Avon Rubber — Continuing to deliver

Avon Rubber

Continuing to deliver

FY results

Aerospace & defence

14 November 2018

Price	1,300p
Market cap	£403m
$1.28/£1
Net cash (£m) at 30 September 2018		46.5

Shares in issue	31.0m
Free float	96%
Code	AVON

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	7.4	(5.1)	15.9
Rel (local)	6.8	2.8	21.7

52-week high/low

1,475p

1,065p

Business description

Avon Rubber designs, develops and manufactures product in the protection (70% of 2018 sales) and dairy (30%). Its major contracts are with national security organisations such as the US DoD. Over 70% of 2018 sales are from the US.

Next event

AGM	February 2019

Analysts

Annabel Hewson	+44 (0)20 3077 5700
Andy Chambers	+44 (0)20 3681 2525

industrials@edisongroup.com

Edison profile page

Avon Rubber is a research client of Edison Investment Research Limited

Avon Rubber’s FY18 report demonstrates the success of the new business strategy, delivering growth across both divisions. The product portfolio has been updated and the company is winning contracts in new geographies. The company has also taken action to address its business structure and production footprint. We see continued opportunity for organic growth supported by selective bolt-on acquisitions.

Year end	Revenue (£m)	PBT* (£m)	EPS* (p)	DPS (p)	P/E (x)	Yield (%)
09/17	159.2	25.9**	83.3**	12.3	15.5	0.9
09/18	165.5	27.2	76.5	16.0	16.9	1.2
09/19e	176.3	29.8	78.6	20.8	16.4	1.6
09/20e	187.0	32.8	86.3	27.1	15.0	2.1

Note: *PBT and EPS are normalised, fully diluted and excluding amortisation of acquired intangibles, exceptional items and share-based payments. **Restated for AEF disposal.

FY18 demonstrates momentum behind strategy

FY18 reported revenue of £165.5m (FY17 £159.2m), equated to 8.7% growth at constant currency. FY18 adjusted operating profit of £27.3m (FY17 £26.1m) reflected profitable growth in both divisions, up 11.8% on a constant currency basis, demonstrating momentum behind the business strategy. FY18 adjusted EPS of 77.1p (FY17 83.8p) was fractionally down at constant currency due to a lower tax provision release versus FY17. However, FY18 dividend of 16.02p (FY17 12.32p) reflected management’s confidence in the business going forward. Cash conversion was strong at 108.2% of EBITDA, supported by the contribution from AEF disposal for $9.25m.

New order generation points to favourable outlook

Avon has demonstrated success in winning orders on new programmes and geographies. The company expects to deliver growth through its three strategic priorities of growing the core, selective product development and value-enhancing acquisitions. There is a growing requirement from global defence agencies to address chemical, biological, radiological and nuclear (CBRN) threats and Avon has developed its product portfolio to address this. Additionally, while the dairy market is not without challenges, Avon is offering technology globally to improve yields and enable farmers to operate more efficiently and profitably.

Valuation: Premium justified

Our DCF on a calculated WACC of 8.0% currently delivers a value of 1,532p, vs 1,499p previously. Our sum-of-the-parts valuation is shown as 1,878p. On our updated forecasts, Avon Rubber is currently trading on 16.4x FY19e P/E. This multiple looks undemanding versus the UK aerospace and defence peer group, which is deserved, given its exposure to the growing US defence budget environment. Avon’s position to address the heightened CBRN threat in the UK and overseas underpins the higher than average margin performance and future growth in our forecasts. Hence, we believe a valuation premium is justified.

FY18 financial performance

Reported FY18 orders of £173.3m (FY17 £166.0m restated) were ahead of reported FY18 revenues of £165.5m (FY17 £159.2m restated). This equated to 8.7% revenue growth at constant currency and against our estimate of £160.8m. Reported adjusted operating profit was £27.3m (FY17 £26.1m restated), up 11.8% at constant currency. FY18 adjusted EPS was 77.1p (FY17 83.8p) and the final dividend 10.68p gave a total dividend per share for FY18 16.02p (FY17 12.32p).

Avon Protection

Exhibit 1: FY18 revenue split of Avon Protection

Source: Avon Rubber

Avon Protection reported FY18 revenue of £115.7m (FY17 £109.8m restated), up 10.6% at constant currency. Orders received of £124.6m (FY17 £116.0m restated) resulted in a book to bill of 1.08x. The division reported FY18 adjusted EBITDA of £26.6m (FY17 £26.8m restated), representing growth in constant currency of 5.3%. The adjusted EBITDA margin actually decreased by 140bp, reflecting product mix with higher M50 mask system volumes versus FY17.

The Military division reported FY18 revenues of £66.1m (FY17 £64.2m), up 8.0% at constant currency. US Department of Defense revenues increased to £52.7m (FY17 £50.5m), reflecting higher M50 mask system deliveries plus higher aftermarket sales. The initial 10-year M50 contract concluded in July and the M50 order book for FY19 stands at 89,000 systems. The company is in discussions for a follow-on contract for the M50 mask systems. In addition, the company has invested in the M69 aircrew mask and M53A1 mask and powered air system. Closer to home, Avon has re-established its role with the UK Ministry of Defence through the General Service Mask contract. This contract has allowed Avon to demonstrate its technical capability and the company believes that this could drive further domestic contracts. Globally, Avon recognises the demand for defence agencies to address CBRN threats with its broad product portfolio.

The Law Enforcement division reported FY18 revenues of £35.4m (FY17 £29.0m), up 28.1% at constant currency. The division benefited from higher sales of filters and spares, plus initial sales of the powered air range boosted the year-end progress. Looking forward, Avon believes that it will increase its market penetration into law enforcement agencies in the US and elsewhere.

The Fire division reported FY18 revenues of £14.2m (FY17 £16.6m), down 10.0% at constant currency. As we have discussed before, the market has been challenged by delays in introducing the 2019 National Fire Protection Association (NFPA) standards, which, in turn, has delayed product purchases. Avon believes that these delays will start to be reversed from FY19, as it launches its Magnum Self-Contained Breathing Apparatus (SCBA) range in H219. Avon has also introduced the argus Mi-TEC E L camera to the US market and it is already NFPA-approved. Overall, while the fire market has had its challenges, Avon has addressed its strategy and product portfolio to deliver growth going forward.

We believe Avon Protection has invested in its product portfolio to ensure it is well-placed to leverage growth in defence and law enforcement budgets globally. We believe that the delays experienced in the fire protection markets will reverse and support growth. Meanwhile, Avon has taken action to tidy up its business portfolio, with the sale of the Avon Engineered Fabrics business in FY18. In addition, the business has also relocated the West Palm Beach electronics assembly, acquired with the Hudstar deal in FY15, to the Cadillac site in Michigan, which is Avon’s main US manufacturing facility. In addition to a production assembly line in Kazakhstan, the company will continue to explore flexible production solutions to align with customer requirements. We also believe that the company will seek to bolster organic growth with selective bolt-on acquisitions.

Milkrite | InterPuls

Exhibit 2: FY18 revenue split of milkrite | InterPuls

Source: Avon Rubber

milkrite | InterPuls reported FY18 revenue of £49.8m (FY17 £49.4m), up 4.3% at constant currency. Orders received of £48.7m (FY17 £50.0m) resulted in a book to bill of 0.98x. The division reported FY18 adjusted EBITDA of £10.9m (FY17 £10.9m), representing growth at constant currency of 5.2% and a 20bp step-up in margin.

Interface reported FY18 revenues of £35.6m (FY17 £35.9m), up 2.9% at constant currency. While sales in North America were weaker than expected in H118, there was a notable pick-up in H218, supported by the Merrick’s calf nurser product line acquisition. So although FY18 North American revenues declined by 1.7% at constant currency, H218 performance grew 3.9% on the same basis. FY18 revenue growth at constant currency in Europe was 7.2%, while liner revenue grew in Asia Pacific and Latin America by 8.2% and 11.5%, respectively. Going forward, the business will focus on expanding its dealer network and product innovation to drive growth.

Precision, Control & Intelligence reported FY18 revenues of £9.0m (FY17 £9.0m), up 1.9% at constant currency. Growth was visible in Europe and the Middle East., We anticipate that the business will leverage the Interface platform in North America through the sales specialists it has already added. The business has also boosted its technical support capability.

Farm Services reported FY18 revenues of £5.2m (FY17 £4.5m), up 19.8% at constant currency. Cluster Exchange is at the heart of the growth here, boosting cluster points from 35,000 (624,000 cows over 1,900 farms) in FY17 to 40,000 in FY18 (637,000 cows, over 2,100 farms). Growth has been visible in both North America and Europe.

While the overall dairy market is not without its current challenges, Avon has innovated its product portfolio to ensure it is providing an attractive solution to the global market. The growth in Farm Services is continuing to build intelligence from usage data as well as adding greater revenue predictability. We believe the division will deliver organic growth while looking to bolster this through bolt-on acquisitions.

Financials

The table below reflects our estimate revisions and introduce our FY20 estimates.

Exhibit 3: Revised estimates and FY20 estimates

£000s	2018			2019e			2020e
	Prior	Actual	% change	Prior	New	% change
Avon Protection	110,898	115,700	4.3%	114,225	124,956	9.4%	133,703
milkrite I InterPuls	49,894	49,800	(0.2)%	52,389	51,294	(2.1)%	53,346
Total sales	160,792	165,500	2.9%	166,614	176,250	5.8%	187,049
EBITDA	35,935	35,300.0	(1.8)%	38,324	38,729.9	1.1%	42,203.4
Avon Protection	20,405	21,500	5.4%	21,648	23,492	8.5%	25,890
milkrite I InterPuls	8,233	8,000	(2.8)%	9,011	8,464	(6.1)%	8,978
Unallocated	(2,000)	(2,200)	10.0%	(2,000)	-2,266	13.3%	(2,334)
Underlying EBITA	26,638	27,300	2.5%	28,659	29,689	3.6%	32,534
Underlying PTP	26,453	27,200	2.8%	28,496	29,832	4.7%	32,756
EPS – fully dil underlying continuing (p)	74.2	76.5	3.1%	75.3	78.6	4.4%	86.3
DPS (p)	16.0	16.0	0.0%	20.8	20.8	0.0%	27.1
Net debt/(cash)	(46,173)	(46,500)	0.7%	(64,502)	(61,886)	(4.1)%	(77,731)

Source: Avon Rubber, Edison Investment Research

Valuation

Our cash-based capped DCF valuation is, in our view, a conservative basis for estimating cash flow values as it does not assume any growth in the terminal value. While we do normalise working capital to zero and capex to equal depreciation, it still eliminates some element of the potential tail value. The DCF on a calculated WACC of 8.0% currently delivers a value of 1,532p, previously 1,499p. Our sum-of-the-parts valuation is shown 1,878p. Taking an average of our DCF valuation and our sum-of-the-parts valuation gives a fair value price of 1,705p, which would imply a FY19e P/E of 21.7x.

On our updated forecasts, Avon Rubber is currently trading on 16.4x FY19e P/E, which we feel is undemanding versus the UK aerospace and defence peer group. Avon’s position to address the heightened CBRN threat in the UK and overseas underpins the higher than average margin performance and future growth in our forecasts. Hence, we believe a valuation premium is justified.

Exhibit 4: Financial summary

	£000s	2017	2018	2019e	2020e
Year end 30 September		IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		159,200	165,500	176,250	187,049
Cost of Sales		(97,600)	(99,900)	(106,389)	(112,907)
Gross Profit		61,600	65,600	69,861	74,141
EBITDA		36,300	35,300	38,730	42,203
Operating Profit (before amort. and except.)		30,300	30,400	33,407	36,609
Intangible Amortisation		(4,200)	(3,100)	(3,718)	(4,075)
Operating profit (company definition)		26,100	27,300	29,689	32,534
Exceptionals		(7,000)	(5,700)	(4,300)	(4,300)
Other		(33)	(100)	(100)	(99)
Operating Profit		19,067	21,500	25,289	28,135
Net Interest		(200)	0	243	321
Profit Before Tax (norm)		25,867	27,200	29,832	32,756
Profit Before Tax (FRS 3)		18,867	21,500	25,532	28,456
Tax		2,900	(1,800)	(4,870)	(5,426)
Profit After Tax (norm)		25,502	23,500	24,164	26,532
Profit After Tax (FRS 3)		21,767	19,700	20,662	23,031

Average Number of Shares Outstanding (m)		30.4	30.5	30.5	30.5
EPS - normalised (p)		83.3	76.5	78.6	86.3
EPS - (IFRS) (p)		71.5	64.6	67.7	75.5
Dividend per share (p)		12.3	16.0	20.8	27.1

Gross Margin (%)		38.7	39.6	39.6	39.6
EBITDA Margin (%)		22.8	21.3	22.0	22.6
Operating Margin (before GW and except.) (%)		19.0	18.4	19.0	19.6

BALANCE SHEET
Fixed Assets		66,700	64,100	61,060	57,950
Intangible Assets		40,400	41,500	40,646	39,800
Tangible Assets		26,300	22,600	20,414	18,149
Investments		0	0	0	0
Current Assets		80,500	102,000	120,598	139,800
Stocks		21,800	23,000	24,739	26,517
Debtors		23,800	24,200	25,772	27,351
Cash		26,500	46,600	61,887	77,732
Other		8,400	8,200	8,200	8,200
Current Liabilities		(39,000)	(41,400)	(43,616)	(45,903)
Creditors		(37,200)	(41,300)	(43,615)	(45,901)
Short term borrowings		(1,800)	(100)	(1)	(1)
Long Term Liabilities		(52,600)	(39,900)	(39,838)	(39,777)
Long term borrowings		0	0	0	0
Other long term liabilities		(52,600)	(39,900)	(39,838)	(39,777)
Net Assets		55,600	84,800	98,205	112,071

CASH FLOW
Operating Cash Flow		29,754	33,400	35,776	38,679
Net Interest		(154)	(200)	0	243
Tax		2,900	(1,800)	(4,870)	(5,426)
Capex		(5,500)	(8,900)	(9,101)	(9,659)
Acquisitions/disposals		0	5,100	0	0
Financing		(1,000)	(1,100)	(1,000)	(1,000)
Dividends		(3,200)	(4,100)	(5,419)	(6,992)
Other		(96)	(600)	0	0
Net Cash Flow		22,704	21,800	15,386	15,844
Opening net debt/(cash)		(1,996)	(24,700)	(46,500)	(61,886)
HP finance leases initiated		0	0	0	0
Other		0	0	0	0
Closing net debt/(cash)		(24,700)	(46,500)	(61,886)	(77,731)

Source: Avon Rubber, Edison Investment Research

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