Avon Protection Profit Warning: Shares in protection specialist Avon Protection (LON:AVON) fell sharply in early trade on Friday as a variety of issues led them to reduce guidance for FY21. This was the third profit warning of the same day (following Venture Life and Best of the Best). One thing that these shares have in common is that they appear to have been beneficiaries of the pandemic. Avon’s share price was over double this at the turn of the year:
This business has nothing to do with the cosmetics line of the same name. It was formerly known as Avon Rubber due to the production of items like tyres and inflatables it produced. However, due to sales and acquisitions the connection with rubber is much smaller. Nowadays the company specialises in the manufacture of gas masks and by means of acqusition have moved into the ballistic protection business. The company name was changed to Avon Protection in July of this year.
As we can see from its website, the company’s products have several uses, from military, industrial to law enforcement. Unsurprisingly, a very constant level of demand for products has seen this company become a favourite with investors. It has been paying a small, but progressive dividend, is profitable and had a growing cash balance (until the latest acquisition).
What did the Avon Protection profit warning say?
The bad news comes in a trading update RNS. We actually start with good news, in that there has been order book growth, and organic as well, not just through acquisition. However guidance for revenue drops to $245-260m due to:
· Delayed receipt of c.$16m of expected orders under existing contracts, including a significant M50 order, as a result of procurement bottlenecks;
· Extended lead times for predominantly electronic and textile components delaying the shipment of c.$6m of deliveries under existing orders; and
· Remaining uncertainties as to the timing of receipt of other orders that we expect to receive and ship before the end of the financial year.
Checking this is made harder as Avon reports in GBP, however a research note from May gives an estimate for sales at $284.9m; so potentially a large fall if at the lower end. We also have an effect on margins:
The result of the lower revenue expectations, combined with an adverse mix effect and an overhead base that is fixed in the short term, means that adjusted EBITDA margin guidance is expected to reduce to between 17% – 18% for FY21, before recovering thereafter.
Using the same report, EBITDA appears at close to 22%. This certainly does reflect the fixed cost of the overhead base. There is also a knock-on effect for the next year with $320m-$340m predicted (against previous estimates of $362m). However, beyond this the company are bullish and maintain their forecasts.
Avon Protection: The Business
The business has quite a lot of moving parts which makes it harder to analyse. There was a significant acquisition of Team Wendy in 2020, which cost $130m, however earlier in 2020 Avon disposed of its Milkrite business for an even larger figure – £180m. These businesses had a turnover roughly similar to each other, however this had led to distortion in the accounts as £130m was booked on the profit from divestment:
Wiping out this gain, we get an operating statutory profit of £5.9m however here there are £24.3m of adjustments comprising amoristation of intangible assets, acquisition costs and also an inventory impairment cost of new items received. This gives an adjusted operating profit of c.£30m which reflects the longer term trend and also the boost from covid trading.
The results also show that this is not a global company but now heavily weighted towards the US:
It also is worth mentioning that there is customer concentration risk: the US Department of Defence accounted for most of its revenues in the past year, spending £95.3m of that £168m. Thus recent trends with regard to its military spending may be quite relevant here. Given the low figures for Europe, we can presume this may be the only army it supplies.
Balance sheet-wise, this should still sit in good health even after paying for the Team Wendy acquisition. A new borrowing of £31m has come up in the last year; debt is not something that usually features on the Avon Protection balance sheet and may be paid off by now with the proceeds of the sale. Of more concern is the pension obligation. The last year saw a £21.8m payment towards the deficit, which still increased from £54.1m to £62.5m. This was a result of the net benefits being paid out being greater than the return on assets; acturial measurements accounted for the rest. This defined benefit plan could be potentially costly in future years, eating up profits.
Is the Avon profit warning a buying opportunity?
There is a lot to like about this. Avon are not in any kind of distressed position financially. They have good margin on their products with a competitive advantage of agreed supply arrangements. Disposals have changed the business into something more focused and there are synergies between the main business and what it has acquired. Many of the adjusted costs they make are unlikely to be repeated.
Most importantly, many of the reasons behind the profit warning are not to do with the company itself. Supply issues, delayed shipping and labour shortages are something that is affecting many companies at this point. With demand unlikely to drop off a cliff anytime soon, it is perhaps more prudent to have more inventory on hand rather than less. If we believe that the economy will return to normal, then these issues should also receed and be one-offs rather than part of an ongoing picture.
A tricky aspect is how the share should be valued. For one thing, there is a good amount of growth which is promised. The previous 2022 forecast of $362m revenues represents over double what was achieved in 2019. This would also have been achieved without the need to dilute shareholders. The addressable market is large – every army and police force in the world is a potential customer.
Against this is the heavy customer concentration of the US army (which may involve limitations on sales elsewhere), as well as a pension deficit that may eat into profits for some time. The share price I believe pretty much follows many shares: it simply got ahead of itself. A £1bn+ valuation for the company is too rich for my liking. Technology is evolving and it won’t be just Avon working on it – another company could produce a substantially better piece of kit which goes on to be popular.
We may be looking at a forward P/E of around 20 or so; my gut feeling is that this is fair. 3/5.