Essentra growth portfolio candidate

An international supplier of specialist plastic, fibre and foam products with four principle operating divisions – component & protection solutions, porous technologies, coated and security products and filter products. I have no holding in this company (epic code: ESNT). Previously known as Filtrona (epic code: ESNT)

 

Market/Index	Full/FTSE 250	Industry	Food & Tobacco
Sales	£663.4m	Earnings	£52.2m
Market Cap	£1.57bn	Share Price	741p
Norm. EPS	27.6p	Historic P/E	26.9
Est. 2013 growth	32.3%	Prospective P/E	20.3
Est. 2014 growth	15.9%	Prospective P/E	17.5
Rolling PEG	0.77	SGR	11.6%
PBV	6.67	Historic Yield	1.69%
ROE	23.6%	Operating Margin	13.0%
5 yr BV + Div return	19.3%	5 yr FCF return on BV	21.7%

This is the fourth company from the growth screen and was formerly part of Bunzl plc, demerging in June 2005 to became a separately listed company. Many people will know them as the supplier of filters to the cigarette market, although today this represents less than 36% of sales and less than 25% of operating profit.

Many on the executive board have been with Filtrona for some time, with the notable exception of the CEO Colin Day, who joined in April 2011 from Reckitt Benckiser where he had been CFO for 10 years.  Day had a good reputation at Reckitt Benckiser and during his tenure grew earnings by 18% pa and oversaw a share price rise of 15% pa.

Filtrona are an acquisitive company, with their most recent purchase completed this month for Contego Healthcare, specialising in plastic fibre & foam products to the pharmaceutical and healthcare market at a price of £160m (11.5x operating profit).  They financed this purchase through a placing, issuing an additional 9.99% of their then issued shares.

Filtrona earn good operating margins and a healthy return on equity, demonstrating that there are probably high barriers to entry to their various market niches.  It is worth noting though that operating margins did decline slightly last year by 40 basis points and free cash flow (FCF) at £31m was substantially less than 2011’s £50m.  This FCF decline was due to a much higher spend on capital expenditure that was double the rate of depreciation, leaving one to assume that much of this higher spend was due to expenditure on expansion.  An example of this is Moss, Skiffy and Alliance their US based Component Distribution business, that opened a new office, plant and warehouse in Houston, doubling the size of the facility to underpin future potential growth.  Consequently net debt has increased from £144.9m in 2011 to £163.5m in 2012 resulting in net gearing of almost 70%, although interest cover is strong at 8.2x and debt/EBITDA at 1.39 and operating cash flow/debt of 45.3% are acceptable.  

Their 5 year return on book value is respectable in both terms of earnings and cash, demonstrating both good conversion of profits into cash and improved shareholder value.

Filtrona has an estimated weighted average cost of capital of 8.6% and earn a good average return on their capital employed of 23%; the wider this gap the higher economic return that shareholders will experience and Filtrona perform well in this respect.

Filtrona though is an expensive share at 26.9x historic earnings and 20.3x this year and you will be paying almost 7x book value.  For that though you receive an investment in a well run company that produces good returns, well in excess of their cost of capital.  On a discounted cash flow basis Filtrona have a fair value of about 700p, using a cost of equity of 11.6% and free cash flow (FCF) growth of 20% over the next two years, 15% for the following 8 years and 2.5% in perpetuity. I have assumed a starting sustainable FCF of £50m (similar to 2011, rather than the depressed 2012 number). 

In summary Filtrona is a high quality growth company, run by a fairly new CEO with a strong track record from the past, but they are currently fully valued.