.5

0.0%

Mechanics

54.8

55.1

0.4%

59.2

59.5

0.4%

Total group revenues

173.5

173.7

0.2%

195.6

195.9

0.1%

 

 

 

 

 

 

Electronics

19.6

19.6

0.0%

23.2

23.2

0.0%

Mechanics

3.3

3.3

0.4%

4.7

4.8

0.4%

HQ Other and intersegment

0.2

0.0

-100.0%

0.2

0.0

-100.0%

EBITDA

23.1

22.9

-0.8%

28.1

28.0

-0.6%

PBT

4.6

6.5

41.1%

9.1

12.2

34.7%

 

 

 

 

 

 

EPS – underlying continuing (€)

0.74

1.14

53.2%

1.22

1.82

48.8%

DPS (€)

0.0

0.0

 

0.0

0.0

 

Net cash/(debt)

(84.1)

(48.8)

-42.0%

(82.3)

(42.4)

-48.5%

Source: Edison Investment Research estimates

Sale of semvox

The disposal of semvox to CARIAD, a subsidiary of Volkswagen, was completed on 12 May 2023. The sale value of €43m was on a cash and debt-free basis so after deduction of a €3m loan the proceeds due to paragon are €40m, although this is subject to closing account adjustments, which should be finalised by early July.

paragon’s management believes €40m is a conservative assumption for total proceeds and received €34.5m on completion, which was initially used to repay interim financing used to facilitate the €21m CHF bond final redemption and the first scheduled partial payment for €5m nominal of the Eurobond in April 2023. The payment of the balance of the proceeds should be made in July at the latest.

The company continues to progress with net debt reduction (Exhibit 3), with the current level of €51.1m (excluding leases) following the April bond redemptions showing a substantial decline compared to €117.4m in FY19. Consequently, we forecast FY23 net debt of €49m, implying a healthier leverage ratio of 2.1x.

Exhibit 3: paragon adjusted net debt (excluding leases) reduction

Source: Company reports, Edison Investment Research estimates

Bond redemptions

Having successfully redeemed the CHF bond, the immediate priority for paragon is to complete the accelerated repayment of the additional €25m nominal of the Eurobond that fell due as a result of the disposal.

Management has already redeemed a further €4.8m of nominal through a public buyback offer in April 2023 at 60% of nominal costing €2.9m. That leaves an outstanding €20.2m nominal (market value at 15 June 2023: €15.0m) to be redeemed by 5 January 2024.

We expect management to secure the balancing repayment using the remaining proceeds from the semvox deal together with a possible modest new line of debt (<€10m). We expect the cash redemption cost to be between the current market value and par (€20.2m).

After this transaction the Eurobond debt will be reduced by 50%, significantly further reducing the interest payable by paragon. We estimate net debt should be less than €50m at the end of the current year. We expect net debt to EBITDA would fall to less than 2x for FY23, a far more manageable and appropriate level for an industrial company such as paragon. This alone should significantly advance sentiment and de-risk the investment proposition. As free cash flow improves with trading, the future bond redemption and debt servicing should be more readily covered.

Shareholder structure – the last elephant

With such good progress being made in trading and ongoing debt reduction, it is frustrating to have the ownership and management of the company subject to a great deal of uncertainty.

External investor ElectricBrands AG of Germany exercised an option during 2022 to assume control of just under 30% of the listed entity. The stake came from the Frers family holding of 50% plus one share, leaving Mr Frers holding just over 20%. However, our understanding is that the remaining holding may also be subject to the option, but as ElectricBrands clearly did not want to make a full mandatory offer initially, it is unclear as to the precise agenda, control or cooperation. In either event, group management has to date regarded the move as hostile.

However, the KGaA structure of paragon means that even if ElectricBrands exercised the remainder of the option, it would not gain control over the company but just own the majority of the economic value. It would also be forced to make a mandatory bid for the remaining share capital of the listed company. However, in order to gain control of the operations, ElectricBrands could make a bid for the management company, which is 100% owned by the Frers family. In such a case ElectricBrands would need to be seen to treat listed shareholders fairly, so any bid for the listed entity would need to reflect a fair value.

It is unclear to us what the ultimate outcome might be: a bid, buyout or status quo. In any event, given the debt reduction programme and positive trading, we think investors should await further developments.

Valuation: An inflection point looms

As the equity value has risen since our last Update note, our calculated WACC has also increased a shade to just over 8%. The result is a decline in our capped DCF value to €23.8/share (€26.6/share previously), although we have not yet reduced the equity risk premium from 10% to reflect the substantial deleveraging of the company. The table below provides visibility of how that adjustment may affect the value.

Exhibit 4: paragon DCF sensitivity to WACC and terminal growth rate (€/share)

WACC

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

Terminal growth rate

0%

38.7

34.2

30.3

26.9

23.8

21.2

19.0

16.9

15.1

1%

39.2

34.6

30.6

27.2

24.1

21.5

19.2

17.2

15.3

2%

39.6

34.9

31.0

27.5

24.4

21.8

19.5

17.4

15.5

3%

40.0

35.3

31.3

27.9

24.7

22.0

19.7

17.6

15.7

Source: Edison Investment Research estimates

While the shares and Eurobond are now trading at recent highs, the low single-digit FY24 P/E multiple of just 3.2x fails to reflect the operational outlook. Our capped DCF valuation of €23.8 per share implies a multiple of 13.1x our revised post disposal FY24 EPS estimates. While this might look ambitious, we feel that such a multiple could increasingly be supported by fundamental metrics as the growth strategy is executed, with strong earnings improvements and rising operational cash flow facilitating further future reductions in the debt burden.

Exhibit 5: Financial summary

€m

2020

2021

2022

2023e

2024e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

127.2

135.4

160.3

173.7

195.9

Cost of Sales

(69.2)

(72.1)

(94.2)

(99.0)

(109.7)

Gross Profit

58.0

63.4

66.1

74.7

86.2

EBITDA

 

 

13.8

15.1

11.6

22.9

28.0

Operating Profit (before amort. and except).

6.6

8.4

4.8

15.7

20.3

Intangible Amortisation

(6.0)

(6.0)

(5.0)

(3.8)

(4.0)

Exceptionals

(11.2)

(4.2)

(2.9)

(2.5)

(2.5)

Other

0.0

0.0

0.0

0.0

0.0

Operating Profit

(10.6)

(1.8)

(3.1)

9.4

13.8

Net Interest

(6.5)

(5.9)

(7.7)

(5.4)

(4.1)

Profit Before Tax (norm)

 

 

(6.0)

(3.5)

(7.9)

6.5

12.2

Profit Before Tax (FRS 3)

 

 

(17.2)

(7.7)

(10.7)

4.0

9.7

Tax

9.6

0.5

2.1

(1.8)

(3.3)

Discontinued

(37.1)

(4.2)

5.3

12.5

0.0

Profit After Tax (norm)

3.6

(3.2)

(5.2)

5.1

8.2

Profit After Tax (FRS 3)

(44.7)

(11.4)

(3.4)

14.7

6.4

Average Number of Shares Outstanding (m)

4.5

4.5

4.5

4.5

4.5

EPS - normalised (€)

 

 

0.79

(0.72)

(1.15)

1.14

1.82

EPS - normalised fully diluted (€)

 

 

0.79

(0.72)

(1.15)

1.14

1.82

EPS - (IFRS) (€)

 

 

(9.87)

(2.52)

(0.74)

3.24

1.41

Dividend per share (€)

0.00

0.00

0.00

0.00

0.00

Gross Margin (%)

45.6

46.8

41.3

43.0

44.0

EBITDA Margin (%)

10.8

11.2

7.2

13.2

14.3

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

5.2

6.2

3.0

9.0

10.4

BALANCE SHEET

Fixed Assets

 

 

143.1

115.0

75.6

74.3

73.4

Intangible Assets

81.5

76.4

43.1

42.0

41.1

Tangible Assets

47.0

36.2

25.7

25.5

25.5

Right of use asset

13.1

1.8

5.1

5.1

5.1

Investments

1.5

0.6

1.6

1.6

1.6

Current Assets

 

 

57.4

44.7

97.0

50.9

54.7

Stocks

27.3

24.0

25.2

25.2

26.5

Debtors

11.6

10.9

7.7

8.7

9.8

Cash

5.7

1.5

18.1

6.1

6.1

Other

12.7

8.4

46.0

10.9

12.2

Current Liabilities

 

 

(90.6)

(125.5)

(99.6)

(35.0)

(37.8)

Creditors

(41.3)

(31.9)

(47.8)

(35.0)

(37.8)

Short term borrowings

(49.3)

(93.6)

(51.8)

0.0

0.0

Long Term Liabilities

 

 

(96.6)

(30.9)

(72.3)

(74.8)

(68.5)

Long term borrowings

(67.6)

(10.2)

(52.3)

(54.9)

(48.5)

Lease liabilities

(18.7)

(12.1)

(16.0)

(16.0)

(16.0)

Other long term liabilities

(10.4)

(8.6)

(4.0)

(4.0)

(4.0)

Net Assets

 

 

13.2

3.3

0.7

15.3

21.7

CASH FLOW

Operating Cash Flow

 

 

11.6

18.7

17.9

14.3

25.7

Net Interest

(6.5)

(5.9)

(7.7)

(5.4)

(4.1)

Tax

9.6

0.2

2.7

(1.4)

(4.0)

Capex

(7.7)

(15.0)

(7.7)

(10.2)

(11.2)

Acquisitions/disposals

0.0

8.4

0.0

0.0

0.0

Financing

1.9

4.7

8.4

40.0

0.0

Dividends

0.0

0.0

0.0

0.0

0.0

Net Cash Flow

8.9

11.1

13.6

37.3

6.4

Opening net debt/(cash)

 

 

117.4

111.2

102.3

86.0

48.8

HP finance leases initiated

0.0

0.0

0.0

0.0

0.0

Other

(2.7)

(2.2)

2.7

0.0

0.0

Closing net debt/(cash) (excluding leases)

111.2

102.3

86.0

48.8

42.4

Total financial liabilities

 

 

130.0

114.4

102.0

64.8

58.4

Source: Company reports, Edison Investment Research estimates


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This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

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New Zealand

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. 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 (i.e. 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.

United Kingdom

This document is prepared and provided by Edison 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.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison 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. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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Helios Underwriting — Active Lloyd’s risk management and promotion

Helios Underwriting delivered a strong capacity increase in FY22 as well as improved portfolio diversification, enhanced by selective risk taking in existing Lloyd’s of London (Lloyd’s) syndicates and as a promoter of new initiatives. Its new CEO’s strategy aims to enhance risk selection and management, capital management and growth initiatives (organically and as a promoter and acquirer). The strategy includes increased investment in future growth through reinsurance, financing and capacity building strategies. The FY22 EPS loss was slightly higher than expected due to investment losses and a delay in underwriting turnaround. After allowing for Helios’s new strategic investment and adding conservatism for current global uncertainty, we have cut our FY23 and FY24 EPS forecasts by 31% to 15.1p and 15% to 26.6p respectively. This still represents meaningful near-term growth, while our confidence around long-term growth has been enhanced by impressive capacity accumulation prospects and strategic investment. As a result, we maintain our valuation of 252p/share, at a 47% premium to our FY23 forecast net asset value (NAV).

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