UK Edition
Questor: after its near-death experience, this transformed company is a core holding
A 90-year-old manufacturer that was “at death’s door” a few years ago has transformed itself into a specialist, high-margin business with enviable returns on capital and cash generation – yet its valuation remains reasonable.
Scapa originally made consumables for the paper industry. But it got into difficulty in the Nineties and sold that entire business to a German rival. “It was at death’s door at that point,” said Keith Ashworth-Lord, whose SDL UK Buffettology fund includes Aim-quoted Scapa as a top-10 holding.
“Once it had sold the paper arm it was essentially left with a business that made industrial and electrical tapes, which are relatively unspecialised and low-margin products. Scapa at first did little to develop the tapes business and the group remained a bit of a mess.”
All that changed in 2009 with the appointment as chief executive of Heejae Chae, previously of Volex, the cables group, said Ashworth-Lord.
“Chae basically turned the business upside down,” the fund manager said. “He attacked the manufacturing base and started to take the products upmarket.”
This involved a shift in the group’s focus from low-margin industrial tapes to more hi-tech areas such as wound dressings.
“Then the company got even cleverer, making products that require ‘clean room’ technology, for example, and started to become a preferred partner to the likes of Johnson & Johnson and Smith & Nephew,” Ashworth-Lord said.
The company’s transformation was largely achieved by the acquisition of three healthcare companies.
“The areas it operates in now are more value-added – they involve providing solutions rather than just selling a product,” the fund manager said. “Scapa has always made double-digit margins in healthcare; they are currently about 16pc.
“Meanwhile, margins in the legacy industrial business have also been improved: they are 11.5pc this year, up from about 3pc in 2011.”
The industrial side still has the higher turnover but because of the difference in margins the healthcare business contributes more to the group’s profits.
Scapa has improved efficiency in the industrials arm by consolidating its output into fewer factories, but has done so “really smartly”, Ashworth-Lord said.
“It has maximised the value of redundant sites. For example, it demolished a factory in Switzerland, then cleared the site, got planning permission and sold it for housing. The result was a profit on the book value of the site. There is probably room for more consolidation of this type. The company does everything in a measured way.”
He said the transformation of the company’s operations had a huge impact on its financial success, adding: “Returns on capital were once about 3pc; now they are 11pc, although returns on the capital most recently deployed are in the mid-20s. Cash conversion last year was 95pc. That sort of cash generation means that acquisitions can be funded out of cash flow.”
Net debts are accordingly relatively modest at £16m, compared with net assets of about £100m. “That puts ‘gearing’ at 16pc – it’s not an over-leveraged balance sheet at all. All told, this is the kind of business I love.”
The stock’s price-to-earnings ratio, based on last year’s “adjusted” profits, is 32.1, but growth is 30pc-40pc annually: earnings per share were 3.6p in 2013, then 4.4p in 2014, 7.7p in 2015, 10.5p in 2016 and 14.8p last year.
“It’s not dirt cheap, but you are paying a fair price for a quality business,” Ashworth-Lord said.
“I have absolute faith in this company – the management knows its stuff, the business is really firing, I never have to worry about profit warnings. In the end it will probably be acquired but for now it is a core holding.”
As an Aim-quoted trading business, Scapa should qualify for inheritance tax exemption if held for at least two years.
Questor says: buy
Ticker: SCPA
Share price at close: 475.8p
Update: HSBC
A year ago we tipped HSBC on the basis that it was a top-10 holding in Richard Buxton’s Old Mutual UK Alpha fund. At the time his firm said the bank was poised to benefit from a rise in US bond yields, something that has come to pass since.
Questor says: hold
Ticker: HSBA
Share price at close: 719.2p