Crystal Amber's analysis28 Jan 2022 09:21
"During the quarter, De La Rue published its unaudited interim results for the six months to 30 September 2021. Adjusted operating profits rose by 166 per cent. to £17 million. Positive operating cash flow was £25.8 million and the outlook for the full year was described as being in line with the board's expectations. Nevertheless, earlier this week, De La Rue released a trading update stating that as a result of headwinds relating to the Covid-19 pandemic, including employee absences at global manufacturing facilities and supply chain shortages, operating profits are now expected to be flat on the previous year at between £36 million and £40 million, as against previous market expectations of between £45 million and £47 million.
Prior to the trading update, the Fund had been in dialogue with De La Rue's Chief Executive and Chairman regarding gross margins. The Fund conveyed its view to De La Rue that its pricing has been wrongly focused on capacity utilisation rather than on gross profit and contribution to fixed overhead maximisation. Prior to the trading update, operating margins at De La Rue's Currency division were forecast at 8.4 per cent. Following the trading update, the operating margin is forecast at 6.2 per cent. In 2010, De La Rue achieved operating margins of 23.2 per cent. Currency demand from central banks has been buoyant and the Fund believes that De La Rue could have secured higher gross margins.
De La Rue is the global leader in currency with a market share of 30 per cent. Whilst De La Rue's supply chain headwinds are outside of its control, the Fund believes that much of the £36 million per annum of cost savings have effectively been utilised to subsidise customers. Had gross margins on its Currency division's revenues of close to £300 million, been three per cent higher, operating profits would have been £9 million higher.
In July 2020, De La Rue completed a £100 million fundraise which was priced at 110p a share. Over the last eighteen months, the business has been transformed, yet following the profit warning in this week's trading update, the share price has returned to 110p. Furthermore, businesses with similar pension profiles are now benefiting from rising interest rates expectations. The Fund believes that in the coming year, at De La Rue, this should result in a material reduction in future pension contributions and accordingly increase free cash flows.
Shares in De La Rue now trade on 9.7 times revised earnings per share to March 2022 and on 8 times to March 2023. The Fund believes that following the Covid-19 pandemic, the industry requires consolidation. Given its current rating, the Fund believes it is highly likely that in the coming months, De La Rue will be the subject of a takeover bid from one or more of its overseas competitors. The Fund believes that this will be the inevitable outcome of management prioritising 100 per cent capacity utilisation rather than cash gross margin maximisation."
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