SIF Folio: Macfarlane shows potential + CAML update
I’m going to start this week by doing something I have only done two or three times since I launched my rules-based SIF portfolio in April 2016. I’m going to sell a stock from the portfolio ahead of schedule, without it triggering either my stop-loss or profit warning rules.
The company in question is copper, lead and zinc producer Central Asia Metals (LON:CAML) - an AIM-listed stock which generates two-thirds of its EBITDA from copper assets in Kazakhstan.
The reasons for my decision are straightforward enough. Kazakhstan’s regime is said to be closely allied with Russia, its large and powerful neighbour. Although I’m guessing that CAML’s operations have not yet suffered any disruption, I don’t think it’s too much of a stretch to imagine that some problems might arise. Export routes to Turkey might be affected, for example. Currency movements could also have a material impact on profits.
Rightly or wrongly, the market seems to share my sense of caution. CAML’s share price has diverged sharply from the price of copper since January:
My decision: Due to external events, I think the upside opportunity here is no longer worth the downside risk. I would argue that this balance has changed significantly since I added CAML to SIF in November. For this reason, I’m going to sell the shares from SIF and my own holdings
Macfarlane (LON:MACF) - another year of growth?
Selling Central Asia Metals will mean that the portfolio no longer has any exposure to the Basic Materials sector:
I don’t have a big problem with this, as I think the portfolio is reasonably diversified at the moment. However, it turns out that the company on my radar this week is also listed in the Basic Materials sector.
Packaging group Macfarlane (LON:MACF) has proved a savvy investment for investors who spotted the opportunity in the depths of the 2020 market crash.
This company has two main segments, packaging distribution and manufacturing. Macfarlane’s loss-making labels business was sold last year.
Packaging distribution: This is a volume operation serving a range of sectors, including industry, retail and ecommerce. This division generated 90% of revenue from continuing operations last year, at an operating margin of 7%. This generated 85% of operating profit.
Manufacturing: Macfarlane’s manufacturing business is a higher-margin, low volume business that designs and produces bespoke packaging for high-value products. Market sectors include electronics, automotive and defence. Manufacturing only accounted for 10% of revenue last year, but a 12% operating margin meant that it contributed 15% of group operating profit.
Macfarlane’s share price has fallen back somewhat in this year’s sell off and is now down by around 15% from its 52-week high.
The stock has qualified for my SIF buying screen since issuing a strong set of 2021 results on 24 February. Stockopedia’s algorithms also seem to like Macfarlane:
Broker forecasts suggest growth should continue this year. The valuation doesn’t look outrageous to me. I’m wondering if this could be a good time for me to add Macfarlane to the SIF folio. Let’s take a closer look.
Value: super cash flow
ValueRank: 66/100
Macfarlane’s shares qualify for the valuation element of my screen thanks to an earnings yield (EBIT/EV) of 8.5%. This is above my 8% minimum.
However, on a broader view Macfarlane’s value metrics are more mixed:
The stock’s high price to book ratios reflect a relatively asset-light operation. There’s also a high level of intangibles on the balance sheet. These are likely to be the legacy of past acquisitions.
However, I think the company does perform where it counts. A price to free cash flow ratio of 9.5 looks attractive to me and is consistent with strong cash generation in recent years.
According to Stockopedia’s data, Macfarlane’s free cash flow has been consistently higher than its earnings since 2018. This reflects the impact on earnings of non-cash amortisation and depreciation charges (mostly relating to past acquisitions). In my view, this strong cash performance is a strong indicator of Macfarlane’s quality.
My view: I think Macfarlane is probably reasonably valued at current levels.
Quality: a clean bill of health
QualityRank: 93/100
I’ve already discussed Macfarlane’s strong free cash flow, which is an element of quality.
The stock’s profitability metrics are also quite strong in my view, especially given the semi-commoditised nature of the business:
Return on capital employed has hovered consistently around 14% since at least 2016. In my view, this suggests management are able stewards of the firm’s capital and have made decent acquisition decisions. Investigating these deals in detail is beyond the scope of this article, but I’m very encouraged by this consistent performance.
The other key element of the QualityRank is the Piotroski F-score. This looks at nine key measures of fundamental health to assess whether the business is improving or not. Macfarlane scores 8/9, reflecting improving profitability, growth and cash flow.
My view: I’ve no concerns about Macfarlane’s quality metrics.
Momentum: optimistic
MomentumRank: 95/100
A high MomentumRank suggests the market is expecting continued strong performance. As usual, I’ll split my review of Macfarlane’s momentum down into its two component parts.
Earnings estimates: Macfarlane’s outlook statement for 2022 includes a laundry list of reasons why profits could come under pressure. Cost inflation, supply chain delays and rising staffing costs are all mentioned. Only after this does the company conclude that it’s confident of further growth in 2022.
Analysts covering the stock seem to have taken a more bullish view on cost pressures. From what I can see, consensus forecasts show a 6% increase in revenue this year, paired with a 30% increase in earnings per share.
I’d guess that some of the margin improvement implied by these forecasts might come from operational gearing. In other words, making fuller use of existing fixed cost capacity such as warehouses and trucks. Beyond that, I’m not sure where the rise in profits is likely to come from.
However, if correct, these forecasts suggest Macfarlane is trading on 11 times forward earnings, with a dividend yield of 2.6%. That seems potentially attractive to me.
Price momentum: The technical picture also looks strong. A look at the momentum snapshot included on the StockReport shows me a sea of green:
I suspect that the high volumes over the last 10 days are linked to the publication of the annual results on 24 February. But the other metrics here all suggest a very strong technical backdrop for the shares. I see this as a useful supporting factor to the fundamental investment case.
My view: Macfarlane appears to have strong momentum, although earnings estimates seem quite bullish to me.
My decision
It’s probably no surprise that I’m going to add Macfarlane shares to SIF this week, and to my own holdings. As usual, I’ll make both trades after this article has been published.
Let me know what you think about this choice. Am I late to the party, or is there still a big opportunity here? I’m impressed by what I’ve seen but wary about the risks to economic growth over the remainder of 2022.
Disclosure: Roland owned shares in Central Asia Metals at the time of publication.
Disclaimer
This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
18 comments
Roland, bear in mind MACF report figures (oddly) without stripping out amortisation of acquired intangibles, which depresses their reported EPS (and margins, and so on). The broker forecasts strip these out, giving a boost in earnings, but you’re not comparing apples with apples when comparing historics with forecasts unless you dig a little deeper.
Gavsmith01 - Oh that's interesting. Thank you for pointing that out. The updated MACF figures in the stockreport seem to be a bit of a mess.
apologies for what's turned out to be a lengthy post as I've been going around in circles trying to figure out what the figures on the stock report are based upon.
The FY21 figures are ok - the 12.6m net profit is correct. But the reported eps should be 7.9p (diluted continuing and discontinued) not 8.62p which is the continuing (normalised) diluted eps. So that appears to be a minor mistake.
The forecast figure for FY22 of 14.5m net profit looks about right - being an increase of 15% over the FY21 figure of 12.6m. It's only an increase of 5.5% over the continuing profits of 13.75m. That looks like conservative MACF forecasting to me.
The 11.3 eps figure for FY22 I don't recognise.
It doesn't match the eps calculated from the 14.5m forecast net profit - which would be 9.2p statutory basis or 9.1 diluted.
So what is it? You might well be right that its an underlying estimate of some sort.
Anyway - for the first time this year MACF reported an Operating profit before Amortisation. They didn't go so far as to provide an underlying profit or earnings though. Small steps.
Taking the amortisation figure and allowing for nominal tax on the increased profit - I'd put underlying profit at 17.15m which would be 10.8p eps. Still not 11.3p - but I do get 11.3p if I don't allow for nominal tax on the increased underlying profit - which seems bogus to me? But what do I know?
I'm not sure that's down to MACF - it's shown in the stock report in the line labelled normalised eps and should be calculated on the same basis as the other normalised eps figures even if its a forecast?
Looks like another mistake by the data provider alongside the reported eps figure? Otherwise Stockopedia really ought to have a warning statement to make clear that forecast eps can be constructed any old way the analyst might choose?
To cap it off - down in the analysts estimates section of the stockreport the target share price has been shown as 87p for some time now! Makes me chuckle each time I see it.
( But don't tell effortless cool - because his cool won't be effortless any more :-) )
Anyway I don't agree with any of the figures. The 14.5m figure is most likely a guide from MACF given that there is only one broker? This years 12.6m is conservatively accounted by MACF as they took a 5.1m tax charge - 1.5m more than the nominal 19% charge due to adjusting the defered tax liability for the corporation tax hike amongst other items. And with a full year of the two acquisitions an additional 0.5m profit so thats 2m on 12.6m - or 14.6m profit without having to grow organic profits at all. Typical. Did I mention that they tend to be conservative?Even in this challenging year that leaves room for upgrades - though I do agree with them - given unknown cost inflation and other pressures it's hard to forecast the likely outcome now. I'm still revising my spreadsheet - but with a finger in the air and a slight following wind - I'd go for 15.8m net profit, thats 25% up on last years 12.6m. Which is a bit of an ask. But a more reasonable 8% up on the equivalent figure given a normalised tax charge and a full year from the two acquisitions - but mainly because its 10p eps.
cheers
Mark
As Roland says, Central Asian Metals has a lot of exposure to Kazakhstan...
Kazakhstan is of course a member of the Collective Security Treaty Organisation (CSTO) which is sort of like NATO only for Russia and nearby allies (hence why 3000 troops were sent not so long ago in order to scupper the attempted coup - not explained in our media).
In other words you probably run similar risks owning this to owning Russian companies right now!
Any idea please as to whether Macfarlane (LON:MACF) have hedged their energy cost for the next year or two and/or whether energy forms a significant part of their costs?
Funnily enough, in the absence of this information, with Somero Enterprises Inc (LON:SOM) reaching ridiculous levels, and the Macfarlane (LON:MACF) SP holding up pretty well after their strong results, a couple of days ago, I sold Macfarlane (LON:MACF) and bought £SOM.
Given the ridiculous approach to Net Zero in the UK, which has left us massively exposed to Russia, particularly wrt gas prices, I feel much more comfortable with a US based company with significant domestic demand.
That is not to say that I think Macfarlane (LON:MACF) is badly run in any way. Hopefully I will invest back in Macfarlane (LON:MACF) in the relatively near future.
Bought for the regular dividends, the numbers still tell me to buy more Central Asia Metals (LON:CAML) which I am holding onto.
imho this is panic selling ..not following the rules is inappropriate in a rules based portfolio. Also a swap to a manufacturer while miners are at the start of a super cycle with plenty of choices on the lse!
Hartshay,
Thanks for your comment. It's possible that you're right. But I do reserve the right to make decisions outside the rules when exceptional things happen. In my view, this is one of those situations.
I should clarify that my decision to sell Central Asia Metals (LON:CAML) is based purely on the geopolitical risk of investing in a country that's closely allied to Russia. In my view, geopolitical factors are likely to trump any other factors in influencing the performance of this stock over the coming months.
I have no way of knowing what will happen, making this a speculative situation for me.
As a result, my view is that this falls outside the affordable growth remit of SIF, hence my decision.
Regards,
Roland
CAML - I did the same for the same reasons last week. Nothing wrong with CAML, but Russia has already been meddling in Kazakhstan and further interference would not be a surprise.
Macfarlane - popular here I know. A lot of share issuing historically, but effectively none since 2017, which is encouraging. Since 2017, the average annual tangible equity build up averages c3.1% pa, add this to the dividend and you get a tangible surplus of around 5.3%. That is a fair price, and not a bargain, and even the fair price assessment is based on Macfarlane not returning to their share issuing habit.
Compare this to the tangible surplus of LGEN for example, the value creation for shareholders relative to MCap - i.e. the divi added to the average annual increase in net tangible equity, the sum expressed as a % of the current MCap, for LGEN is more than double that of MACF, making LGEN a far stronger buy.
Interesting. A Macfarlane competitor, DS Smith, has had a torrid time of it in terms of share price recently. Why do you think Macfarlane holding up better than an industry comparator and will that advantage continue?
Hi Roland,
I first bought Macfarlane (LON:MACF) seven years ago and have added 26 times since, with not one sale. Over that period, management have executed their buy and build strategy and managed their way out of a very large pension deficit with great skill. Although I have had a good return on this so far (c. 18% IRR), I do not feel that the progress they have made is at all adequately reflected in the share price yet. Further, there is more good news in the pipeline:
I'm still in the process of updating my valuation to reflect the FY results but the outcome will be in excess of 200p.
In short, there should still be plenty of time left for you to enjoy the Macfarlane (LON:MACF) party.
Some how categorising MACF as Basic Materials doesn't feel right. I would have thought there is closer affinity with Consumer Cyclicals.
Bronstein,
I kind of know what you mean re. classifying packaging groups like Macfarlane (LON:MACF) as basic materials. However, the packaging sector does have heavy exposure to commodity prices (pulp, wood, paper, etc). Commodity price movements do play a role in driving margin compression and expansion.
In Macfarlane's case, I guess commodity exposure might be slightly dampened by virtue of the fact that much of the business is distribution, not manufacturing. I'm not sure how pricing works for the distribution business.
I think your comment is probably a useful reminder to all of us not to depend too heavily on sector classifications as a measure of diversification. In my view, they are (at best) only a crude measure of how diversified a portfolio might be.
Regards,
Roland
£MACF thanks for this. Roland how are you viewing companies with low operating margins ATM. I am looking at companies to buy into and cant help thinking that margins under 10 percent could be more vulnerable to inflationary headwinds. I know its much more complex than that, but wondered what your thoughts were, and if its a simple consideration as a buy or back burner share.
Macfarlane (LON:MACF) Seemingly a good mix of organic growth, bolt-on acquisitions and product development. Total size of markets in the countries in which it operates suggests there is plenty of room to continue to increase market share.
I do enjoy your SIF anaylsis, Roland, but I am hoping your failure to stick to your process this time with Central Asia Metals (LON:CAML) will prove to be a mistake. I am quite a long-term shareholder, and of all my portfolio, this was the one of concern. So I did a bit of digging and would like other shareholders to have some balance.
1. Central Asia Metals (LON:CAML) is also zinc and lead from Macedonia.
2. It sells at the mine (not even from the gate). Routing is a problem for its offtake partner, Traxcys and there are ways through Turkey, which, unusually, has distanced itself from Russia.
3. Kazakhstan is on the fence, admittedly, but there are anti and well as pro-Russian demos, a long way from Kounrad.
4. They are making money hand over fist with the price of copper, which is in short supply anyway, so there are buyers in China.
5. They are now essentially debt-free.
6. £FAR (I hold), also in Kazakhstan, has issued an RNS , stating the currency drop is helping them, as most of their costs are inTenge, and I imagine this is at least partly true for Central Asia Metals (LON:CAML) as well.
This time, another BB is useful to consult, lse.co.uk, where Genghis15 quotes a reassuring conversation with a company representative.
I hope this helps others. I am not selling. And the mining part of my portfolio is of course the best performing in these tricky and inflationary times. Everyone should consider a basket of them as lower risk for once than many other sectors.
Have you considered Atalaya Mining (LON:ATYM) as an alternative copper exposure? Similar valuation and yield to Central Asia Metals (LON:CAML) but based in Spain so limited m geopolitical risks.
although the share price has also been subdued despite increasing copper price possibly the result of director selling around 4.40
I AM considering £ATYM. It is the other goody; I just wanted to see a few months more of travel towards being sure of that dividend , and I would certainly consider splitting my investment, but feel Central Asia Metals (LON:CAML), with any calming down of the war, will rise rapidly to 250p. Still shy of the 300p it should be worth, in my view.