Guidance for FY19 is maintained after a slow H119 as recent major multi-year mask orders commence delivery in H219, accelerating Avon Rubber (LON:AVON)’s growth and more than compensating for the weaker than expected milkrite | InterPuls performance. However, even here a rebound in H219 will further skew the half-yearly split. Despite the divisional mix shift, our overall estimates remain unchanged. While H119 was tough, the outlook is promising as the company continues to grow the core, focus on selective new product development and search for M&A opportunities. In our opinion, the full year progression warrants the premium rating Avon enjoys, but H2 execution and momentum into FY20 is key.
H1 performance challenged
As previously noted by management, a variety of factors served to depress performance in H119, with both divisions delivering reduced profitability. In Avon Protection, only Military revenues showed progress boosted by sales to the Rest of the World. DoD sales declined due to a fall in low-margin M50 volumes and adverse phasing of spares and accessories, which still grew as a proportion of divisional sales, reducing margin. The Law Enforcement and Fire segments were depressed by the prolonged partial shutdown of the US government. Dairy market conditions saw lower milk prices in Q119 adversely affected milkrite | InterPuls, although milk prices and sentiment improved through Q219. Overall H119 group revenues declined 5.3% to £73.6m, and adjusted operating profit fell 25% to £8.7m, a £3.9m decline.
Sharp improvement is expected
The good news came in the form of burgeoning Military orders at Avon Protection, stronger opening backlogs elsewhere for H219 including encouraging signs of an H219 recovery in milkrite | InterPuls, a strong financial position with £46.8m of net cash at the period end, and the 30% hike in the interim dividend. Management maintains expectations that Military sales should accelerate in H219, with stronger margins due to better pricing for new product volumes. We expect DoD sales to rise around 25% in H219 compared to H119, with a continued strong performance in the Rest of the World. The Law Enforcement, Fire and dairy segments also rebound and, while we have shifted our divisional mix, our estimates are maintained.
Valuation: H2 backlog delivery is key for premium
Avon is currently trading on an FY20e P/E rating of 16.6x, a significant premium to many UK peers. However, the momentum of the H219 recovery should provide a basis for growth in FY20 as multi-year contracts increase volumes and margins. The dividend policy designed to reduce cover over the cycle is also supportive.
Business description
Avon Rubber designs, develops and manufactures products in the protection (70% of 2018 sales) and dairy (30%) sectors. Its major contracts are with national security organisations such as the US DoD. Over 70% of 2018 sales are from the US.
H119 results
At face value, H119 was an extremely challenging period, with softer dairy markets affecting Q119, and the prolonged US government shutdown compounding what was already a difficult period for Avon Protection. Management confidence of a sharp improvement in H219 to meet its current expectations was reflected in the further 30% increase in the interim dividend.
Orders received £94.9m (H118: £88.3m), up 7.5% or 2.1% at constant currency, and representing a book to bill ratio of 1.3x.
Closing order book up 45.6% at £59.1m, 38.2% at constant currency.
Reported H119 revenues of £73.6m (H118: £77.7m), down 5.3%, or 8.7% at constant currency.
Adjusted H119 operating profit of £8.7m (H118: £11.6m) down 25.0%, a fall of 28.0% on constant currency.
Adjusted H119 profit before tax down 24.1% at of £8.8m (H118: £11.6m), down 27.0% at constant currency
Adjusted H119 EPS fell 29.3% to 23.2p (H118: 32.8p) or 31.6% lower at constant currency.
Interim DPS was 6.94p (H118: 5.34p), an increase of 30.0%.
Net cash £46.8m up £0.3m compared to FY18 year end.
As the company pursues its three-pronged strategy of growing the core organically, augmented by selective new product development, bolstered by appropriate M&A, encouraging signs came from the increase in the order intake, extending backlogs and a modest cash inflow during the period.
In Avon Protection, the order development was particularly pronounced with a backlog up 40% at £55.4m following another strong period of order intake of £69.3m. The Military segment accounted for much of the divisional backlog build, rising £14.1m to £44.2m. Military sales made good progress in H119 despite lower DoD sales of £22.9m (H118: £25.3m), with the fall more than compensated for by the Rest of the World segment, where revenues quadrupled year-on-year to £8m.
The DoD revenue reduction reflected a fall in low-margin volumes of M50 mask systems to 76,000 in H119 from 79,000 in H118 and an adverse phasing of spares and accessories. The M50 still accounted for a higher proportion of Avon Protection’s H119 sales due to declines elsewhere and, as a result, the H119 margin was also depressed. The new volumes for recently signed contracts for the M53A1 and M69 mask systems and other contracts should accelerate sales dramatically in H219, with improved commercial pricing under the new multi-year contracts. Combined with a recovery in Law Enforcement and Fire activity, we expect a strong uplift in divisional margins.
The company remains in active dialogue with the US DoD for the M50 replenishment phase. Law Enforcement and Fire were both adversely affected by the extended US government shutdown, which delayed domestic US order placements as well as export licensing. Sales have been deferred into H219, with both segments seeing encouraging backlog progression.
Order intake during the period was further supported by subsequent order awards, and deliveries of most of these major multi-year contracts commence in H219. Higher margins are anticipated on the increased volumes and should be boosted by the new product sales.
milkrite I InterPuls faced a difficult half year. Weaker milk prices in Q119 adversely affected all three business segments, as negative sentiment among farmers resulted in deferred investment. Moderate production increases and stable feed prices resulted in a recovery in milk prices through Q219 and improved the adverse customer sentiment. Again, the opening order position for H219 provides encouragement for a recovery and we now expect the shortfall in H119 to be recovered in H219.
Management is confident of a rebound in performance in most segments during H219 and maintains the view that its expectations will be met. Successfully delivering contracted volumes from backlog will be key to the H219 performance improvement, but should sustain improvement into FY20. Our divisional split has been tweaked to reflect the softer dairy performance for FY19 as a whole. The sharp improvement in Avon Protection should compensate for that weaker expectation. It should be driven by initial volumes with higher margins on the recent Military contracts, as well as rebounding US government sales for Law Enforcement and Fire. Our headline numbers thus remain unchanged as shown below.
