API Group growth portfolio candidate

API Group PLC a global supplier of foils, films and laminates.  I do not have a holding in this company (epic code: API).

Market/Index	AIM/AIM All Share	Industry	Chemicals
Sales	£112.4m	Earnings	£5.59m
Market Cap	£56.4m	Share Price	73.5p
Norm. EPS	8.09p	Historic P/E	9.1
Est. 2014 growth	11.9%	Prospective P/E	8.1
Est. 2015 growth	19.3%	Prospective P/E	6.8
Rolling PEG	0.38	SGR	19.7%
PBV	2.26	Historic Yield	0%
ROE	25.2%	Operating Margin	6.0%
5 yr BV + Div return	-1%	5 yr FCF return on BV	10.1%

It has been difficult recently to discover growth companies with a good value rating.  API may just get close to that.




API is a manufacturer and distributor of laminates (49% of sales), foils (44%) and holographics (7%) to printers and packaging manufacturers. These decorative finishes are used to enhance the visual appeal of products and packaging and help communicate brand values and authenticity.

As decorative supplies are relatively low cost, they  normally continue for the life-cycle of a brand; therefore once the supply is approved and qualified, it tends to last for several years.  As customers focus on supplier reliability and quality this creates a moderate barrier to entry.

Since they were first introduced on credit cards in the early 1980s, holograms have become the most common overt security features on valuable documents and branded goods; providing a recognisable mark of authenticity, a carrier for other covert authentication technologies and a powerful deterrent to tampering and counterfeiting.  The holographics market is estimated to be over $1bn in size, growing at seven per cent per year, with a fragmented supply base (there are almost 100 members of the International Hologram Manufacturers' Association).

Group sales are made in the UK (25.5%), the Rest of Europe (49.4%), Americas (19.0%), Asia Pacific (5.8%) and Africa (0.3%).

The current management team arrived in 2007 and, following a £8m fund-raise, started a business turnaround and produced a growth in continuing operation sales from £87.4m in 2009 to £112.4m in 2013.

Over the past 3 years sales have grown by 12.4% pa and EPS by 20.7% pa., whilst the net debt position has been reduced from £18.5m to £2.4m over the same period.  For 2013 the return on equity was 25.2% and the return on capital employed 27.2%, compared to a weighted average cost of capital of around 12%.  Operating margins have been reasonably steady over the past two years at 6%.  EPS is expected to grow by 12% and 19% for 2014 and 2015 respectively and is currently rated at just over 8x 2014 earnings and just under 7x 2015 earnings.  This is a very low rating for a growth business, with a strong position in a niche market; compared to profitable companies in their sector they are at a discount of about 50%.

API's shareholder list is somewhat interesting as it comprises just over 73% held by activist shareholders in the form of Steel Partners (32.4% holding), Wynnefield (29.7%) and Crystal Amber (11%).  Under shareholder pressure from Steel and Wynnefield in February 2012, API initiated a sale process by inviting tenders. In February 2013, the board announced that indicative bids were below 90p per share and all three activist shareholders took the view that an offer at that level would not reflect the value of the company.

Interim results were announced in early December and sales were £56.9m and operating profit (excluding exceptionals) was £3.5m compared to £58.8m and £4.7m respectively last year, although compared to the second half of last year showed an improvement from £53.6m and £3.1m respectively.  The management reinstated a dividend (that had not been paid for over 10 years) of 0.7p, probably due to pressure from the activist shareholders and, expect a stronger second half and some improvement in results for the year as a whole.  Analyst are estimating a 2p dividend for the full year, which would represent a 2.7% yield and dividend cover of 4.5x.

Directors hold 2.6% of the issued capital, which is not a particularly large exposure with the executive directors holding less than 1% and the Finance Director selling 250,000 shares last September, the result of an exercise of options.

Although free cash flow (FCF) has been reasonable over the past 5 years (see 5yr FCF return on BV in the table above), the net book value per share of the business has declined from 31.1p to 29.9p, mainly due to increases in the net liability of their defined pension fund, although this was closed to future accruals in December 2008 and, an impairment charge taken on their 51% owned Chinese operation in 2010 of £5.1m (£2.6m for API).

Based on an average of their FCF over the last 3 years of £4.7m, an assumed growth of 10% over the next 10 years and 3% in perpetuity, discounted by their cost of equity of 11% - I would view a fair value for the shares of about 130p, providing a substantial margin of safety of 77%.

There are substantial risks here, not least that their second half does not perform as expected, but the presence of activist shareholders (the most recent arrival being Crystal Amber in February 2012), should ensure a positive outcome for shareholders and there is a good margin of safety, both in the discounted FCF model and in the comparison to their sector valuations (Sector P/E would imply a price of 139p and EV/EBIT 107p).

Results for the year-end 31 March 2014 are due, on a to be announced date, in June.