Is Tissue Manufacturer Accrol Group a Value Stock to have in Your Portfolio?

 

Accrol Group manufactures tissue for a living and supplies the biggest supermarkets in the UK.

The share price took a tumble last year, following a number of health and safety incidents, but mainly because of the placing.

Followers of this company will want to know if Accrol Group is either ripe for the upside or continues to struggle.

 

 

The best way to do it is to create a checklist of the going on of Accrol Group before and after listing their shares back in 2016.

 

Let’s start with the basic.

 

1). Company’s business model

It manufactures and supplies tissue to the biggest supermarkets like Tesco, Morrisons and Aldi. The company is the fifth largest operator in the UK. And takes up 9% of the market share.

Their product mix is 8% multiples, 74% discounters and the rest are others.

The company was founded by the Hussain family back in 1993.

 

You would have thought this boring business would be easy to run since the tissue is an essential household item. But things didn’t go as well when the shares were lifted from their suspension in November of last year, as the stock took a tumble.

Before we go into details, you need to start from the beginning.

 

2). That acquisition

Back in 2014, they were called Accrol Group Holdings and through its subsidiary Accrol UK Limited, purchased the entire issued share capital of Accrol Holdings Limited for a consideration of £45,600,000.

 

The key detail was making this acquisition allowed the company to gain access to financing from the Hussain family and NorthEdge (both holding 45% or more of the company each) was to bring additional funding.

Details of the funding are as follows:

On 14 July 2014, both the Hussain family and NorthEdge lent £20.495m each at 10% fixed rate in the form of a loan note 2023.

Basically, Accrol Group is paying 10% interest on £41m or £4.1m per annum. At the time, operating profit was declining from £8.4m to £3.9m in 2015.

But it was worth it, as operating profit bounced back to £11.9m in 2016, before the Brexit vote.

 

 

3). The IPO

Next, came their IPO in 2016. The valuation of the business was around £93m and the purpose was to pay off the owners.

Here are the details:

The issue of 63.5m shares at £1 each is split between a placing of 43.3m at £1 and net proceeds of £41.4m and Vendor placing of 20.1m at £1 with net proceeds of £18.2m. The owners were paid as follows:

-£41.1m went to repaying the loan note;

-£20.2m went to reducing the owners’ stake from over 72.5% (the combined stake of the Hussain family and NorthEdge) to 30% (according to their annual report 2016). The reduction of 42.5% stakes values Accrol Group close to £47.5m. (RED FLAG!)

It looks as though valuations were misleading from the beginning because the owners did receive two years-worth of 10% interest (per annum) totalling £8.2m from the combined loan note value of £41m.

Maybe, they decide to agree to reduce their stake at a reduced valuation as a sign of a good gesture.

If not, then the company is misleading retail investors into investing at a high price and was a red flag.

 

 

4). Recent health and safety incident

The company had a health and safety prior to listing in the stock market but was subsequently resolved as it was fined for £120,000 (much lower than it expected).

Accrol Group has agreed to address this issue, which will result in cost rising, although this is a good thing!

 

5). More Fundraising

It is looking to raised £18m at 50p each and the directors’ intentions are to fund operations in the short-term, improve operational efficiency, review health and safety and meet banking covenants.

 

Now, we know why as interim results showed the business borrowed an extra £7.9m in six months, as net debt grew to £29.3m. With net proceeds from fundraising of £16.8m, then net debt is reduced to £12.5m.

 

Basically, the company is struggling. With Brokers forecasting free cash outflow of £14.4m in 2018. The first half saw £6.6m, so expect further outflows of £7.8m or net debt rising to £20.3m by FY 2018.

The cash balance of £18m is likely to decline to £10m.

Hopefully, management will see light at the end of the tunnel and lower cash outflows.

 

6). Rising costs of pulp hardwood – Check Gross profit margin

 

The company main material costs are pulp hardwood and pulp softwood. Here is their statement: “The Company, along with the industry generally, began to experience a sudden and significant change in trading conditions in the second quarter of its current financial year.  This was caused principally by rapid inflation in pulp prices with BHKP (hardwood) pulp prices increasing by 40.6% in the period from January to October 2017*, which relates to the majority of Accrol tissue production, and NBSK (softwood) pulp prices increasing by 13.7% in the same period.”

It looks like the cause is down to supply shortage due to the closing of pulp mills in China and maintenance delays in Brazil.

Here is an article about the effects of pulp prices is having in Japan.

 

The weak pound is also to blame for the rise in costs, but since they hedge the pound last year, it didn’t have a material effect.

And since the hedge has ended, Accrol Group has to purchase with the newly weaker pound which is still down 10-15% before Britain had their Brexit vote.

 

 

7). Revenue Breakdown

Accrol Group relies on four major customers that account for over 10% of their business. The numbers are as follows (2017):

-£31.6m;

-£14.5m;

-£14m;

-£12.6m.

They didn’t identify their customers’ names but we can all guess.

In total, it makes up more than half of group sales.

There is a minimal risk that one of their customers can stop business with Accrol group given how fragmented the tissue market is.

 

 

8). Interim Results

The interim is pretty bad, but we already know this.

Unsurprising, sales rose by 13.1% to £72.3m, but the important news is margin declining by 34.7% to £11.9m, despite the rise in sales.

Management did say the price increase comes into effect during the third quarter of 2018, although we don’t know how much of the price increase they negotiated!

Accrol Group’s gross margin fell to 16.4% from 28%. If it wants a return back to £1 per share price, the price increase needs to rise by 11.5% to retain 28% gross margin.

Details of the calculations are shown below:

£72.3m* 0.28 = £20.2m;

£20.2m minus £11.9m = £8.3m;

£8.3m/£72.3m = 11.5%.

N.B.: These are rough estimates and doesn’t account for further price rises in material costs, adverse FX and so forth.

I doubt that the supermarket will agree with an 11% increase because of its 3.5 times greater than inflation!

So, therefore, Accrol Group needs to reduce costs, which they have indicated, although there are no costs saving targets set.

 

Next, the company indicated net debt rose to £29m, but the placing of £16.6m will reduce this to £12.5m. Also, the new cash balance is roughly £18m. Given the likelihood of future free cash outflow of £14m, then FY 2018 cash balance would come down to £10m.

 

The pace of cash outflow is very much dependent on external costs stabilising, the level of price increases negotiated with the supermarkets and cost savings from internal operations.

 

Investors need to keep an eye on receivables and payables because both these items rose by 31% and 50% respectively and more than the 13% in revenue. I don’t know if this is concerning because customers might pay in November or the company was waiting for the placing to pay their suppliers.

But looking back to their interim results in 2017, there wasn’t a lot of receivables growth and payables were in-line with sales growth.

You need the full year results confirm if this deterioration in business is real.

 

 

 

9). Outlook

I would put this stock on your watchlist for now because we are missing a lot of details: –

A). How much of a price rise help improve the company’s gross margin from H1 2018?

B). Will Pulpwood prices decline or continue rising?

C). What will the adjusted EBITDA be like in FY 2018? If it breaks their covenant of -£2.8m. Also, to see if the firm going to make adjusted EBITDA profit for 2019.

D). Will there be there cost savings made? If so, then it will positively contribute to adjusted EBITDA.

E). What the year-end cash balance looks like and to see if the business becomes more sustainable?

F). Finally, will Accrol Group be able to maintain high levels of receivables and payables, were both saw a jump of 32% and 50% respectively vs. sales growing 13%.

The mixture of a delay in payments from customers (aka the supermarkets) and suppliers wanting their payment early could lower the company cash balance more than expected!

 

Market Valuation

I won’t give a share price until I see their FY 2018 results and get a clear understanding of how the business is coping when times are tough.

The number of shares will rise to 166m giving a market cap. of £61.4m. It is backed by £18m in cash or 30%, which will fall to 18% if the share price stays at the current level.

And with management forecasting a slow return to profitability in 2019, the market won’t be in a rush to re-rate these shares anytime soon.

 

If you are taking a punt today, then consider it speculative because anything can go wrong.

 

 

 

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