Performance materials specialist Low & Bonar (LON:LWB) today issued a profit warning as tough trading in the first quarter is expected to impede on full-year expectations. The share price has declined 20%, although arguably most of the damage has already been done:
The share has lost most of its value in the past year from a high of 58.40p. A lot of the damage was done in October, when it dished out a profit warning and it seems as if momentum has continued to move downwards. Even looking before that the trends are similar, there was another profit warning towards the back end of 2017.
Low and Bonar may be a tricky business to evaluate. They describe themselves as ‘an international textiles business’, which converts polymers into a range of fabrics which have many different practical applications in real life. As you may guess, this results in a far reaching business which are covered by five different technologies within the group: Colback, Enka, Coated Fabrics, Needle-Punched Non-Wovens, and Construction Fibres.
Up to 2017 the business was moving along nicely and generating profits. Since then, impairments to business divisions and transformation costs have seen profits swing to a loss. It does seem to have been the case that this trend is continuing.
The warning hits us in a trading update RNS for Q1. We are reminded of the equity raise and sale of some divisions. Trouble looms for some of the others:
As indicated in January, sales volumes in the Group’s remaining divisions, Colbond and Coated Technical Textiles (“CTT”), were held back in the early part of the year due to several factors. These included lower volumes at one important US Enka customer, and reduced capacity at the Lomnice site following the fire in late 2018. In addition, both Colbond and CTT saw subdued demand in some markets.
Going further it explains:
As the first quarter progressed, Colbond continued to experience lower market demand levels than expected, particularly in automotive and flooring segments, and increased competitive pressure in the lower margin European roofing market. Good progress is being made attracting new customers, notably for Colbond in the US and APAC, which gives confidence for the rest of the year. In CTT, while operational capability is being rebuilt, volumes have continued to be held back by legacy supply issues and intense competition
And as a result:
As a result of reduced volumes, Group revenues in the first quarter were below prior year levels and management’s expectations. A temporary increase in inventory as a result of the lower sales will be addressed during the year as part of a continued focus on working capital. Overall, despite some benefit from lower raw material costs, the weaker revenues and some manufacturing inefficiencies contributed to lower than expected profitability in the quarter, which the Board expects will have an impact on full year performance.
There are no numbers indicated here. The most recent analyst report on Research Tree was published in February and guides profit before tax lower to £18.9m from £21.0m so it remains to be seen if there will be a further downgrade.
A quick view on Stockopedia paints the impression that this was a business that seems to have unravelled badly in the last couple of years, and historical Stockranks back that up: two years ago, this was on a high of 96, today it sits at just 37.
One of the biggest bug-bears seem to have been at least partially addressed. The debt pile was too large here for many investors to consider. This is now bigger than the market capitalisation of the whole company, and many times profits. An equity raise in February has raised c.£50m in funds, and this is set to repay borrowings. This still leaves the remaining borrowings as high: the analyst report predicts that the level will be £121m in future years.
However, this may not take into account that some parts of the business are being divested and this may free up future funds. The sale of two businesses in the division is set to complete in the financial year. Looking at the accounts though, it may be that this division is no real loss: it generated £77.6m of revenues, contributing £0.1 of operating profits. By contrast, the Interiors and Transportation division has been much more successful, gaining £125.7m in revenues and £18.5m of underlying operating profits. The analyst refers to this as a ‘structural balance sheet unwind’ and potentially offers another £20m boost, taking the debt position to under the £100m mark.
So given the current performance of the business, this debt looks manageable, if unwelcome. A glance at the balance sheet as well may also provide some more reassurance. Intangibles have decreased sharply over the previous years because of the impairment write-off; one might suspect there may be no more forthcoming. The net asset position is positive even after disregarding these intangible aspects and will be even stronger after the equity raise. Cash has gone up to £47.8m so it seems that there are few liquidity risks. Notably, it now trades below net asset value.
The cashflow statement is incredibly busy with many transactions on it. Cash from operations was £51m although this benefits from a £13.6m favourable working capital movement. Interestingly, there appears to be still a dividend paid, and there will continue to be as long as their are profits. This has also been trimmed, and a 0.9p projected payout gives a high, but risky yield.
It seems rather likely that Low and Bonar will be at the mercy of the economy: a prolonged slow-down will lead to a reduced demand for their products. Alongside general retailers, ancillary suppliers to the building industries are also being hit.
Some of the positives are quite obvious. The business is profitable, and the reorganisation makes sense. The equity raise has also given it further strength and the products are niche, meaning it may be less vulnerable to get into bidding wars.
The downsides may require more investigation. It may be niche, but in a tightening market, can the niches be defended, or are there substitutes available? This is not immediately clear to me, and the ‘competitive pressures’ cited in the RNS suggest not. Also the dividend policy must come into question: would a better use of funds be to correct existing problems? Relatively speaking maintaining this was expensive and may have resulted in under-investment in other divisions.
There is no denying the share is cheap, but it does seem a turnaround will not be fast, and further extrapolation of the downtrend would result in a precarious position with regard to debt. 3/5.