Essentra is too good to ignore

High quality assets should overcome weak market sentiment
Thursday 24 Nov 2016 Author: William Cain

Investors on the lookout for bombed out opportunities should check out industrial distributor Essentra (ESNT) after a mild profit warning triggered a 20% share price slump.

Essentra’s share price tumbled on Monday 21 November as operating profit guidance was reduced by around £20m to between £137m and £142m, taking year-to-date share price losses to more than 50%.

While we have been bullish on the stock all the way down from around 760p to today’s 396p share – and some risks remain – Essentra should offer decent upside if trading performance can be stabilised quickly.

Acquisition splurge

Essentra’s stock price now trades little higher than when it began a merger and acquisition spree in 2011 under new chief executive Colin Day.

Problems started with the downturn in oil and gas markets at the end of 2014. Revenue and profit margins at Essentra’s oil and gas-focused Pipe Protection Technologies (PPT) unit crumbled in the first six months of 2015.

Perhaps it was concern over the impact of an oil and gas downturn that encouraged Essentra to diversify through the $455m acquisition of specialty packaging business Clondalkin in early 2015.

Backed by institutional shareholders through a placing at 714p a share, Clondalkin should have provided a new earnings stream to offset poorer performance at PPT.

Plans to reduce costs by closing distribution hubs met resistance from customers and profit expectations were not delivered here either.

A 2016 slowdown in Essentra’s two other operating divisions, Filters and Distribution, triggered a profit collapse and spelled the end for chief executive Day.

Compounding the issue, Essentra conducted a fire sale of Specialist Technologies, one of its most prized assets, because of the need to reduce net debt.

Solid foundations

A perfect storm across the entire business means Essentra’s trading and stock market performance subjects its investors to high risks. But it seems unlikely incoming chief executive Paul Forman would have left Coats (COA), a global market leader in its own industrial niche, if Essentra’s prospects were doomed.

Trading at another quoted business suggests brighter days in oil and gas. Rotork (ROR) reported improved strong order intake in the third quarter of 2016. Former Essentra chief Day always maintained there was significant upside in the PPT unit when conditions in that market stabilise.

Better performance at PPT, combined with steadier performance elsewhere, could prove the basis for Essentra’s return to form.

Analyst expectations, which may not have been updated since Essentra’s trading update, indicate adjusted earnings per share for 2016 at 43p rising to 44p a year later. Those numbers look around 10% too optimistic based on management guidance, according to our calculations.

Essentra has lost its way but we remain convinced of the underlying quality of its assets.

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