Overview:
Capral is Australia's largest aluminum product supplier and distributor. It is the only nationwide operator with approximately 28% of the market. 40% of revenue comes from the residential housing sector (windows and doors) with other major uses of products being commercial buildings, transport, shipbuilding and other general metal fabrication. Capral provides some value add through powder coating, CNC, routing and drilling.
Capral has to compete against overseas imports. Dumping has been a major issue. China significantly subsidies aluminum smelting and production. The advantage Capral has over the other overseas producers is their ability to produce a product quickly (next day for warehouse and two weeks for factory orders) which importers can't compete against where this is an important requirement for Capral's customers.
Main Thesis:
Value play. Buying at a EV/NPAT of 4.66 (based on NPAT $23 for FY24 which is the lower end of guidance and share price $9.45) and below management NTA = $11.82 (not management NTA disregards impact of AASB16 leases). This provides a margin of safety from a valuation sense and effective owner earnings yield of over 20% if profitability can be maintained. This investment is somewhat similar to my investment in Atlas Pearls, in terms of low valuation and below NTA, however, Capral has had significant price appreciation over the past few years. Mangement seems focused on returning profits to shareholders through buybacks/dividends, this is in the self-interest of the CEO who has a significant holding. In FY23 Capral returned 72.5c per a share back to shareholders.
The high cash holding ($59-60m) relative to market cap ($162m), low valuation and the fact the company is actively buying back shares on market will hopefully hold the share price at least at current levels which on its own should provide a suitable return. I will implement a soft stop loss of around $9 given the chart provides a pretty clear level of support at that price and given the factors above. 40% of profits expected to be paid out in dividends.
Positives:
- CEO while not a founder is now a significant insider owning approximately 4.45% of shares and would put his holding value at around $7.4m. CEO strongly aligned with incentive to distribute capital to shareholders.
- Low valuation. EV/NPAT = 4.66. Management NTA = $11.82 compared to a share price in the $9+ range.
- Due to previous large losses many years ago, Capral has approximately 8 years' worth of tax losses to work through before they will pay tax again. This increases current shareholders earning rates. Mangement has been able to turn around the business from these poor decisions/near death experience.
- Current strategy to build out distribution network through acquisition will help to improve profitability as these distributors which were already profitable while independent will allow Capral to replace competitors' products with their own improving margins and profitability.
- ASI certified which allows Capral to sell verified lower carbon/green products.
- Australia's largest player in the industry.
- Good dividend yield of approximately 5.8%. Note no franking due to old franking credits being used up.
- Very strong balance sheet, net cash with no debt. Capral is able to sustain a shock if required.
General notes:
- All prices for products are linked to the current aluminum price. Major customers have monthly pricing, quarterly for small and once or twice a year at the distribution level. Therefore, aluminum price doesn't have a significant impact on Capral's profitability, however, can affect required working capital and can change profitability if a large enough move due to the natural net margin improvement that is possible.
- Machinery that Capral owns is expensive but does last a long time (30-50 years) with smaller upgrades and continued maintenance. Approximately $5 a year of capex is required. This potentially creates a barrier of entry for any new players due to capital costs of new equipment.
- Mangement looks of a 2-4 year payback on capital initiatives therefore strong payback and improved profitability is likely on investments made if all goes to plan.
General negatives/Risks:
- High capital intensity and cyclical business. Never going to attract a high multiple.
- Australian economy and housing sector appears weak at the moment and could get worse. This could significantly affect Capral's profitability.
- Lowered margins of competitors or importers improve their order to delivery time and remain cheaper.
- Key man risk with CEO. Appears to act like an insider and has turned the business around over his tenure.
- NTA could be the maximum value of the company. IE don't get any multiple expansion. The market could always have a poor view of the company, therefore capital returns the only way that money is made from the investment.
- Protection from dumping is lowered.
- New construction methods that are cheaper/better are created.
Probabilities of outcomes:
- 50% - Capral continues to operating the $20-30m NPAT over the cycle on average. Some growth in NPAT if distribution strategy works.
- 20% - Housing downturn that hits profitability.
- 10% - Importers hit Capral significantly, making them uncompetitive.
- 20% - Capral has EPS growth thanks to buy backs and potential NPAT growth.
Note - these are absolute thumb suck numbers! Just a way guesstimate where things could go...
Investment KPIs:
- Maintain profitability above $20m with margins also able to be maintained.
- Mangement able to meet the guidance set out. For FY24 NPAT $23-27m.
- Growth of the distribution network (I expect this will be slow).
- Core management remains.
- Capital return strategy to shareholders continues.
How I expect this will play out:
If it goes poorly:
- Australian economy struggles especially construction, and this significantly hits Capral's profitability.
- Mangement changes strategy or moves on.
- Capral becomes unable to compete with importers.
If it goes right:
- Over time capital return to shareholders provides a decent return.
- Capral is able to increase EPS over time.
- Maintains strong balance sheet and cash flows that provides a floor for the share price.
When to get out:
- Profitability to fall below $20m
- Management stops trying to get cash back to shareholders through dividends/buy backs.
- Have a soft stop loss at approximately $9. Price shouldn't get much weaker with company buy backs unless there is something wrong.
Starting with a small position (20% of my normal full holding amount) prior to results being announced and will add further upon satisfactory results as per my personal buying rules.
