Free to Read: Is the bad news over for Avon Protection?

Avon has had a horrible 2021. Trying to call a bottom to its share price is not easy, but if profits forecasts can stabilise quickly the shares are arguably interesting right now.

Photo courtesy of Avon Protection plc

Avon Protection (formerly known as Avon Rubber) is a good example of what can happen to a highly valued share when things start going wrong with the business behind it.

High valuations imply high expectations of future growth. If these can’t be met share prices have a tendency to fall heavily. This is what has happened to Avon Protection shares.

This time last year, all seemed to be going swimmingly well for Avon. Its Military Protection business was trading well and picking up plenty of orders from the US Department of Defense (DoD) for its respiratory masks business.

It had made what look like two very sensible acquisitions which broadened its military product portfolio into areas such as helmets, body armour and ballistic protection. The exit from its lacklustre milking machine and parts business cleaned up the company and focused it on what seemed like the higher quality earnings and growth potential from its military business. 

The stock market liked what was going on and put a high valuation on the company’s shares at over 30 times forecast earnings.

It’s a business that I liked a lot of the time and the shares had significant positions in my model portfolios having picked them up for around £13 at the end of 2018 and the beginning of 2019.

As I wrote elsewhere at the time, I sold out completely after the company’s full year results last December at £42.55 for the following reasons:

  • Very weak organic sales growth in the second half of last year.
  • Strong future growth already looked priced into the shares. It was difficult to see a source of meaningful forecast upgrades.
  • Messy cash flows and exceptional items in the accounts which did not sit well with me.

However, I never expected what was going to happen in the next 10 months but it has been something of a horror show that has caused Avon’s share price to collapse.

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The first sign of trouble came just two weeks after the full year results with the announcement of contract delays. A trading update in April maintained full year profit guidance but pointed to second half weighting of revenues, higher stock levels and longer material lead times.

August saw a further downgrade to revenue and margin guidance whilst this week has seen guidance for revenues come in at the lower end of its previous range and a further hit to margins as weak ballistic sales have seen the value of stocks written down.

As a result, EBITDA margins for the year ending September 2021 are now expected to be 15-16 per cent compared with 22.9 per cent in 2020.

If you strip out the impact of the acquisition of the Team Wendy helmets business, revenues for the rest of the business went backwards last year, largely due to a 31 per cent decline in ballistic sales. This has inflicted a lot of pain.

Is the worst over?

The collapse in profit forecasts has been severe and no doubt investors have lost a lot of confidence in Avon. That said, businesses rarely go bad overnight and I don’t think this one has.

The company still makes good products that are class leading which military customers around the world still want to buy. This is shown in the order book which excluding Team Wendy has grown by 15 per cent over the last year.

What we have seen this year is largely a problem of capacity utilisation. Put simply, Avon’s manufacturing plants haven’t had enough work and revenue to absorb its overheads as well as the year before. This – and the stock write offs – explains a large part of the reason why profit margins have fallen back so much.

The order book suggests that this situation will improve next year and therefore profits could be capable of making a very strong recovery, especially with strong rebound in product sales such as body armour.

Better loading of manufacturing plants will leverage the fixed overheads – of which there are plenty in this company – and drive higher profits, margins and return on capital. 

In a couple of years’ time this company could be looking pretty decent again and the share price could be a lot higher than it is now.

Looking at current forecasts for 2022, they currently assume a bounce back in EBITDA margins to just over 21 per cent and exceeding 23 per cent the following year.

This is not impossible or unreasonable with some good fortune, especially as Team Wendy has a richer margin compared with the remaining business which would suggest that EBITDA margins should go above 2020 levels with a revenue recovery.

Avon Protection 2021F EBIT history

Source:SharePad

What will trouble investors is whether the bad news is over. We currently live in a world where supply chains are really struggling to function well and delays are common. It’s not inconceivable to think that downgrades for 2022 forecasts are more than a possibility.

The other key consideration is what kind of valuation and profit multiple will investors attach to the shares going forward. Last year, the answer was well over 30 times forecast earnings compared with around 20 times now on current estimates at a share price of 1884p.

I don’t see this share back at 30 times forecast earnings on recovered profits any time soon. This kind of valuation is usually justified for businesses with a high level of dependability and growth and Avon does not have that reputation at the moment. It could take some time to get it back as a lot of trust has been lost.

That said, if the company can get back on track, I think the shares are interesting down here albeit not without risk. They look worthy of a position on investors’ watchlists at the very least.

Avon Protection:Current Forecasts

Year($m) 2021 2022 2023
Turnover 250.2 325.9 359.6
EBITDA 42.3 68.9 84.2
EBIT 28.8 50.9 63.8
Pre-tax profit 25.2 48.4 62.1
Post-tax profit 20.2 35.6 48.1
EPS (¢) 64.9 124.2 158.5
Dividend (p) 32.8 42.0 54.4
Capex 16.8 18.8 18.7
Free cash flow -25.0 32.1 36.6
Net borrowing 58.3 45.7 32.1

Source:SharePad

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