Norcros’s compelling investment case was underpinned at the half year where underlying operating profit was down less than 3% despite material revenue pressure. Group operating margins rose 60bp, the UK business reported record underlying profits and Norcros continued to take market share in both the UK and South Africa. We believe that Norcros’s key strengths are underappreciated and that legacy issues, notably the pension deficit, have been resolved. We retain our estimates and value the shares at 246p, implying c 50% upside.
H1 pressures, but strategic progress evident
H1 revenue declined 8.3% y-o-y at the headline level to £201.6m, but was down only 4.1% on a constant currency, like-for-like basis. Underlying operating profit was down only 2.7%, largely reflecting the decline in revenue, but the underlying operating margin rose 60bp to 10.6% despite the revenue pressure due to strategic management action that included the closure of the adhesives operation and the 50% capacity reduction at Johnson Tiles. Underlying PBT declined 9.0% as interest costs rose and diluted EPS slid 12.4% to 15.6p. An interim dividend of 3.4p was declared, flat year-on-year. Strong cash generation contributed to the reduction of net debt, from £58.9m a year ago to £46.6m. The net debt to EBITDA ratio at the half year was 1.0x, which implies material headroom.
Compelling investment case underlined
Norcros’s successful growth strategy has remained consistent and largely unchanged for many years, focusing on the development of leading market positions with strong brands in highly fragmented markets. Its capital light structure and targeting of the more resilient mid to premium section of the repair, maintenance and improvement (RMI) market reduces volatility. The strong focus on new product development and its 25% ‘vitality’ rate (sales of products launched in the last three years), coupled with its leading supply chain, implies it is winning market share from smaller competitors. One new product example is the Triton Envi shower, a behind-the-wall digital shower with strong environmental credentials.
Profit forecasts and valuation maintained
While we have reduced our FY24 and FY25 revenue forecasts by c 7–8%, we have maintained our profit estimates and therefore our valuation of Norcros (LON:NXR). Our P/E based valuation implies a value of 236p/share based on our diluted underlying FY24 EPS estimate, while our DDM implies a value of 255p/share. The average is 246p, implying c 50% upside. Norcros is trading at the lower end of its long-term consensus forward P/E range on 5.4x (Edison forecast P/E: 5.2x), suggesting that a lot of negativity is priced in. As and when we begin to see recovery in the UK and/or South Africa, the company may well attract a higher multiple.
New record for UK profits despite tough markets
Norcros’s H124 results highlighted the resilient nature of Norcros. Although total revenue declined 8.3%, underlying operating profit was down just 2.7%, benefiting from strategic management actions (described below), which resulted in the achievement of record UK operating margins. We are maintaining our FY24 and FY25 profit estimates, though we have reduced revenue estimates, reflecting current trends. Norcros is a leading player in its field and, with the stock trading on a P/E of just 5.2x, we believe there could be significant upside from the current depressed price level. Furthermore, one of the key historical issues faced by Norcros, that of its historically large pension deficit, remains well under control as the fund has been in an accounting surplus for the last two years.
Group margins up despite issues in South Africa
H1 revenue declined 8.3% y-o-y at the headline level to £201.6m, driven down by a combination of modest revenue growth in the UK and weaker demand in South Africa. Revenue was down only 4.1% on a constant currency, like-for-like basis, but was up 11.3% versus H120 (a pre-pandemic period) in total terms. Underlying operating profit was down only 2.7% y-o-y, largely reflecting the decline in revenue, but was up 23% versus the same period in CY19 (fiscal H120). The underlying operating margin rose 60bp y-o-y to 10.6%, despite the revenue pressure, as the benefits of management action to exit the underperforming adhesives business and the 50% capacity reduction at Johnson Tiles were felt. The inclusion of the higher margin Grant Westfield business was a further positive.
Underlying PBT declined 9.0% as interest costs rose due to the higher average levels of net debt during the period reflecting M&A financing and higher interest rates, and diluted EPS slid 12.4% to 15.6p. An interim dividend of 3.4p was declared, flat year-on-year. Net debt was reduced from £58.9m a year ago, reflecting the acquisition of Grant Westfield, to £46.6m. Net debt stood at £49.9m at 31 March 2023. The net debt to EBITDA ratio at the half year was 1.0x, which implies material headroom to the committed £130m revolving credit facility.
UK profits hit record, South Africa hit by power outages
In the UK, which now accounts for 71% of revenue, Norcros generated revenue of £143.9m, up 0.8%. On a like-for-like basis, and excluding Grant Westfield (acquired in May 2022) and Norcros Adhesives, which was closed, revenue slipped just 0.8% with lower volumes almost completely offset by price increases. In particular, the key brands of Triton, Merlyn and Grant Westfield performed well, driven by new product launches, excellent stock availability and great customer service, although Vado was negatively hit by delayed new product launches. RMI demand remained the key driver of revenue. Export revenue increased driven by demand from Ireland, France and the Middle East.
H1 operating profit rose 14.7% or £2.4m, to £18.7m, a record level, and implied that margins rose 160bp to 13.0% in the period. The growth reflects the efforts made to improve the brand portfolio.
The South African business, which makes up 29% of revenue, fell 25% in absolute terms and declined by 11% on a constant currency basis, as higher levels of energy rationing hit consumer confidence and demand. The ‘loadshedding’ has had a minimal impact on Norcros’s own operations and retail stores as they have been equipped to operate during these periods of interruption. Despite the headwinds, Norcros maintained its market share gain momentum by focusing on product development and customer service in the region.
TAL, the leading adhesives business in the region, was able to grow market share, as did House of Plumbing despite flat revenues in a challenging market. Johnson Tiles and Tile Africa were both affected by market slowdowns, particularly in the new housebuilding sector. The market turbulence mentioned resulted in a decline in operating profit, from £5.7m to £2.7m, which implies a decline in margins from 7.4% to 4.7%.
Despite the tough market conditions, Norcros continues to take market share and should benefit from the national roll out of House of Plumbing in South Africa. We anticipate it should also begin to see the market stabilise as energy constraints become less of an issue.
Valuation suggests c 50% upside
Following the H124 results, we have essentially maintained our profit estimates and therefore our valuation of Norcros. Our P/E based valuation implies a value of 236p/share based on our diluted underlying FY24 EPS estimate of 31.5p/share, while our dividend discount model (DDM) implies a value of 255p/share, and if we take the average of the two, we arrive at 246p, implying c 50% upside. Norcros is trading at the lower end of its long-term consensus forward P/E range on 5.4x (Edison forecast P/E: 5.2x), suggesting that a lot of negativity is priced in. As and when we begin to see recovery in the UK and/or South Africa, the company may well attract a higher multiple.
Simple forward P/E multiple valuation implies 236p/share
The chart below details the progression of Norcros’s forward P/E over the last cycle. The range at the extremes is a low of 4x reached briefly post COVID-19 and again in 2022, and the high is c 12x at the end of 2013, before the Brexit hiatus. Over this period and outside the extreme ratings, the ‘real’ range has arguably been 6–9x and the average over the whole period is 7.4x.
If we apply the 7.4x forward P/E multiple to our estimate of FY24e diluted underlying EPS of 31.5p, we arrive at a value of 236p/share, implying c 45% upside to the share price. Arguably, this method gives little credit for future potential acquisitions, which are part of the company’s strategy and may be forthcoming.
Dividend discount model implies a valuation of 255p
Our DDM valuation of 255p lends support to the P/E valuation above of 236p/share. We have maintained the base dividend of 10.2p/share, which is more than three-times covered by diluted and underlying earnings. We are confident that forecasts are likely to rise in the longer term given the numerous growth channels available to Norcros, justifying our 5% long-term dividend growth estimate. We remind readers that dividends grew 10.7% pa between 2015 and 2019, which further supports our dividend growth assumptions.
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