Trifast — Update 14 June 2016

Trifast is a specialist designer, manufacturer and distributor of industrial fasteners. While its origins are in the UK, the group has built a global presence, extending initially into Asia, but more recently into continental Europe and, to a lesser extent, into North America. 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 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 share price has risen by 17% over the past six months, much in line with the 15% average of the majority of its peer group. The peer group table shows a distinct discount accorded to companies supplying the industrial products relative to those supplying electronic components (11.8x vs 20.1x CY16 prospective earnings). This is understandable in the context of the challenging global trading climate, but does seem over cautious. We believe the market is not recognising Trifast’s consistent trading performances since the management changes in 2009. Its size relative to its peers could justify a lower rating, but this is more than balanced by the likely medium-term impact of recent investment decisions by management, including key acquisitions.

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.

Trifast has built on its strong first half performance in the year to March 2016. While the majority of the profits increase was delivered at the interim stage, when a £0.6m currency benefit in Singapore helped lift underlying PBT by 25% from £6.6m to £8.3m, further profits progress was reported in the second half. Over the full year and in an ongoing challenging trading climate, underlying pre-tax profits rose by 12% from £14.3m to £16.0m, comfortably above our £15.4m estimate.

Exceptional costs (related to acquisitions) were materially lower at £0.3m, compared to £1.2m in the previous year. The IFRS2 charge and intangibles amortisation were doubled, up from a combined £1.3m to £2.6m.

A small amount of equity dilution related to shares issued as part of the consideration for the previous year’s acquisition, but, with the help of a lower tax charge, diluted adjusted EPS rose by 15% from 8.68p to 9.99p. The group raised its full year dividend ahead of market expectations, by 33% to 2.80p, maintaining the sharp increase seen at the interim stage; we had assumed a 1:2 split between the interim and final payments, implying a total of 2.4p. The increased dividend was covered 3.6 times.

In essence, the impact of acquisitions, organic growth and an increase in gross margins combined to comfortably outweigh the adverse impact of the tough economic climate across much of continental Europe and the translation of overseas profits into sterling. Italian acquisition Viterie Italia Centrale (VIC) was consolidated for the full period compared to 10 months in the previous year, while there was a maiden six months’ profit contribution (£0.5m) from the more recent Kuhlmann acquisition.

Overall gross margins rose by a further 70bp to 29.7%, reflecting a combination of further improvement in the underlying businesses and the high returns earned at the recent acquisitions; this improvement contributed to a 50bp boost to operating margins from 9.9% to 10.4%.

The adverse impact of currency translation involved £3.9m revenue and £0.4m of underlying PBT. A 6.8% increase in constant currency (CER) was reduced to 4.3% after adjustments, largely related to the euro. Similarly, a 14.8% increase in underlying PBT was reduced to 11.8% in actual currency (AER).

We remain confident that the consistent rises in gross margins delivered over the past few years (29.7% in FY16 vs 24.5% in FY10) can at least be sustained. Management has established a business model whereby quality of product and service is seen by customers as fundamental to the development of their own businesses. Trifast continues to invest in people, training and the sales and marketing infrastructure.

Trifast has continued the rationalisation of lower-margin business in the UK, with the group generating better quality new contracts, especially in the automotive sector. Revenues edged 2.0% lower to £64.2m, but with a rise in margins from 8.9% to 9.6%, there was a 5.8% rise in operating profits to £6.2m. The message provided at the interim stage, when profits were running 11% higher, suggested a relatively flat market, with several key customers in automotive and electronics outperforming the market. Management has indicated that there was a softening in demand over the second half – we sense that this may involve an element of customer destocking stemming from increasing uncertainty about mainland European economies and, more specifically, fears about a possible Brexit. In addition, there was a strengthening of the sales team – this would have lifted the cost base, ahead of benefits to emerge over the next two to three years.

Investment by management to lift efficiency levels in inventory storage and stock picking should also start to deliver in the coming months, but conditions are likely to remain challenging in the immediate future.

The potential for the group’s continental operations has been transformed by the VIC and Kuhlmann acquisitions, which have provided the group with key market positions in Italy and Germany, supplementing long-standing strategic positions in a number of other key continental markets. Last year’s results showed a 24.9% CER increase in revenues; while acquisitions were responsible for the majority of this growth, organic growth across the longer standing businesses was strong, at 10.9%, Weakness of the euro was a key factor on translation into sterling, but reported revenues (AER) rose by 16.7% to £54.0m. Underlying operating profits rose more modestly, by 6.4% (AER) to £6.9m.

Exchange rate movements undermined the margins at VIC, although the business continued to grow consistently. New investment in its manufacturing facilities has broadened the manufacturing plant’s capabilities and raised its capacity.

Kuhlmann has quickly been integrated into the group – its profits were at the upper end of management expectations, while the sales team has already been extended to facilitate the introduction of the wider Trifast product range across its customer base. The benefits should begin to emerge in the current year, with the real impact coming over the medium term.

The longer standing businesses continued to secure useful new contracts, especially supplying to the group’s core list of some 50 multinational customers. These contracts tend to be related to new products or product upgrades; revenues will emerge as these new products come to market delivering over the medium term.

Trading conditions across continental Europe remain challenging, but management sees this region as a major engine for growth in the immediate future and over the longer term, as the impact of management action filters through to revenue and profits.

The group’s US business continues to move forward. Helped by a sound US dollar, revenues advanced by 7% to £4.6m, with operating profits up by 23% to £0.4m. Investment in top-line growth, supplying to a small number of key customers, continues to deliver increasing returns on a relatively modest cost base. The US remains a major opportunity for the group, with many of its core customers operating manufacturing plants. There are acquisition opportunities, but asking prices appear high, while most available businesses tend to be regional suggesting that several deals will be necessary to achieve a real presence; meanwhile, the current business continues to move forward steadily.

Following a challenging FY15, profits from the group’s Asian operations moved ahead strongly last year. Revenues were virtually unchanged, down 0.3% to £38.6m, but with a strong recovery in margins (up from 14.8% to 17.4%), underlying operating profits rose by 17.4% to £6.7m.

The strongest progress was achieved in Singapore, where revenues were lifted by 9.4% to an estimated £12m. Profits moved ahead sharply, especially during the first half, when there was a favourable currency movement contributing some £0.6m to the bottom line. In addition, deliveries began build up on a number of new contracts, especially those for one specific, but unnamed, domestic appliance industry customer.

We understand that operations in China and Taiwan delivered useful progress, despite media comment to the effect that growth rates are slowing. New investment in Taiwan, extending capacity, points positively to the future.

The main disappointment was, again, Malaysia where revenues slipped back by 8.3% to just under £11m. The statement refers to falling consumer demand and domestic market weakness – we would suggest that automotive sector demand was particularly quiet. The group completed a major plant investment during the final quarter. Again, the investment has lifted capacity, but has also brought certain disciplines in house. We see little improvement in the local economy in the short term, but some profit recovery can be expected in the current year.

There has been no further comment on the business extensions into India and Thailand (under the auspices of the Singapore management team) – this would suggest progress in line with management expectations, although positive returns are still some way into the future.

The overall picture for the group’s Asian operations remains positive. On present indications, there should be further profits progress in the current year, while the medium-term outlook has been enhanced by recent and current investment plans.

There are six distinct planks to the Trifast strategy, which was re-established in 2009, when former group executives were reinstated to invigorate a struggling group:

In the past we have compared Trifast with UK-based global electronic component distributors and overseas-based fastener distributors. Following the sale of its fastener business, Anixter (US) is no longer appropriate as a comparator, while the rating of Bossard is held back by the extent of family control. We have decided to concentrate on a short list of UK-quoted international distributors.

Trifast’s share price has risen by 17% over the past six months, much in line with the 15% average of the majority of its peer group; SIG has fallen by 10% reflecting cautious trading statements and its high involvement with the eurozone. The peer group table shows a distinct discount accorded to companies supplying the industrial sector. This is understandable in the context of the challenging global trading climate. However, we believe the market is not recognising Trifast’s consistent trading performances since the management changes in 2009. Its size relative to its peers could justify a lower rating, but this is more than balanced by the likely medium-term impact of recent investment decisions by management, including key acquisitions, which point positively to the future.

The global trading climate remains challenging, with mainland Europe still failing to sort out its endemic problems and South-East Asia, under the lead of China, indicating growth rates running below earlier forecasts. Nevertheless, management has indicated a strong order pipeline, especially related to the policy of working more closely with the group’s top 50 multinational customers. The current year will benefit from a full contribution from last year’s Kuhlmann acquisition, while the recent investment in extending group manufacturing and marketing capabilities should also start to contribute during the current year.

Our previous underlying FY17 PBT estimate of £16.5m is clearly looking conservative – we have decided to lift this target to £16.9m. We believe that this figure will prove conservative, but with currencies fluctuating quite sharply, because of the uncertainty surrounding the Brexit referendum, we have decided to maintain a cautious posture. It is quite likely that, as the year progresses, we shall be able to make a more optimistic assessment.

We remain positive about the medium-term outlook, with the clear strategy likely to deliver ongoing consistent earnings growth. We are introducing an estimate of £17.9m for the year to March 2018 – again, we are hopeful that this will prove conservative.

Net borrowings rose by £2.6m to £16.0m over the year to March 2016; gearing stood at 19% of shareholders’ funds. The group generated £15.9m from operations, after a relatively modest £1.8m rise in working capital. With taxation, interest and dividends absorbing a total of £6.3m, there was £9.6m available for investment. Net capital spending was £2.3m, while acquisition expenditure net of funds/borrowings acquired lifted total net investment expenditure to £10.0m. Other factors, notably the impact of exchange rates on the translation of overseas cash and borrowings into sterling, led to an adverse movement of £2.2m.

In the absence of further acquisitions and assuming unchanged exchange rates, we would expect to see a net reduction of at least £2.0m in net borrowings over the year to March 2017. New facilities are being discussed with the group’s bankers. Management has indicated a likely £5m rise in the RCF, implying total of £50m, plus a £20m accordion facility. This would enable management to act quickly in response to appropriate investment opportunities.