Zotefoams – What The Foam? #ZTF
Zotefoams manufacture and sell foam.
The two key segments representing 98% of turnover are the Polyolefin and High Performance Products.
The company has been around for a long time, coming into existence as a result of a management buyout from one of BP’s chemical divisions.
They also have a licensing business but that is immaterial to the two main segments.
Now I have no expertise in the foam market, but suffice it to say, foam is used all over the place – think about the cushions in your sofas, aeroplane and car seats, the soles of your trainers and if you ever lived without a dishwasher, then you have probably purchased a fair amount of foam yourself!
Also, producing foams is not easy – think precision manufacturing facilities where the raw materials (chemicals, elements and polymers) are treated (with other chemicals, elements and polymers) to produce the right density / performance product depending on end use.
But foam wasn’t able to soften the landing for Zotefoams, a highly rated stock that was recently brought back down to earth with a 36% drop in a single day.
Should I be foaming at the mouth or licking my lips???
You guessed it, it was a profit (and revenue) warning in the trading update issued 3rd October.
“We anticipate polyolefin foam sales are therefore likely to be around £6 million below current market estimates, resulting in Group sales for the second half of 2019 approximately £2m below the first half of the year. Anticipated profit for this period is impacted by our limited ability to change the operational gearing in the business in this timeframe.
Our High-Performance Products (“HPP”) business unit is performing as expected with strong growth in T-FIT® insulation products and ZOTEK® technical foams mainly in aviation and footwear.”
They hadn’t previously warned, but the interim results announcement did say that they were mindful of trading conditions.
Warning or not, those of us with a heartbeat and who watch these things could expect that suppliers to the industrials / manufacturing sector might be having a tough time at the moment, especially if their customers are in the aviation and autos sector.
Revenue expectations for full year 2019 are reduced from £90.5m to £87.1m, while 2020 is reduced from £102.1m to £97.5m.
This compares with £81m delivered in the full year to December 2018
Profit expectations for 2019 and 2020 are each reduced by just over 10%, to £8.8m and £11.1m, respectively.
This compares with £8.33m in the full year to December 2019.
So far, so bad
Having previously traded at 25x, for a capital intensive chemicals business – is the drop overdone or was it the initial valuation that was overdone? Why did it command such a high valuation in the first place – see pre-warning multiples below.
(Insert rant here re: negative interest rates, mis-allocation of risk and mis-pricing growth and then carry on reading!)
Current Market Cap: 162.8m
I have used Market Cap / Net Profit to get to the below multiples.
Stockopedia has it at 16x rolling 12 month, so I agree with my figures!
Pre Warning P/E: 25.6 21.3
Post Warning P/E: 18.5 14.7
The real reason for the high rating was the very strong performance in the High Performance Products (HPP) business, growing 67% two years ago and approximately 40% in current year.
It represented 19% of sales in 2017, to 27% in 2018 and 30% at half year 2019.
I expect it could be as high as 44% in the H2 of FY 2019 and 37% of the full-year revenues. It also happens to be the higher margin business – operating margins at 20-25% versus 12 – 17% in the core business.
It would appear that on a quarter on quarter basis, given a 2m reduction in revenue vs 6m in Polyolefin, that HPP has delivered 40% growth vs half year to June 2018 and 36% growth vs half year to December 18.
HPP is approaching 50% of turnover, higher margin than the core offering and delivering > 30% growth.
The growth has been driven by the footwear industry, but as the recent trading update makes clear, the product is gaining traction in aviation and I expect it will extend to other industries – much like elite athletes want comfortable shoes, I expect elite travellers to want comfort for their posteriors and elite drivers, DITTO.
Considering where we are in the cycle and the fact that the business delivers revenue and earning growth even when the (historical) core business suggests a near 25% drop in revenue, gets me thinking about Peter Lynch.
One of the 5 classifications for Peter Lynch was the fast growers, and he specifically called out when a small division is delivering high growth such that it becomes a meaningful part of the total business.
If HPP growth is sustainable, this has the hallmarks of a Peter Lynch fast grower that is not always identified – specifically, one where a non-core business is growing rapidly and becoming a meaningful portion of revenues.
Zotefoams appears to have reached that stage (although, ideally it would do this without obliterating revenues from the core business).
The capacity enhancements made by the company would support the view that this growth is sustainable in the short to medium term, with improving margins and cash flow as the recent uplift in CAPEX won’t be repeated.
Clearly it wasn’t under the radar, given the pre-profit warning valuation, but a jittery market seems to have forgotten why it was rated so highly, incorrectly perhaps!
In a cyclical upturn, the core would return to growth, while they have a business growing > 20% with a >20% operating margin. Given recent CAPEX, growth should not come at the expense of free cash.
Is Polyolefin going to make a comeback and is the HPP growth sustainable – perhaps those with expertise in foam (use or production) can answer, but the numbers suggest to me that what we have in front of us, is growth at a reasonable price.
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