Various UK-oriented shares are falling amid a cocktail of fears for UK economy: Brexit, the Bank of England hinting at interest rate rises, falling real incomes and a weary appetite for debt.
Cyclicals especially, have become exposed where shareholders have enjoyed good gains in recent years. Despite “Help to Buy” supporting new home-build, the housing market is perceived as stagnant and home improvements suffering from less cash.
Topps Tiles (TPT), for example, reports 0.6% like-for-like revenue growth in its six months to end-March, within which second-quarter sales fell 2.2%, and despite adverse weather deterring shoppers “it is also clear that there has been a softening of the underlying market.”
Holders can take some comfort from a circa 5% yield covered twice by earnings, but fresh money is quite deterred by management saying: “we are retaining a cautious view of market conditions for the remainder of the year.”
Polypipe bosses reckon it’s time to buy
A sprucier view is taken by the chairman and chief executive of Polypipe (PLP), a mid 250 listed supplier of plastic piping – split quite evenly between residential and commercial/civil applications.
Respectively they have snapped up 100,000 shares at 350.5p and 40,000 at 345.6p, to own 275,000 and 109,726. The current CEO has been in the role for six months after previously being chief financial officer, joining from Norcros in May 2016.
Market price has dropped from 410p since the 2017 prelims and rebounded modestly to 365p after the bosses bought. It had been as low as 222p after the June 2016 EU Referendum, not only amid fears for the UK economy and housing market, but because sterling’s plunge raised materials’ input costs.
Management says it continues to pass on price rises to customers and the business has a good history of doing so even in more difficult trading conditions.
The 20 March, 2017 results were respectable if mixed: a 7.9% advance in underlying pre-tax profit on revenue up 6.3%, with underlying EPS on continuing operations up 10.1%.
With the outlook unchanged, broker forecasts for £71.6 million pre-tax profit this year imply EPS of about 29.0, thus a prospective PE of about 12.6 times.
A more attractive cash flow valuation may apply: see from the table how cash flow per share has trended 60% to 80% higher than EPS, helping explain why Polypipe became a buyout target in 2005.
Mind that if the narrative turns adverse, other measures don’t offer real support. Despite a 9.9% rise in the dividend and a similar growth forecast for 2018, the prospective yield is a modest 3.3%. Nor does the balance sheet help, with intangibles at 118% of net assets, also some £134 million net debt currently.
Polypipe Group – financial summary Estimates year ended 31 Dec 2013 2014 2015 2016 2017 2018 restated Turnover (£ million) 301 327 353 387 412 IFRS3 pre-tax profit (£m) 24.6 16.9 41.5 53.5 55.6 Normalised pre-tax profit (£m) 24.5 29.0 41.3 60.9 65.7 71.6 Operating margin (%) 12.8 11.2 13.2 15.8 15.2 IFRS3 earnings/share (p) 10.0 7.0 17.1 21.8 22.7 Normalised earnings/share (p) 9.8 13.0 17.0 24.7 27.2 29.0 Earnings per share growth (%) -3.5 32.7 30.4 45.3 10.1 6.6 Price/earnings multiple (x) 13.4 12.6 Historic annual average P/E (x) 25.5 22.1 17.5 17.0 14.2 Cash flow/share (p) 19.5 18.3 31.0 34.7 Capex/share (p) 7.5 9.5 9.4 Dividend per share (p) 1.5 5.3 10.1 11.1 12.2 Dividend yield (%) 3.0 3.3 Covered by earnings (x) 8.7 3.2 2.6 2.5 2.4 Net tangible assets per share (p) 1.4 -58.9 -42.5 -27.5
Source: Company REFS Past performance is not a guide to future performance
A tale of two building sectors: private versus public
Polypipe has two main divisions for its piping systems: Residential, where 2017 revenue was 10.3% higher and underlying operating profit 13.3% ahead at £44.3 million, on a slightly higher margin of 19.8%.
This is benefiting from a strong new-build market although as with Topps Tiles, demand linked to renovation, maintenance and improvement remains slow.
Then there is Commercial & Infrastructure, with revenue 2% higher but operating profit 3.7% lower at £28.3 million, also on a slightly lower margin, of 15%.
Its UK operations did quite well, with revenue up 4.1%, although road projects have got tougher and the commercial sector is subdued. “Although the project pipeline improved toward the back end of the year, it is clear that projects are being delayed as the continuing UK political and economic situation causes uncertainty.” A Gulf states’ trade embargo impacted exports and led to closure of a Dubai manufacturing facility at a total £4 million cost.
So the hope is demand from new homes building will continue to offset relative weakness in renovation and public projects.
A mixed narrative is likely to continue
Understandably the outlook statement is kept quite simple – “another year of progress” – like-for-like performance currently ahead and second quarter 2017 expected to benefit from selling price increases.
While the UK construction market is broadly flat, Polypipe has a strong record of outperforming it – as the UK’s dominant pipes’ brand with the widest product range and support capability, this being quite a competitive advantage as buildings’ regulatory requirements increase.
Another alleged defensive factor is the UK plastic pipes’ market being oriented around imperial measures, versus overseas suppliers’ gearing to metric (for however long their complacency lasts).
“Rest of Europe” constitutes only 4.6% of group revenue so Polypipe is not directly exposed to any lack of future trade deal with the EU, though Brexit uncertainties can affect the wider UK economy which represents 89% of group revenues.
That Polypipe shares jumped 15p in response to the bosses’ dealings, only to pause, implies investors continue to wrestle with the macro uncertainties.
End-2017 balance sheet is somewhat stretched
It’s quite how mid caps end up after years of trying to impress investors with EPS growth. Not high-risk albeit showing stretch-marks. Acquisitions have contributed to fixed assets showing £356.5 million intangibles in context of £302 million net assets.
At end-2017 there was £184.1 million long-term debt which generated £6.9 million finance costs, covered 10.5 times by underlying operating profit. Cash was £35.7 million, now augmented by some £14.4 million equivalent from the sale of Polypipe’s French operations – management saying it will apply the proceeds to pay down debt “and pursue complementary opportunities”.
The group therefore remains expansion-minded and when interest rates rise there is likely to be additional debt service cost, if nothing drastic.
There’s no short-term debt but I’d note £87.6 million trade payables being over 2.5x £34.5 million trade receivables. Note 12 doesn’t clarify trade payables any further but I think all listed companies should explain a material imbalance versus trade receivables – which was a stark red flag over Carillion and Conviviality, well before administration. More positively, Polypipe’s trade payables as a percentage of turnover is reducing, and solvency includes plenty of wider issues.
So take your view on the UK economy
It’s normal to see cyclical shares drop, even after reporting record profits, when investors are questioning the economic future. Implicitly Polypipe’s bosses reckon they can “fight the tape” whereas cautious investors are likely to demand any fresh buying involves conviction.
Polypipe can’t satisfy on that score, being a cyclical stock in uncertain times. But if you think the macro fears are well-rehearsed, i.e. priced in, then follow the directors – so long as you appreciate there’s no margin of safety except in the Polypipe brand. Speculative buy.
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