Questor share tip: Devro profits recover ahead of Asian expansion

Devro
320p +21.25p
Questor says HOLD

Sausage skin maker Devro [LON:DVO], which is currently embarking on an ambitious overseas expansion plan, enjoyed a recovery in profits during the first half of the year.

Chinese bangers

Peter Page, chief executive of Devro, is passionate about his product. He believes Devro’s collagen casings (sausage skins), are better than its competitors’ products that use more traditional animal gut.

It is the company’s technological know-how behind its banger that is in demand across the world.

Meat consumption has increased in emerging markets, because people eat more animal products as they get richer.

Devro has expanded rapidly into overseas markets such as Latin America, eastern Europe, Japan and China.

It is also investing £100m developing new facilities in the US and China. These factories are expected to begin production by the middle of next year.

Mr Page said that flying Scottish sausage specialists to China to oversee the project will push up exceptional costs to between £16m and £18m in the second half of this year, from £4m in the first half.

Over the long-term, the new sites will reduce costs; and as production shifts overseas, around 130 jobs will be lost from Scottish manufacturing facilities.

^{Collagen sausage case making in action}

Profit recovery

The company said pre-tax profits increased to £9.6m during the six months to the end of June, from £1.6m last year. Revenues increased by £3m to £112.7m in the first half, leading Mr Page to point out that “market demand is strong”.

Last year was painful for Devro, as restructuring costs and slowing demand resulted in a nearly 30pc slump in profits.

However, analysts at Panmure Gordon have said they expect full-year pre-tax profits to rise almost 10pc to £30.5m, giving 15.5p in earnings per share.

Time for an upgrade

Shares in Devro now trade on a price to earnings ratio of 19.3 times. That rating looks quite high given the challenges ahead during the next 12 months.

There is also rising balance sheet risk as the company takes on more debt to complete the new manufacturing facilities. Net debt increased by £36m to £106m at the end of June, and is forecast to reach about £130m by the end of the year. Using borrowing for expansion is normal for a business but it does increase risks to shareholders.

The last time Questor looked at the shares (Sell, 211p, April, 2014), the recovery was far from certain.

With profits now heading in the right direction and an exciting expansion phase ahead we are happy to upgrade. Hold.