Norcros — Vast opportunity and new targets revealed

At its recent CMD, Norcros went to great lengths to highlight why it is very different to many, if not all, of its competitors and why it is likely to grow considerably faster than its underlying markets. This includes its design-led, sustainable, asset-light model that focuses on product, relationships and customer service, among other aspects. The model is likely to result in the achievement of the company’s revised financial targets, which include above market growth, expanding margins and the maintenance of a strong balance sheet. Ultimately this is designed to drive above-average shareholder returns, which also benefit from a progressive dividend policy.

Norcros is the UK’s leading design-led, sustainable bathroom and kitchen products group. It performs the same function in its other chosen market, South Africa, where it is the number two player. Overall, the UK, excluding Johnson Tiles, accounts for 69% of group revenue, while South Africa accounts for 31%.

Norcros is different from many other suppliers of bathroom and kitchen products because it designs and curates its own products, which are manufactured on its behalf, mainly in China, by partner companies that share the same vision of quality, attention to detail and customer service. It owns numerous brands such as Triton (showers) and Merlyn (shower enclosures), which have been acquired periodically to build a portfolio of businesses that address different aspects of the home.

The brand proposition is positioned at the mid-market and premium ends of the market (collectively c 71% of the UK bathroom products market, according to BRG), which is mainly driven by more resilient and higher-margin repair, maintenance and improvement (RMI) demand, rather than new build, where sales can be more volatile and usually lower margin, although it does have strong underlying medium-term growth drivers. According to BRG, the UK bathroom products market is 80% RMI, with residential new build accounting for 13% and commercial RMI and new build accounting for the rest.

Furthermore, because Norcros’s manufacturing is effectively outsourced, capital demands are much lower and cash generation is better.

Conversely, Norcros is therefore not, nor will it become:

Norcros operates in large, very fragmented and growing markets, which offer both organic growth and M&A opportunities. Furthermore, customers are becoming more aware of and demanding more products that offer better sustainability credentials, such as water and energy savings in use for example. As the group grows, it can extract synergies and share best practice around the group, which offers cross-selling opportunities and higher margins.

Currently, Norcros estimates that the combined core markets of the UK and South Africa have an addressable market of c £3.5bn, of which Norcros claims a 15% share in the UK (excluding bathroom furniture and sanitary-ware) and a c 7% share in South Africa. The geographies have similar underlying growth drivers, including RMI in both the residential and commercial space and from design, sustainability and service drivers.

In addition to the core UK market discussed above, there are many product categories to which Norcros has zero or only limited exposure. These include the sanitary-ware and bathroom furniture sectors, which combined have sales of c £1bn in the UK, which implies that the total addressable market in the UK and South Africa could amount to c £6bn. Other significant unaddressed UK sectors include plumbing products, ventilation and underfloor heating.

In Continental Europe, Norcros sees similar opportunities, particularly in West Europe (France, Italy, Spain and Portugal), and in the DACH markets (Germany, Austria and Switzerland). It estimates that both of these country groupings have addressable markets of over £5bn each and they are regions that it currently exports product to. Sub-Saharan Africa and the Middle East are smaller markets but also attractive geographies where Norcros also exports to. Collectively, these four regions are thought to offer an addressable market of c £14bn in addition to the £6bn of existing addressable markets mentioned above.

Norcros has a three-pronged plan to grow the business, via M&A, organic growth and operational excellence. These initiatives are not new and have all been part of the Norcros success story for many years. We discuss each in turn below.

Norcros has a well-developed ‘play book’ for M&A targets, having assessed numerous opportunities over the last 10 years and executed six, which are detailed in the table below. Given the level of activity, we believe Norcros is seen as the ‘go to’ buyer of businesses that are looking for new owners, typically good, well-run operations, but that often have succession issues, rather than having operational issues. Norcros is not attracted to ‘turnaround’ situations, preferring high-growth, high-quality businesses that complement its existing high-quality activities.

Target companies need to be strategically aligned and earnings accretive at the point of acquisition. They also need to be growing and offer additional routes to market that pave the way for organic growth in other businesses in the group. This cross-selling requirement is discussed in the next section, and is an important requirement.

Norcros believes that much of its long-term success with acquisitions is based around four key factors:

Furthermore, Norcros is happy to make divestments, where necessary, of operations that are unable to fit its criteria. The closure of Norcros Adhesives in 2023 and the disposal of Johnson Tiles in 2024 are examples of this ‘housekeeping’ activity, which helps pave the way to achieving the company’s revised medium-term targets, also discussed below.

Norcros is able to drive organic growth in a number of complementary ways:

Norcros retains its own in-house design team, which focuses on developing products that fit with customer demands and trends, such as the drive for more sustainable products such as water saving showers for example. This has resulted in a well-invested new product development (NPD) pipeline, with the NPD Vitality Index (ie the percentage of sales driven by products launched in the last three years) standing at 25%. An example of this is illustrated below, showing sales of Norcros’s new waterproof bathroom panel, Tile Effect. From a standing start, sales in FY23 amounted to £3.5m, and in FY24 sales expanded fivefold to £17.7m, with a strong trend suggesting further growth in the current year.

Key account management, where Norcros develops and nurtures strong long-term relationships with customers, is viewed as a significant differentiator, as is its first-class dedicated customer service operations, which provide customers with the support and confidence to choose Norcros as a trusted supplier.

Exhibit 6 below gives a clear indication of the opportunity available to Norcros simply by harvesting sales of products to existing group customers, which is facilitated by the account management and customer service operations mentioned above. Sales to existing top-20 customers account for c 45% of UK sales and are represented by the dots in the boxes.

The gaps therefore represent potential opportunity. It is also worth noting that four of the top five customers take product from four Norcros brands. However, only one of the ‘bottom’ five takes more than a single product brand, thus highlighting the substantial potential to drive sales into these existing customers.

Norcros prides itself on having sufficient scale to facilitate sufficient capital expenditure to differentiate it from its peers. It also has a strong culture of collaboration between the group companies, which share best practice, and therefore there are better outcomes for the company and its customers. This includes simplifying operations and sharing logistics and warehousing, which drives cost and service synergies as well as boosting the margin. It also offers customers better access to data systems, which contributes to service and efficiency.

At the CMD, Norcros announced a revised set of medium-term targets, which we believe the company has a good chance to achieve. These include:

Following the CMD, we have reduced our revenue estimates from FY25 to reflect the sale of Johnson Tiles, but maintained our profit estimates. Our revised P/E based valuation implies a value of 243p/share (from 236p) based on our diluted underlying FY25e EPS estimate of 32.5p/share, while our DDM implies a value of 260p/share (from 255p). If we take the average of the two, we arrive at 251p (from 246p), implying c 15% upside. The Norcros share price has bounced in recent weeks and is trading on a forward P/E of 6.7x in FY25, still below the historical average. As the strategy gains momentum, a higher multiple could potentially be justified.

The chart below details the progression of Norcros’s forward P/E over the last cycle. The range at the extremes is a low of 4x reached briefly post COVID-19 and again in 2022, and the high is c 12x at the end of 2013, before the Brexit hiatus. Over this period and outside the extreme ratings, the ‘real’ range has arguably been 6–9x and the average over the whole period is 7.5x.

If we apply the 7.5x forward P/E multiple to our estimate of FY25e diluted underlying EPS of 32.5p (previously FY24e diluted underlying EPS of 31.5p), we arrive at a value of 243p/share, implying c 11% upside to the share price, which has bounced in recent weeks following the CMD. It is entirely possible that the strategy outlined will be successful and looking at the historical average forward P/E ratio may ‘under-club’ what is possible in the future. Each one-turn of P/E ratio adds c 30p to the valuation, so it is possible that higher organic growth could attract a higher multiple, which in turn could be augmented by future potential acquisitions, which are part of the company’s strategy. Higher growth could in turn lead to higher dividend payments, which has implications for the DDM discussed below.

Our DDM valuation of 260p lends support to the P/E valuation above of 243p/share. We have lifted the base FY25e dividend to 10.4p/share (from 10.2p), which is more than three-times covered by diluted and underlying earnings. We are confident in the long term outlook given the numerous growth channels available to Norcros, justifying our 5% long-term dividend growth estimate. We remind readers that dividends grew 10.7% pa between 2015 and 2019, which further supports our dividend growth assumptions.