Scapa Group share price (LON:SCPA) dropped as much as 35% in trading this morning as it issued a trading update forecasting profit to be significantly below expectations. The share price reaction was quite harsh:
In the bigger picture, Scapa suffered a nasty profit warning in June, which slapped the share price down to the 160p region. This was spurred on by the loss of a large contract plus the potential for further litigation. This issue went away with the dismissal of ConvaTec’s claim, but the share price has yet to really recover to the 400p levels seen less than a year ago. Today’s profit warning takes the Scapa share price close to where it was pre-litigation.
Scapa have an interesting niche, specialising in adhesives. These are sold under two broad categories, Healthcare and Industrial where there are many applications such as the stowing of cables to medical dressings. The company has traded profitably, and the Scapa bulletin boards are quiet, but positive on the stock.
What’s gone wrong at Scapa Group?
The bad news comes in a trading update today. The news gets straight into it:
The Group expects FY20 revenue to be approximately £306 million, broadly in line with market expectations. However, trading profit is now expected to be approximately £28 million, significantly below consensus.
There is no guidance as to what this consensus is, and additionally trading profit is a different measure from the net profits that Stockopedia forecasts. (£24.1m). Reading the annual report, it seems that this strips out amortisation, exceptional costs and pension admin costs. On this measure it is down from the £38.2m seen in the past year.
The reasoning is quite vague but seems to be blamed on a reduction of margins in Healthcare, and in particular the Industrial segment:
Industrial revenue is expected to be approximately £168 million, which is slightly below market expectations but has a material impact on Group trading profit. This is primarily the result of adverse macroeconomic conditions, particularly in the automotive and specialty products markets.
As we can see from these figures, both the segments are quite balanced in terms of sales.
Scapa Group: Positive Impressions commensurate with valuation
The profits in the last year were battered by exceptional items totalling £12.8m, which mainly related to the closure of manufacturing facilities. Whilst we can expect these costs not to re-occur, we can expect some further exceptional items for the current year in the form of the litigation costs in this year’s dispute with Convatec as well as the contract being written off.
If we can put these costs aside, it does appear that the business is growing at a reasonable pace, although the loss of the Convatec contract will mean growth stops for the meantime. With some healthy operating margins we can infer that there is some advantage in the products, indeed the annual report references IP protection. Excluding the past year the cash conversion to profits has also been pretty good. Capital expenditures are easily covered, although in the past year have shot up as new production facilities have moved to Knoxville, this seems rational enough considering most of the revenues are generated in North America.
The question moves on to finance. There is no doubt that much of Scapa’s expansion has been by acquisitions, and what was a standard tapes company moved into its niches by acquiring other businesses. These type of bolt-on acquisitions promise a high degree of synergy, with plenty of product expertise on hand. In terms of the balance sheet, there are almost £120m of intangible assets, although net tangible asset value is positive at around £20m.
Financing has been relatively conservative. In recent years these acquisitions were small, the company ran almost at debt-free. In recent years this has stepped up: Euromed was acquired in 2016 for $35m, and Systagenix in 2018 for £31m. Euromed was (almost) paid out of cashflows, but the Systagenix acquisition necessitated a £42.5m increase in debt.
Finance has been relatively cheap, reflecting the current trading here. Their facility is for £70m with a £30m ‘accordion’ and interest is charged at 2.2% effective rates. From this, it can be seen that it may be in the companies interest to pursue acquisitions, although it may be the case that for now, they have enough on their plate. Interest costs amounted to £1.9m, so a relatively small proportion of profit.
So we have the case that as long as the business continues to trade normally, there should not be any type of financial distress as cashflows are strong enough to ensure that this debt will continue to be paid down.
Are Scapa shares good value?
It seems likely that FY20 will be a poor year in terms of operating profits for Scapa, although this will not be that evident to many as the headline basis excludes many of the exceptional costs they will incur.
One of the unknown circumstances surrounding the share is the Convatec issue. With the case dismissed, they have now counter-claimed for $83m in damages – relative to the company this is a material sum of cash, which would wipe out their debts. This could even kick off another round of acquisitions. Unfortunately, there is no real guide to how likely this is to be achieved, and the claim might be kicked out. Or more likely, both firms settle at a much lower level.
Underneath it all it does seem like a decent business which is generating profits, while facing some macro headwinds – but arguably, many businesses are too in the current climate. US hospital software specialist Craneware implied that some spending had been delayed.
This already may be priced in despite the profit warnings. A brokers note on Research Tree surprisingly goes against the grain and states there is better value elsewhere, admittedly made when the Scapa share price was 272p. The stock price is a lot lower now, but the implied forward earnings ratio is still a little high. Overall in the longer term I think the prospects are good, but can wait for more clarity. 4/5.