Shares in Porvair is having a time of their life.
As they ride the crest of a wave, should you be worried if this rise is sustainable or, are we likely to see a consolidation period?
Before we answer these questions, let’s look at the background.
Porvair develops, designs and manufacture specialist filtration and separation equipment. Upon hearing the word “specialist”, there is a chance the company has some patent protected technology.
The company has two divisions: –
Metals Filtration; – it helps to handle molten metal in metals such as Aluminium, Iron Foundry and Super Alloys.
Microfiltration; – this is their biggest division and involves the following industry: – Aerospace, Energy (to do with gasification and nuclear), Bioscience, Water (water quality) and Industrial Application.
A breakdown of its revenue and profits looks like this: –
So, the microfiltration is twice as big as metals, but contribute over 90% of net profit.
However, if you add together both these divisions net profit together you will notice it EXCEED net profit reported in their financial statements.
There is an ‘Other unallocated’ segment, which comprises Group corporate costs, some research and development costs, new business development costs and general financial services.
These costs come in the form of a net loss: –
Most of these costs are bear by the microfiltration division, but it doesn’t diminish the importance of this division, especially when it made a recent acquisition further enhancing this segment.
Porvair, a growing filtration business
Sales in Porvair grew by 8.4% per year for the past 11 years, while profits average 17%, which could mean it is growing in competitiveness. That’s because of margin growth.
During this same period, their cash balance grew from £1m to £13.6m, while eliminating £20m in debt. Still, they paid £13m to shareholders with current payout at £1.625m.
A business with good growth and sound fundamentals may catch your attention. But, we need to know if there is further growth on the horizon?
Market Opportunities for Porvair
Well, there is further growth because the global filtration market is forecasted at around $80bn (£65bn) by 2018. And it is growing at 6% per annum.
Looking at each filtration industry separately, the Pharmaceutical Filtration Market is growing at 10% per annum and is valued at $13bn (£10.5bn) globally. This is expected to rise to $22.7bn (£18.5bn) by 2021.
The Industrial Air Filtration will size double in size between 2014 and 2022 from $3.74bn (£3.21bn) to $7.12bn (£6.3bn), averaging 8% growth.
These are just a few markets that Porvair operates in.
The opportunities are there for it to expand. If you aren’t convinced, maybe you need some in-depth analysis of their financials.
Fundamentals Analysis on Porvair
Looking at the raw numbers, Porvair’s operating profit rose from £3.3m to £10.7m. Good, but we want the margin performances.
Operating margins grew steadily, but is perceptible to recession like in 2008/09.
In terms, of equity and capital, both the ROE and ROTC ratios are seeing greater returns, but there could be signs of a decline. This requires further data.
Some of this extra returns are down to lower or zero debt.
Porvair has zero debt, but keep an eye on pension deficit
Debts are paid off, but net pension liabilities have more than doubled in ten years from £7m to £16m. However, Porvair should be able to meet pension obligations from existing cash or from internal cash profits.
Dividend payments covered by Free Cash Flow
As a growth business, Porvair may want to make acquisitions. This can be a reason for the low dividends payout.
And in April 2017, they purchase J. G. Finneran Associates, Inc, another filtration business, see HERE for details. The initial price is £6.4m with a further deferred cash payment of up to a maximum of £4.8m, payable in the years ending 30 November 2018 and 2019.
There isn’t much about J.G. Finneran Associates, apart from this website estimating its revenue of between $20m (£16m) and $50m (£40m).
The latest dividend of £1.6m represents 13% of total net cash profit. A more interesting observation is it generates free cash flow of £6.58m, which meets dividends four times over.
Assessing this over 11 years, free cash flows total £50.7m, while dividends come to £12.8m. This is why debt was paid off and a growing cash balance.
Porvair is a competitive business
When people say this business or that business is competitive, what does it mean?
You can think of a few things like:
-Higher profit margins;
-Lower capital expenses;
-Increase in dividends or share buybacks;
-Lower debt levels;
-Building up its cash “war chest”;
-Rising share price.
But, the thing people often ignored is PRICE.
Is the company able to sell their goods at a price that covers total costs and more? If yes, how would you verify it?
One ratio/equation I used is called Gross Margin Return on Investment. This is “Gross Profit” divided by “Average Inventory Costs.”
If the percentage is at 100% it means the company is selling their products at costs of acquisition, whereas anything below 100% means selling at below costs of acquisition.
However, this includes direct costs but ignores selling costs, salesperson, insurance, rents, utility bills, interest costs, taxes and distribution costs.
Porvair is able to achieve percentages of over 200% in the majority of the past eleven years, apart from 2008. Currently, it is achieving a 240% marked-up in price.
The consensus from one analyst is a forecast of adjusted EPS of 18 pence in 2017 and 19.3 pence in 2018, giving an earnings growth of 5.2% and 7.2%, respectively.
Meanwhile, dividends are forecast to grow from 3.8 pence per share to 4.1 pence in 2017, and to 4.5 pence in 2018, which is easily achievable.
Porvair’s valuation is a little topsy-turvy, see chart below.
Over eleven years, Porvair’s EV/EBIT has average 14 times, which is not far from the current value of 14.7 times, and Porvair’s EV/ASSETS averages 1 times, which is lower than the current value of 1.3 times.
However, the current valuation is based on an average share price of £3.58 in 2016. Today, Porvair’s shares trade on £5.75 per share or 60.6% higher. This means on a 6-month trailing EV/EBIT, it’s at 23.6 times, and for EV/ASSETS, it’s at 2.1 times, a record high on both measures.
For those P/E fans, it trades at 33 times, compared with the eleven-year average of 21.6 times.
The one reason why Porvair has a high valuation is that the market is high, other than being in a growth market.
Another reason comes from their recent acquisition, but the value of that £9m purchase vs. current market value of £250m means any impact to overall earnings is minor.
Think about it, you got adjusted earnings growth at single-digits for the next two years, when P/E is in their 30s. Also, forward-dividends yield in the next two years is forecast to be below 1% at current share price.
Porvair’s Technical Charts
So, is there a chance of a pullback, if fundamentals are not supporting the share price?
Porvair’s share price looks to be going hyperbolic, as it leaves the 50-day moving average behind. The weekly RSI is strongly indicating a divergence on the notion of a lower-high against a higher-high, four years ago.
If we took a longer-term view, the monthly RSI is definitely indicating that Porvair’s share price is seeing a correction.
When you combine “single-digit” earnings growth in the next two years and high valuation levels, then the likelihood of the share price correcting is becoming likely.
Share Price Forecast
Considering all the facts and forecast. Mix in some technical analysis, I consider Porvair share price to be on the high-side of valuation.
Base-Case Scenario; – Expect the share price to correct between £4.50 and £5.10, in the next 12 months. (A 75% chance of happening)
Reasons: – Fundamentally, the company isn’t growing as fast as the share price, if you factor in forward adjusted P/E of 32 times in 2017 and 29.9 times in 2018.
On a technical basis, the momentum indicator RSI is signalling a lower-high for both the weekly and monthly chart.
Best-Case Scenario; – The shares will trade between £6.30 and £7.50 in the next 12 months. (A chance of 20% of happening)
Reason: – It will rise because of the continuation of the bull market. Also, there is a possibility that management may upgrade its operational performance, due to their latest acquisitions performing better than expected.
Worst-Case Scenario; – The shares could fall to £4 in the next 12 months. (A 35% chance of happening)
Reasons: – This is because in the monthly chart, for over six years, the shares been supported in the 50-day moving average. It is currently at £3.34, and there have been a couple of times where the shares have pulled back close to the average.
However, if the shares took their time to correct, then the 50-day moving average will continue to rise. The pace depends on where the share price at relative to the average.
At £4, the forward adjusted P/E of 22.3 times in 2017 and 20.8 times in 2018, which is closer to the average.
Porvair is a great business with steady growth, however, the shares are fully priced relative to earnings growth for the next two years. Unless the shares correct by 25% or more, it should go on your watch list.
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The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.