SIF Folio: Macfarlane Could Have Potential In Difficult Year

9th Sep '20 by Roland Head

4 comments 3311 reads

The news doesn’t seem overly encouraging at the moment. COVID-19 case numbers are rising sharply. US tech stocks have started to wobble. The FTSE 100 is down nearly 10% from its May high of c.6,500. And a hard Brexit might be on the cards again, as press reports suggest the UK government may choose to override parts of the EU withdrawal agreement.

Against this backdrop, it’s encouraging to find companies that have performed well in 2020 and are expected to continue doing so. One such company is last week’s selection, FTSE 250 gold miner Centamin.

This week another stock which trades in the Basic Materials sector has appeared in my Stock in Focus screening results - small cap packaging group Macfarlane (LON: MACF). This £140m business has previous form in my SIF fund. In 2016, a previous position resulted in a disappointing 10% loss. In 2018/19 my Macfarlane trade delivered a more credible 30% gain for SIF.

Macfarlane (LON: MACF) - opportunity from adversity?

Macfarlane’s share price has bounced around since late 2019, but has not really gone anywhere. However, the firm’s recent half-year results looked fairly positive to me. Strong demand for packaging items for internet retail, household goods and medical products helped to offset weaker demand from the automotive sector and high street retailers.

Although H1 sales and earnings were down slightly on the same period last year, the decline was fairly modest in my view:

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Macfarlane passes all of my screening tests. Stockopedia’s algorithms appear to like it too:

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With the firm’s peak trading period still ahead of it this year in Q4, this could be an opportunity to buy into a stock with the potential to beat expectations.

What could go wrong?

Playing devil’s advocate for a moment, it’s certainly easy enough to construct a generic case against this group.

In general, I’d imagine that there will always be pressure on profit margins from rivals and customers. Macfarlane may also lack the economies of scale and diversity of larger rivals.

A more specific concern for me is whether the group’s manufacturing division really justifies its presence in the group. Whereas Macfarlane’s packaging distribution business generated an operating profit of £12.4m in 2019 at a margin of 6.3%, manufacturing contributed just £1.2m…

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aflash

9th Sep '20

There was an excellent opportunity to buy MACF below 70p at the end of June, early July. It qualified then for a screen I use.

I constantly scan the sector loosely gathering in order of interest: RBN (Held until recently) MPAC, MACF, IGR (recent Acquisition), SKG, BNZL, MNDI (I hold), SMDS (I hold), CRU.

Both MNDI and SMDS have pension issues, not that I have made a detailed comparaison.

As you may have seen the expert is here and the thread is updated in his comments:

https://www.stockopedia.com/co...

Effortless Cool

aflash,

Thanks for your attribution of Macfarlane (LON:MACF) expertise - I'll take it!

Regarding the points made by Roland, I think it is worth reproducing this exhibit from the other thread here.

This splits growth into like-for-like and that produced by acquisitions. It illustrates that Macfarlane's top line growth over the period has been mainly driven by acquisitions. The main benefit of this is that the resultant economies of scale have driven a steady increase in the operating profit margin. Additionally, the increased size of the business means that the pension deficit issue has shrunk in comparison. I view this as extremely effective application of a "buy and build" strategy and see no reason why they cannot continue in the same way, especially since the post-COVID environment is likely to throw up a few opportunities.

Also, on the pension deficit, it is worth flagging that Macfarlane have a large holding of liability-driven investment funds, which seem to have given very effective protection against the reductions in long-term interest rates this year. I see a big opportunity for dividend increases once the deficit is cleared in a couple of years.

LeicesterPete

Thanks for this, I think you are spot on. This went onto my list to investigate and Stocko’s forecast PE didn’t stack up for me on release of the H1 results. Apart from that I like the business and will continue to watch and jump in should the share price present better value.

10th Sep '20

Roland,

Regarding sales growth, this was 1.9% in Q1 but that dropped to -5.2% in Q2. The broker, Arden Partners, have assumed -5.6% in Q3 and -10.0% in Q4. This seems way over the top pessimistic to me, given Q2 was largely in lock-down and 2020 H2 will benefit versus the prior year from the purchases of Leyland in September 2019 and Armagrip in January 2020.

As you can see from the table in post 2 above, I am anticipating a 0.4% increase in revenue in 2020, with a 2.7% contribution from acquisitions outweighing a COVID-driven 2.3% decrease on a like-for-like basis. For 2021, I have an unambitious assumption of 2.6% growth, with no contribution from acquisitions (although one or more is likely in practice).

I therefore think it unlikely that Macfarlane (LON:MACF) will fail your positive sales growth rule.

SIF Folio: Macfarlane could have potential in difficult year

Macfarlane (LON: MACF) - opportunity from adversity?

What could go wrong?

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Roland Head

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