Tyman — Update 25 August 2016

There were a lot of moving parts behind the good progress seen in Tyman’s headline H116 results Underlying year-on-year revenue progress was supplemented by improved margins, achieved by all three divisions. Positive acquisition and FX effects added to this, with further gains to come in H2. Strategic M&A activity is the primary driver behind higher net debt levels in FY16.

North America – AmesburyTruth (AT): Favourable FX translation effects (average US$1.4336/£ versus US$1.5287/£ in H115) broadly doubled the underlying US dollar revenue and EBIT rate of growth, resulting in double-digit percentage increases on both metrics. Headline comparative performance was influenced also by the absence of discontinued extrusion activities (H115 revenue c US$2.5-3.0m, FY15 c US$6.5m) and inclusion of Giesse’s North American distribution activities (H116: four-month revenue contribution of c US$0.5-1.0m).

The existing AT businesses sustained their leading group margin position and made further progress with a 68bp improvement to 17.2% on 5.8% underlying sales growth. Top-line progress was driven by good residential window and door fabricator OEM demand in a US market showing good year-on-year increases in building data especially in single dwellings. Harvard’s LIRA measure of RMI activity was at or above its long-term average in H116 and AT’s initiatives in the commercial construction segment accelerated revenue growth here despite some market softness in large projects. The smaller Canadian market began to improve, but remained below prior year levels, with US-based suppliers including AT also facing relative US dollar strength/Canadian dollar weakness. AT profitability benefited from higher volumes, pricing effects (+c 2% y-o-y) and lower input costs versus last year. Against this, the absorption of some line relocation costs will have weighed on reported profitability though the net margin impact was clearly positive overall.

The North American strategic footprint change programme looked to be more focused on capital projects during H1, including a new facility at Sioux Falls, South Dakota, and an extension to the Juarez, Mexico, site (partly to accommodate lines from elsewhere in AT). The roll-out of a new ERP system to additional locations is also ongoing. Additional projects included the absorption of Giesse’s Tennessee distribution facility into an existing one at Sioux Falls and preparatory work on the strategic acquisition of Bilco (which completed on 1 July). The minor movement in short-term provisions suggests that, line relocation aside, operational impacts of the footprint programme were relatively light in the period. P&L benefits were always expected to flow from the change programme from FY17 onwards; this appears intact and the profile of operational execution is likely to increase.

Looking ahead, US market segments’ lead indicators remain positive, and while Canadian markets have shown some signs of improvement, they are likely to lag the prior year. AT entered H2 with order books c 2% up year-on-year against a comparatively strong exit rate at the end of H115. While some input costs have started to rise, we still expect to see a good seasonal increase in underlying profitability in H2, supplemented by a maiden contribution from Bilco.

UK – ERA: The reported trading performance was partly affected by the disposal of EWS (a non-core reinforcer business) last year and, to a lesser extent, the acquisition of Response Electronics (sales, marketing and distribution of electronic/electro-mechanical security products) in March this year. Response chipped in c £1.2m sales in its 15 weeks of ownership and, implicitly, a small loss.

Stripping these items out, the underlying operations achieved a good EBIT uplift on modest sales progress (+11.4% and +1.5%, respectively). There were pockets of good top-line progress; the distributor channel (+4.4%) benefited from increased focus while Ventrolla (+7.2%) continued recent positive momentum underpinned by business investment. Implicitly, the OEM sales channel was pretty flat with volumes probably slightly down year-on-year after taking into account price inflation following input cost pricing pressure from Q1. ERA’s primary sub-sector focus is RMI spending and market conditions were subdued. While new housebuilding demand has been firmer to date, this forms less than 20% of divisional revenue currently. A 90bp increase in divisional EBIT margin was very creditable and partly reflected steps taken to reduce costs in the prior year ahead of the intended consolidation of three facilities onto one site (scheduled for H117).

In the near term, management is anticipating RMI market softness and expects 2017 volume to be flat to down. Ongoing input price pressures following post-Brexit sterling weakness is an additional challenge; ERA is substantially hedged for the remainder of the current financial year so success in passing on materials inflation is a flag for FY17 financial performance. Competition faces the same pressures and smaller players are already understood to be adjusting prices. ERA will continue to control its cost base including intended site consolidation, which should also bring customer service benefits. Construction of the new combined light assembly and distribution facility is expected to start in Q416. So, ongoing self-help measures are already well in hand to help to mitigate any deterioration in market conditions. To benchmark FY17, revenue and EBIT for the ongoing businesses in FY15 (ie prior to Response) were £66.7m and £10.3m, respectively. Response reported £3.4m revenue and £0.15m EBIT for the same period prior to acquisition.

Other/RoW – Schlegel International: The acquisition of Giesse (an Italy-based window and door hardware business) was the most significant event for this division during H116. In the 15-week period following acquisition, Giesse contributed £20.4m revenue and £3.0m EBIT (compared to c £58.7m/€80.8m and c £7.8m/€10.8m EBITDA, respectively, for the 12 months to December 2015) the majority of which is included in Schlegel’s result. The divisional head office has been relocated to Bologna, where Giesse is based, and Schlegel’s Milan distribution facility has been closed.

Excluding Giesse, the underlying Schlegel businesses delivered a softer year-on-year sales performance but much improved profitability. These two aspects are related through the FY15 closure of a loss-making Barcelona pile seal factory and more gradual ramp-up of the relocated production equipment in the UK. Lower trading volumes in Brazil compounded by local currency weakness were also a factor behind the underlying divisional revenue performance. More positively, demand across European markets improved, with relative euro strength also boosting the outturn in sterling terms. In monetary terms, the financial value of the underlying EBIT uplift was small in the context of the incremental contribution from Giesse but welcome nonetheless.

In addition to the market comments above, Giesse generated increased commercial hardware sales in the Middle East, feeding into a ‘high single digit’ percentage point revenue increase year-on-year (ie compared to pre-acquisition trading). There has also clearly been some margin improvement in this business. Management maintained previous guidance for €4m synergy benefits to be generated from being integrated with Tyman by 2018 and we believe that some of this should become apparent by the end of the current financial year.

In outlook terms, Giesse will be a key driver of Schlegel’s performance with a full six-month contribution in H216 and annualised effects to come in FY17. Commercial orders can be lumpy and there was some benefit from distributor re-stocking in H1 so management guided to a slower rate of growth in H2. That said, UK pile seal manufacturing should make a more positive impact.

Tyman ended FY15 with £81.6m net debt. The H116 period end position was distorted by M&A activity. In underlying terms – excluding M&A – Tyman generated positive free cash flow approaching £4m in the first six months, paid the £10.3m FY15 final dividend and made £1.9m Employee Benefit Trust (EBT) purchases, leaving a net outflow of just over £8m. In addition, there was an adverse US dollar translation effect on net debt of c £12m in sterling terms.

Positive free cash flow in H116: Tyman’s normal annual working capital cycle features a build phase during Q2 and into Q3 and flow back over the remainder of the year, reflecting a stronger H2 seasonal trading pattern in most of its larger markets. In H116, the working capital outflow of £9.8m was almost £8m below the prior year level (which itself was an improvement on H114) and this was largely attributable to the timing impact of US holidays on payables and, to a lesser extent, input price deflation and some site consolidation effects. Together with a stronger EBITDA result (up c £6m y-o-y), trading cash inflow was a very healthy £20m in the first half. Below this line, increased cash tax payments tracking rising profitability and capex also stepped up – being well above depreciation – reflecting US projects as referenced earlier. However, taking all of these items together, Tyman saw a positive H1 FCF performance for the first time in the last four years, during the group’s building products buy and build phase under this management team.

M&A activity expands commercial sector exposure: Tyman has now made three acquisitions in FY16. Two of these (ie Giesse and the smaller Response Electronics deal) were announced with the FY15 results and completed during the half with a combined cash cost of £44.5m during the period (plus c £15m loans acquired). The second significant step into the commercial segment in 2016 came via the acquisition of Bilco, a North American manufacturer of engineered building access and egress products. Around 20% of Bilco’s revenue is in AT’s traditional core residential RMI space, but it also brings greater exposure to the (largely newbuild) commercial cycle. We view Bilco as a highly complementary business that will enable Tyman to build a scale commercial platform in North America. In the 12 months (to March 2016), Bilco generated US$56.9m revenue and US$8.1m EBITDA. Tyman paid a US$71m cash free/debt free consideration, representing 8.8x historic EBITDA, funded from existing facilities and a c 5% placing of new equity at 225p in June (raising £19.1m gross). The deal completed on 1 July.

We expect FY16 year-end net debt to be c £184m: Before acquisition consideration and FX effects, we expect Tyman to be modestly cash positive in FY16 as a whole. This is struck after c £12m non-trading cash costs, including site consolidation moves, transaction fees and integration costs. We summarise the movement in group net debt in H116 and our expectations for H2 and FY16e in Exhibit 2.

Our expected year-end debt position of £184m is equivalent to c 2.1x FY17e EBITDA (a proxy pro forma number, including full year acquisition effects), though we may be on the high side for AT capex and restructuring cash costs depending on project phasing. With bank interest cover of c 7x (c 8x on a cash basis), we are comfortable with the current financing position, especially given good momentum and outlook for the company’s largest markets in the US currently.

On recent readings, US employment trends remain positive and consumer confidence broadly stable. In new housebuilding (single dwellings), permitting activity has been largely at healthy levels (though July was lower), while a strong Q2 period for starts and completions continued into July. Existing home sales were on a rising trend during Q2, though available for sale inventory has declined. The aforementioned Harvard LIRA metric suggests that RMI activity is going to accelerate over the next three quarters. Taken together, we believe that the data suggests that spending in Tyman’s US markets will remain firm. The S&P Homebuilders Select Industry Index (comprising US-listed housebuilders, building products suppliers and retailers) has risen by c 15% since the latter stages of June, indicating market confidence in the industry outlook also.

The UK economic outlook is less certain and GfK’s Consumer Confidence survey readings dipped sharply in July following the Brexit result. Alongside reductions in GDP growth expectations, the July UK base rate cut together with other prospective monetary support reinforced perceptions of downside risk. European indicators have generally been more benign with moderate levels of economic growth anticipated.

With regard to our company-level expectations for Tyman, there are three primary elements to our upward revisions compared to our last published estimates, as follows:

The headline changes to group estimates are summarised in Exhibit 3.