In the near term, Tyman's (LON:TYMN) new management team is tasked with rectifying production-related issues in North America that have caused us to reduce our earnings estimates in all three forecast years. A strategy update is scheduled for mid-2020 and a reduced target gearing range perhaps suggests greater focus on internal/organic performance for the time being. Tyman’s rating is now sub 10x on a P/E basis with a prospective 6.1% dividend yield for the current year.
Like-for-like progress constrained by AmesburyTruth
Headline revenue and EBIT progress in H119 was somewhat overshadowed by production transition issues at AmesburyTruth, which resulted in modest like-for-like declines in these metrics. At group level, normalised PBT was ahead by c 4% (after a small adverse IFRS 16 effect) and, while earnings on the same basis were flat, the interim DPS was increased by c 3% y-o-y. The increase in net debt to £228m (pre IFRS 16) was consistent with the normal seasonal pattern and well within existing term borrowing facilities.
Recovering US performance and sub-sector growth
We believe that the majority of the Tyman group has performed well in markets that have generally offered little help, but inefficiencies during manufacturing moves with related customer service issues in North America need fixing. This is Tyman’s largest market and delivering a sustained performance improvement here is a litmus test for the new management team. Around the group’s sub-sector and regional exposures there are clearly opportunities to grow ahead of the general market and credit should be given for relative outperformance despite market softness if it can be achieved. For now, we have reduced our EPS estimates by c 10% for this year and next while the US issues annualise out, with a more modest cut in our third estimate year.
Valuation: Single-digit P/E and 6.1% dividend yield
The c 14% reduction in Tyman’s share price since the H119 results announcement is likely to reflect some investor disappointment with performance but also increasing rotation away from stocks perceived to have cyclical exposure. Tyman’s rating is at single-digit levels for the current year (ie P/E of 7.8x and EV/EBITDA, pre IFRS 16 and adjusted for pensions cash of 5.8x) with a prospective dividend yield of 6.1%. We expect earnings and dividend progress in each of the following two years.
Business description
Tyman’s product portfolio substantially addresses the residential RMI and building markets with increasing commercial sector exposure following acquisitions. It manufactures and sources window and door hardware and seals, reporting in three divisions: AmesburyTruth (North America;64% of reported FY18 revenue), ERA (UK ;16%) and SchlegelGiesse (RoW;20%).
H119 results overview
Two divisions grew revenue and operating profit organically in H119, but North American performance was hindered by production inefficiencies arising from footprint changes. Annualised acquisition effects benefited all three divisions and sterling weakness also enhanced overseas earnings. H119 results applied IFRS 16 – Leases for the first time, which had a modestly negative impact on reported PBT.Net debt showed its normal seasonal increase and management has set a new, lower target gearing range of 1.0–1.5x adjusted EBITDA. Our earnings estimates have been reduced by c 10% for this year and next, with a more modest reduction for FY21.
North America: Footprint issues constrain progress
Favourable translation of US dollar earnings into sterling meant that AmesburyTruth’s reported H119 results showed gains against the prior year. In underlying terms (adjusting for FX, one additional quarter of Ashland trading and an exit from small non-core lines), local currency performance was modestly lower year-on-year. This softness was broadly in line with noted reductions in US new residential building permits and US/Canadian housing starts in the first half of the year. The LIRA repair and remodelling index was also subdued though new US multi-family housing completions rose.
In AmesburyTruth’s markets, firmer pricing was a feature – including tariff and surcharge recoveries – indicating that volumes were softer than underlying revenues. The tail-end of the phased, multi-year footprint optimisation project (covered in detail in our previous notes) has been problematic as certain manufacturing lines have taken longer to bed down than originally anticipated. This first occurred during the ramp-up phase at Juarez (in 2017) and the effects of some customer fallout from this are still being felt. Additionally, in H119, the build-up of activity at Statesville (and relocation from other sites) has meant that an existing and a new door seal product line (Q-Lon and E-Lon, respectively) have both encountered manufacturing transition difficulties. In value terms, management stated that annual revenues here are running below its original FY19 expectations (of US$21m at the beginning of the year, down from a slightly inflated US$27m in 2018) and attributed reductions of £5.2m in revenue and £4.7m in EBIT in the period to this cause in H119. (NB The EBIT adjustment was disproportionately large owing to additional costs, such as overtime and freight, incurred to compensate for manufacturing inefficiencies against delivery schedules.) Moreover, Tyman recognised £5.3m exceptional asset and inventory impairment charges in the period relating to the new foam door seal product. Ongoing actions are taking place to stabilise manufacturing performance and establish the appropriate capacity; guidance has been re-set to include reduced door seal demand levels into FY20 as customer issues are worked through ahead of recovering volumes. We should note that this line only accounts for c 5% of AmesburyTruth’s annual revenue; the focus is to ensure that manufacturing efficiency is restored and customer relationships are rebuilt especially among the larger OEMs who purchase other lines from the wider AmesburyTruth (AT) portfolio offering. There was also some impact on smaller/tier three and four accounts serviced through the distribution agreement with Industrial Sales Corp (ISC).
Elsewhere in the North American operations, Ashland (a complementary hardware business acquired in March 2018) saw slightly lower revenue but a 13% EBIT uplift year-on-year for the six-month period. We estimate that the incremental year-on-year contribution to AT’s first half results was to add c £11m to revenue and c £2.5m to reported EBIT, incorporating annualised effects, favourable FX movements and synergy benefits realised. The latter item was identified as US$1.8m in the period noting at the same time that the integration programme is on track to yield US$5m annualised benefits by 2020. Bilco, AT’s access solutions business (chiefly commercial roof and floor hatch and related products, so different to mainstream residential door and window hardware and seals activities),grew sales and operating profit by 4% and 7%, respectively. This appeared to be the result of better penetration of the distributor channel, for what are typically specified/technical products.
As noted earlier, divisional profitability rose by 4% on a reported basis with a 30bp reduction in EBIT margin to 16.7%. Adjusting for the separately disclosed Ashland and Bilco performances, we estimate that the core operating margin declined by c 200bp (to just below 16%). We believe that the attributed footprint impact more than accounts for this, suggesting that the substantial part of AT’s portfolio is performing solidly in a generally soft market. Lastly, we note the recent MD change at AT with Bob Burns (previously MD of Ashland on acquisition) stepping up at the end of June to the divisional MD role. He obviously has relevant hardware industry experience and a private equity background though AT as a whole is clearly a larger-scale entity than Ashland (which accounted for c 15% of FY18 divisional revenue on an annualised basis). In the near term, the previously highlighted benefits expected from the footprint programme are likely to be consumed by rectification efforts to recover volumes and re-establish historical service levels. That said, AT retains a leading industry position among its larger OEM customers and is well placed to secure share gains among smaller accounts through its distribution arrangement with ISC.
RoW: Underlying progress supplemented by acquisition and FX
The reported results in the SchlegelGiesse division (covering international markets other than North America and the UK) also benefited from a small acquisition and favourable average exchange rate translation, but revenue and EBIT also nudged ahead in underlying terms.
Reguitti, a complementary Italy-based producer of door and window handles and accessories, was acquired in August 2018 for c £14m, reported then as bringing annualised sales and operating profit of c £11m and £1.4m, respectively, into the group. Without physically integrating operations (Reguitti in Brescia and SchlegelGiesse headquartered in Bologna) the deal brought the opportunity to consolidate support functions as well as broaden the portfolio offering and cross sell to the companies’ respective customer bases. We believe that the businesses have been aligned now though competitive pricing in the market has perhaps not yielded the benefits anticipated at this stage. We interpret this as maintaining pre-acquisition levels of profitability so there should still be a c £1m yoy profit uplift from Reguitti, with an H119 bias.
General market conditions appear to have been similar to year-end comments, which anticipated modest growth in Europe and variability elsewhere. SchlegelGiesse revenue grew in its main European markets, partly offset by declines in Spain and Germany, while progress was also made in a declining Russian market. China was the pick of the other international markets (revenue +28%) despite wider slowing growth concerns and SchlegelGiesse also outperformed its sector in the Middle East. Elsewhere, local Brazilian and Australian demand conditions remained soft. Overall, underlying revenue growth was c 4% and there was a small implicit margin decline with operating profit increasing by c 2% on the same basis. The inclusion of Reguitti at above divisional average margins contributed marginally to double-digit increases in reported revenue and EBIT and a 20bp margin uplift to 12.4%.
We note a couple of areas commented on by management that should continue to be monitored. Specifically, momentum appeared to be slightly softer towards the end of H1 compared to earlier in the year and there were also references to lower-cost competition in some markets. These features may provide challenges to H2 progress though sterling weakness should again be beneficial.
UK:Margin and sub-sector progress in challenging UK markets
As commented upon by others (including Eurocell, Epwin and Safestyle) and the window supply industry body FENSA, H1 trading was characterised by weak RMI demand while the newbuild sector has continued to grow, albeit at a slower rate. With some year-on-year pricing benefits still coming through like-for-like sales volumes in H119 were below the prior year resulting in modest underlying progress of c 1%. That said, EBIT on the same basis moved ahead strongly under these circumstances and by c 13%. Including annualised acquisition effects (ie Zoo Hardware in May, Profab in August 2018) reported revenue and EBIT increased significantly by c 24% and c 43%, respectively. Y-Cam was acquired in February 2019, but was not a material contributor in the period.
Market outperformance from ERA occurred in both the OEM and distributor channels; while underlying OEM sales before acquisition effects were still modestly down year-on-year, sales through third-party distributors were 10% better than in H118. This progress may partly have been a natural evolution from the consolidation of three facilities into one at i54 near Wolverhampton at the beginning of FY18, which has enabled a raised priority and enhanced service levels to the distributor sub-sector. Separately, ERA’s non-hardware commercial product offering has been collectively launched as Access 360, which brings together the roof, wall and floor access hatch/panel product portfolio assembled through the acquisitions of Bilco, Profab and Howe Green made between H216 and H218. We estimate that annualised sales for Access 360 companies are in the order of 15% of the divisional total with operating margins at least in line with the average. The nature of the business is also more project/newbuild oriented.
The noted weaker segments for ERA included Ventrolla (sash window replacement and repair), which has yet to capitalise on capacity investment in 2017 but management and website changes in the last year suggest that it is aiming to regain momentum. Electronic security is another currently relatively small proportion of divisional revenue (chiefly wireless alarm and camera intercom systems) under the Home Smartware brand umbrella. Having entered this segment in H116 with the acquisition of Response Electronics, it is gradually being re-positioned for growth. As part of this process, route to market changes affected H119 sales development. The acquisition of Y-Cam brought additional product, sensor and cloud-based capability and an integrated second-generation product suite is scheduled for launch in the second half of this year.
The weaker areas probably provided some modest drag on the underlying divisional operating margin but further (unquantified) gains from the move to i54 accrued during H119. Moreover, the combination of year-on-year pricing gains and lower input costs drove the like-for-like profit and margin increase referred to above. We believe that the full six-month Zoo Hardware contribution including profit improvement from synergy gains accounted for most of the positive difference between underlying and reported profit progress.
Current market conditions are not favourable for growth but management comments point to expectations of further progress in H2. This is likely to result from some of the initiatives outlined above – especially new products and relative gains in both smaller segments where market shares are smaller and through revenue and cost synergies with acquired companies. Sterling weakness is a medium-term business risk – through input cost increases and the need for compensating price increases – but we believe that forward cover is likely to limit exposure to this in the current year.
Seasonal H1 peak and lowered net debt target range
At the end of H119, group net debt excluding IFRS 16 leases stood at £228m, an increase of c £19m from the year end (and £10m higher year-on-year) including a c £1m adverse FX translation movement. These headline movements are not affected by the implementation of IFSR 16 though this standard changes the presentation; asset finance charges, previously reported as part of opex (long term lease costs), are now shown as financing activities, split between interest and principal payments. Consequently, other things being equal, EBIT/EBITDA and financing costs both increase compared to the previous presentation. In H119, these offsetting increases amounted £4.7m and so the cash flow statements are not directly comparable in these areas as the prior year was not restated.
On a reported basis, net cash generated from operations (before cash tax payments) was just over £23m. In broad terms, this was the net result of c £52m EBITDA (including £3.5m depreciation on right of use assets), c £19m seasonal working capital outflow (comparable to the prior year) and c £10m non-trading cash items. The latter included c £7m identified exceptional cash costs from footprint consolidation and M&A activity in the last 12 months and £0.5m pension scheme recovery cash.
Finance costs and tax cash payments both increased year-on-year, and to £15.5m in total. Underlying bank interest rose reflecting higher average net debt following FY18 M&A, while lease-related finance costs (£1.5m) were separately disclosed for the first time. Cash tax was ahead of its P&L equivalent, we presume due to timing effects only. Net capex was comparable to the prior year at just below £5m with both lower gross and net spend as the footprint programme implementation tapered down as did associated asset disposal proceeds. After all of the above items, free cash flow (FCF) was just above £4m positive for the first six months of the year.
Bridging from FCF to the £18m net cash outflow for the year, the FY18 final dividend payment (c £16m) was the largest single item. In decreasing size order, lease principal repayments, treasury share purchases for employee benefit trust purposes and sub £1m Y-Cam acquisition consideration were the principal remaining elements.
Cash flow outlook: The new management team has established a new target leverage range of 1.0–1.5x net debt:EBITDA, versus the 1.5–2.0x previously in place (both on a pre IFRS 16 basis). Current banking facilities1 provide ample operational headroom and visibility in our view, even around the mid-year seasonal peak, so we do not believe that the range change indicates funding constraints. Rather, in less certain markets, it represents a more prudent level and probably also signifies greater focus on organic development over the next couple of years. Even on reduced estimates (see below) we expect the current year to end at c £184m or c 1.8x, meeting the target with c £149m or 1.4x in FY20.
Despite the estimate changes, our year end net debt projections are not materially different from our last published estimates, with a combination of lower working capital absorption, tax and capex all contributing to this outturn. Now that footprint changes are physically complete, there may be opportunities for more structural working capital changes though we acknowledge that near-term teething manufacturing problems in some areas could hinder this process.
Existing banking covenants are framed on a pre-IFRS 16 (or ‘frozen GAAP’) basis, so the above comments exclude leasing finance. We have simplistically modelled a reduction in balance sheet lease asset and financing levels based on implied annual depreciation and principal repayment schedules at the half year stage. At the end of FY19, we project c £59m finance leases on hand.
Estimate reductions largely in AmesburyTruth
Global growth is expected to remain sluggish2with a number of international trade-related uncertainties contributing to slowing momentum in some sectors. Door and window demand is typically local and country-based; while interest rates and unemployment levels are low in the US and UK, Tyman’s largest markets, consumer spending activity is subdued and housing markets are generally slower than earlier in the year. New product development and the integration of acquisitions are two common areas across Tyman’s three divisions that can help to counter sector weakness and support share gains and outperformance.
In the near term, reduced sales and production inefficiencies arising from the US footprint change programme are the primary driver behind our reduced estimates. Specifically, in local currency terms we lowered our revenue expectations by 7% in the current year and by a further two percentage points in each of the following two years. At the EBIT level, this translates to reductions of 15–20%. Updating our FX assumptions (from US$1.33/£ to US$1.25/£) dampens these effects in sterling, Tyman’s reporting currency.
Elsewhere, we have made a modest reduction to profit expectations in the other two divisions and increased the run rate of group central costs. Note that incorporating IFRS 16 for the first time provides a modest underlying boost to group EBIT (c £1.5m, mainly in AT) and, after interest cost effects, a similar net drag at the PBT level. Our estimate changes are summarised in Exhibit 2.
Not shown in the above table, but we have also lowered our DPS projections by c 9% for FY19 and a few percentage points more in the following two years; we still expect to see annual year-on-year growth and a three-year 4.0% CAGR from the reported FY18 base level.