Norcros, the owner of Triton, Croydex and Johnson Tiles has been struggling lately, regarding growth in their share price movement. In fact, Norcros share price has gone nowhere for four years, despite showing clear operational improvement and higher profitability. Here are the anomalies:
If you compare the market value against net income and operating cash flow, it’s like night and day.
So, why are investors shunning this stock?
A tough question that requires a thorough investigation. Here are five reasons investors could concern themselves about Norcros:
South Africa Issue
South Africa has been in the news for its political crisis, which doesn’t help with its social and economic stabilities. The most important effects from its South African would be poor sales generation and a hit on its profits when the Rand get converted back to the British Pound.
The weakness of the South African Rand is noticeable against the U.S. Dollar when it fell from 6 Rand to 12.8 Rand to 1 U.S. Dollar in six years.
Despite the UK seeing a similar weakness, the British Pound is actually stronger than the South African Rand by appreciating from 10 Rand to 16 Rand in the same period.
Now, we compare Norcros South African operations. Sales did stagnate (2011: £72.4m; 2016: £72.9m), but operating profits have grown from £0.2m in 2011 to £4.1m. Today, results saw its South African operation generate £88.9m in sales and £6.4m in operating profits.
So, the weakness in its share price doesn’t come from South Africa.
Foreign Exchange gains/losses
Given the weakness in the British Pound, how prevalent is this to investors? The graph shows big FX losses.
In the last seven years, Norcros saw FX losses totalled £16.5m. Compare that to the net profit of £60.1m during the same period, the company saw slightly more than a quarter its profits have been eaten away by adverse FX.
Growing pension deficit
On an annual basis, Norcros saw its pensions obligation turned from surpluses into deficits in 12 years (See below).
That growing deficit means Norcros will one day have to reduce that deficit from operational cash flow, therefore future profits are expected to come in below expectation because of the out of control pension deficit!!
However, in their latest interim results that deficit grew to £97.8m, which is a £55m increase from a year ago. It looks like the time is coming soon for Norcros. But, today’s results saw the pension deficit got reduced to £62.7m, thanks to rising equity prices and gilts yield.
Another interesting fact is the pensioner payroll, which has 7,922 members that saw the company paid out £20m per annum or equivalent of 8.5% in total sales to their retired employees, as a contribution.
P.S. The pension scheme has been closed to new entrants since 2013.
The Real Net Debt
This may sound controversial because the traditional way of calculating net debt is total debt minus total cash and cash equivalent.
However, this can mislead investors into a false sense of security.
A company doesn’t need to take on debt, it can delay payments to suppliers. Or, it can let the pension deficit grow larger (see section above).
So, the real net debt should include the following:
On the Debit side: –
Cash, trade receivables and pension surplus.
On the credit side: –
Total debt, finance lease, trade payables and pension deficit.
With that knowledge, you can draw a bar chart comparing the traditional net debt and the real net debt.
As the pension deficit grew, so did the real net debt as it pulled away from the traditional measure of net debt. The real net debt is the second highest since 2005.
Norcros’s Valuation: Cheap or not so cheap
By including pension deficits and changes to receivables and payable, this has affected Norcros PLC enterprise value.
First, an illustration:
The label “New EV” includes the pension deficit.
That graph tells me that a rising pension deficit is responsible for suppressing market valuation of Norcros, and in turn, is the reason why the shares saw no rise. Another interesting fact is that net debt, including the pension deficit, is now greater than Norcros’s Market Capitalisation!!
Other Financial Facts on Norcros
- Revenue at Norcros grew from £147m in 2005 to £236m by 2016. Today, it reported revenue of £271m.
- Shareholders’ equity stands at £47.6m on an annual basis, which has been trending lower for six years. But in their latest interim result, equity has fallen to £22.5m, down from £52.2m, a year ago. Now, shareholders’ equity has bounced back to £56.6m.
- In twelve years, Norcros has paid out a total of £19.1m in dividends.
- One thing you didn’t know is net investing activities totalled £37.5m since 2005, which worked out as £2.88m per year in net capital expenditure. At the time, depreciation costs have totalled £78.7m or £6.05m per year. Does this mean Norcros hasn’t been maintaining their assets?
Share Price Forecast
This is a simple forecast to make.
Best-Case Scenario: – The share price will rise to £2.20 per share in the next 12 months. (Probability outcome: 30%)
That can happen if the pension deficit gets smaller, with this translating to a rising share price. But Norcros operating profits must remain intact!!
Base-Case Scenario: – The share price will hover between £1.40 to £1.80 in the next 12 months. (Probability outcome: 45%) Hopefully, the pension deficit doesn’t grow larger but start to stabilise. Also, Norcros needs to continue to deliver results for the market.
Worst-Case Scenario: – The shares could drop below £1.40 to £1 in the next 12 to 24 months. (Probability outcome: 25%) This is because Norcros face a “catch-22” situation where they allow themselves to report higher profits without dealing with their pension deficit.
Leaving it to grow organically means Norcros needs to borrow from external sources to plug the pension gap in the near future. This would catch investors by surprise!!!
Secondly, there is a case to be made about Norcros not maintaining their assets. However, this hasn’t affected their operations.
Overall, this company is a hold for now because it is trying to deal with the pension deficits. Investors should be concerned if the equity markets start to fall or gilts yield start falling because that would exacerbate the pension deficit.
P.S. An earlier version was written, but I didn’t they were reporting results today, so I included the latest results into my analysis.
Thanks for reading.
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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.