Epwin Group — Update 27 September 2016

First half trading was characterised by a comparable underlying group performance – with a different divisional mix – supplemented by a strong contribution from acquisitions. Investment remains high on the corporate agenda, with raised levels of capex and the purchase of National Plastics towards the period end. Coupled with natural business seasonality, these were the primary drivers behind an increase in net debt to £29.9m at the end of June. We have increased our estimates slightly as a result of the National Plastics deal.

Extrusion & Moulding (E&M): Primarily PVC-based window profile systems, roofline and rainwater goods extrusion activities; wood composite decking products and glass reinforced plastic building products were added to the portfolio offering via two acquisitions (Vannplastics and Stormking, respectively) in H215. (Divisional margin references below are before central costs.)

In underlying terms, existing E&M operations delivered increases in revenue and EBIT of c 5% and c 11%, respectively raising EBIT margins by 60bp to 10.9% in the process. We note that this rate of top-line progress was ahead of that achieved in FY15 (ie +2.6% which included a slower H2 trading period). We read this as being the product of a slightly more favourable balance of business performance rather than an improvement in market conditions. Specifically, the prospective roll-out of a new window system (Optima) in FY16 would have been an increasing drag we feel as 2015 progressed. In H116 – during which the launch took place – window system revenues and volumes are understood to have been flat y-o-y and, hence, the headwind eased. At the same time, roofline demand was firm in H116 overall, while rainwater goods and drainage products – where E&M market shares are smaller – revenue increased by c 10% y-o-y. The net result of all of these elements was the c 5% uplift in underlying revenue noted above. Implicitly, we believe that the sale of proprietary manufactured products to third parties was ahead of the pull-through from the internal supply chain into Fabrication & Distribution (see below). By way of an update, the Optima system launch has been well received by the market; actual and planned conversions of existing fabricator customers onto the new system are progressing to plan and the process is expected to continue into H117.

This underlying progress was supplemented by two H215 acquisitions (ie Vannplastics in October and Stormking in December) making maiden H1 contributions. In absolute terms, aggregate revenue and EBIT of £16.9m and £3.6m, respectively was generated by these businesses. This represented an EBIT margin of 21.3%, raising the reported E&M margin to 12.8% overall (having accounted for c 19% of divisional revenue and c 18% of profit). Moreover, against their pre-acquisition comparator periods, revenues for both businesses are understood to be ahead c 10% year-on-year. Stormking is more exposed to and already has good penetration of the new housebuilder market (where demand levels have been strongest) while Ecodeck has more secondary/RMI exposure currently we believe. The product portfolios of both companies offer reduced lifecycle cost attractions (ie installation and maintenance) versus traditional materials.

Fabrication & Distribution (F&D): Downstream manufacture of glass sealed units and finished windows and doors (using profiles from E&M) and multi-channel B2B distribution – including own branches – of these and other group finished products.

The financial performance of the F&D division remains relatively weak and H1 profitability has now declined in each of the last two years. There is some seasonal H2 bias and we believe that H215 demonstrated some progress over and above this following management change and actions taken to improve operational effectiveness. We believe that there is more work required to increase operational flexibility between sites, including common systems links. Reducing the fabrication fixed cost base should make F&D divisional profitability more resilient at current levels of demand; the measure of progress will become apparent when the impact of higher revenues on profitability is seen.

As its name suggests, this division is a hybrid of functional activities. As a fabricator, it is clearly more sensitive to volume fluctuations than a distribution only business. Part of the weak top-line performance (underlying H116 revenue down c 5% y-o-y) is due to exposure to the social housing subsector which has seen lower activity levels in both newbuild and RMI we believe exacerbated by some client churn. A positive pull-through effect from residential housebuilders will have benefitted distribution volumes but management conceded that performance in the wider trade segment could have been better. In fairness our comments on profitability above are somewhat tentative. It is quite difficult to see the true underlying picture in the division with manufacturing cost reduction having taken place (partly through site consolidation), increased management and sales resource put in place and an unquantified cost associated with these actions taken above the line over the past 18 months or so.

On a reported basis, the percentage revenue and EBIT declines were slightly tempered compared to the underlying performance owing to the inclusion of National Plastics (acquired in June). Its circa one month trading contribution equated to c £0.7m revenue and c £0.1m EBIT in the period. The acquisition of this 30-depot plastic building products distributor increases F&D’s revenue and existing footprint of branches of this type. Strategically, it strengthens this route to market (whereas Stormking and Ecodeck were more focused on products and materials/process capability), with synergies most obviously in purchasing and systems integration. We understand that National Plastics was not an existing group customer. Epwin is to pay £10m cash consideration – with some of this being paid in H216 – which is roughly equivalent to 7x historic EBITDA. The deal enhances earnings by c 4% in the first full year on our revised estimates (see below).

Net debt stood at £29.9m at the end of June, an increase of £15.5m since December. Free cash flow was modestly negative for this six month period and, hence, the initial £8.7m cash paid for National Plastics together with an increased final dividend payment for FY15 of £6m were key drivers behind the headline net debt movement.

As we have seen, prior year acquisitions contributed to a significant uplift in EBIT (and EBITDA). The enlarged company also saw a higher seasonal working capital outflow y-o-y which we believe was to support expected E&M revenue growth. Operating cash conversion is always lower at the interim stage but did improve slightly on the prior year. On our measure (operating cash flow as a percentage of EBITDA), the rolling 12-month figure stood just above 100%. The other material free cash flow item in H116 was capex of £8.3m (including c £0.6m on intangibles relating to systems development). Spend on tangible fixed assets was over two times depreciation, substantially due to the new window system roll-out with some smaller incremental capex projects in other areas also. Otherwise, higher interest reflected higher net debt (especially acquisition effects) and while cash tax was slightly lower y-o-y, this was due to payment timing only and we expect an upward trend going forward consistent with rising profits.

Expected period end position: We expect higher H2 profitability and a seasonal working capital inflow to fund further discretionary cash outflows (on capex, dividends and a small element of National Plastics consideration) and still result in a reduction in net debt to c £23m by the year end. On our estimates (see below), this is less than 0.7x expected FY17 EBITDA (including full year acquisition effects), with interest cover in that year of c 19x (or c 24x on a cash basis). At the end of June, Epwin had in place banking facilities including a £35m RCF, a reducing term loan of £20m (both to December 2019) and a £5m overdraft agreement. As things stand, we expect a FY17 net cash inflow of c £10m and, taken together, Epwin clearly has headroom for further bolt-on acquisitions, should opportunities arise.

Several companies operating in the building materials space reported weaker trading periods in the run up to and immediately after the EU referendum vote, consistent with wider industry data. In recent weeks, commentary has become more neutral with more normal trading patterns in evidence. The lengthening post Brexit time perspective is helpful, although management teams remain very vigilant. This is of particular relevance at this time of year (August through to the end of October) as it coincides with the busiest trading periods for many companies in the space.

As outlined previously, we expect acquisitions to be the primary driver of increased profitability for Epwin in the current year as seen in H116. On a net basis, we have made no change to our previous underlying EBIT/PBT estimates, with an upward revision for 2015 acquisitions offset by softer F&D profit expectations. We now incorporate the acquired National Plastics business into our model for the first time; with a conservative current year expectation (allowing for integration activity) and larger full year effects with the increases in estimates shown in Exhibit 2.

With a slightly higher interim dividend increase than expected (ie +3.8% against our previously anticipated + 2.8% for FY16 as a whole) we have nudged up our full year growth projection to 4.0% now. The c 3.5% growth now expected in the following two years is a slightly higher rate than before off a slightly higher base.