Second Look – MPAC

Actually this is at least my 5th look. As well as looking into them in detail around a year ago including a visit on 19/7/2018, I’ve looked at MPAC three times recently on this blog:

• Once when announcing a transformative acquisition – I concluded they looked like a trading buy, but that in the event I wasn’t happy with the 140p I was offered. (they rose to 150p close and then continued upwards to a peak of 172p before falling back).
• Again when announcing the results of their triennial pension review – I concluded that again they might rise on the news, but said I would continue to hold off (they rose slightly and have continued gradually up, once again approaching the peak of 172p)
• As comparitor when looking at Norcros’s pension scheme when I noted MPAC’s trustees were much more conservative in the choice of assets and growth assumptions.

Too negative?

When writing the last article in particular I started wondering why I was happy holding Norcros but not holding MPAC. They both have oversized pension schemes (MPACs being less risky). They both look cheap on a nominal forecast P/E basis (Stockopedia today says MPAC 7.7x, Norcros 6.2x). They both are more exposed than average to an economic downturn. But importantly MPAC has cash and considerable potential for a turnaround whereas Norcros has debt and a strategy that I disagree with.

Was it possible that I had stuck myself with the opinion I formed a year ago, even though the facts had potentially changed? (At the time I concluded that the time to look into them again was as the FY 2021 results came out, because these were likely to presage a new triennial valuation / deal with trustees that resulted in reduced pension recovery payments.) Having missed several opportunities to buy below 120p I am now irrationally unwilling to pay more since I feel everything that happened recently was fairly predictable?

At this point (perhaps influenced by the rising share price and that the company are based around the corner from me), I had concluded that I probably had made a mistake and this probably was I company that I should own, and that the current share price was perfectly reasonable.

Fresh Look

So I decided to (try to) look at MPAC again from scratch. First I listened to the latest interview with Equity Development and read the latest annual report, making notes as I went. Things started well – I noted things like “record order book” and “50% bigger since divestment” and “targeting healthcare”. But then I started thinking about the business model and what they were not saying.

The word “recurring” simply doesn’t appear in the annual report (with or without the word “revenue”). As far as I can tell, 80% of their sales depend on making sales of new equipment to new or existing customers. The remaining 20% are service and maintenance revenues, but these are generally not contracted in advance and customers can get this done by anyone – indeed, in H1 2018 customers had to do just that (or defer servicing) because MPAC’s staff were too busy supporting new sales.

Any economic downturn that delays customers’ product innovation could have a severe impact on new machine sales, especially in the low-margin food and beverage sector where the majority of their sales lie. Margins on servicing would fall as customers can substitute them with third parties.

They are continually having to develop new machines / platforms and customise them for individual customers rather than having valuable IP that they can sell over and over. This means they are particularly dependent on their staff and are more likely to have contract performance issues in the future (as they have in the past).

There is a big industry trend towards increased self-monitoring and software complexity in such machinery (so-called Industry 4.0). These factors undoubtedly present opportunities as well as threats, especially for the more agile company, but what is certain is that it will require significant ongoing investment and that MPAC have less sales to spread these costs over than their larger competitors.

Terrible

So, I concluded that this basically a terrible business from an investors perspective, and especially this late in the business cycle. And given that until quite recently the majority of their business was with recession-proof cigarette packaging, I can’t look at their history to see how bad it could get in a downturn. Which is probably why I was looking at them from a deep value / asset play perspective in the first place.

I then looked at the latest house broker’s research (1st May, available for free from Research Tree or probably directly from Equity Development, and yes, I did just sneak in a referral link). For all the forecast adjusted profits, the first year they project cash rising is in the full year to December 2021.

The broker’s research also gives figures for the acquisition (Lambert Automation) showing progressively reducing revenues and reducing margins / profits over the past three years and what seems to me quite a high implied valuation. As with any acquisition, there is the risk of discovering contract etc. liabilities or overstated order books, or experiencing integration issues, underperformance or other problems.

So, I think I’m back, rather unexpectedly, to my original thesis that FY 2021 is the time to look at MPAC again. And that Norcros superficially made MPAC look good in comparison does, I fear, say more about Norcros than MPAC.

Nothing is all bad

This has been quite a negative article (and there are many more negative points from my notes that I didn’t cover), so here are some positives to end on:

• Customer concentration is usually below 5% and even when a customer exceeds this their revenues are split across different revenue streams / geographies.
• They have some potentially valuable freehold land (ex-sports club), if they can get planning permission.
• They do seem to be taking action to improve service revenues and are talking about support contracts. Clearly there is a lot of scope for improvement.
• Forward order books do give some visibility.
• Synergies / cross selling opportunities from acquisitions.
• Even customers who suffered from issues in 2017/18 have bought more machinery from them since.
• Capitalisation of investment is low.
• Cash and potential bank facility means further earnings-enhancing acquisitions possible