Overview Comment:

Good result overall, better than guided. Though need to be careful as NPAT for example was boosted by tax deferral item. Not much new to report from the call. Still a strong cash position and returning capital to shareholders through buy backs.

General notes:

•  Key numbers:

• Volume was down but revenue was up due to increased price of aluminium.
• Aluminium prices currently at a 2 year high of around $A4000/t, above FY23 average of $A3610/t.
• Free cash flow removing the acquisitions is approximately $27m.
• Cash balance at $68.9m
• Capital expenditure of $11m expected for FY25.
• EBIT image below shows hit of inflation and lower volume offset by price and mix and cost saving measures:

Positives:

• NPAT was much higher than guided. Note the $32.5m figure includes a deferred tax asset benefit of $3.6m.
• EPS up 6% much higher than profitability increase due to buy backs.
• 76c per share worth of capital returned.
• Industrial volumes remain strong with new truck and van builds helping.
• NTA per share up 12% to $11.25 compared to FY23 end.
• China recently removed VAT export rebate for producers in China which should assist Capral's competitiveness.
• Focus on buy backs as main source of capital return.
• Market liked the result up 10%

Negatives:

• Residential market is soft but expected to start recovering over the next year. Residential builds are down 25% from 2021/22 highs for comparison.
• High Aluminium price is going to require additional working capital for the year ahead. However, heaps of cash on the balance sheet.
• On the call US tariffs were discussed. No direct impact however the flow of trade could have an impact as higher prices in the US will make imports to Australia more attractive to overseas sellers. Anti dumping measures remain in place.
• Increase in inventories, though this is explained by higher prices for aluminium and holding a larger range of stock for customers than prior year.

Has the thesis been broken?

•  No, continues to be on track. Still very cheap on EV/NPAT or NTA basis.

Valuation:

•  No change to most recent valuation using NPAT $27m and PE ratio of 8 with cash giving a valuation of $16.66 per share.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• Guidance for FY25 EBITDA to be similar to FY24. Expect they meet this.
• Is expansion of CAPEX adding value?
• Continued strong use of buy backs.

ABC report with Capral director Tony Dragicevich

The Youtube clip of ABC report provides some good information directly from Tony on the potential impacts of Trump's aluminium tariffs on Capral and the industry at large.

The largest risk I see being China increasing it's dumping activity on the Australian market after being locked out of the US market which has always been a notable risk for any investment in Capral.

As a side note from the report, interesting that 70% of US aluminium comes from Canada and basically the US doesn't produce its own aluminum. A 25% tariff on such a important raw material is going to be a real shock to some industries!

Capral announced yesterday that guidance will be at the "top end or slightly above" previous guidance of EBITDA $50-54m and NPAT $23-27m. Increasing valuation to match the $27m figure and buying to continue to build position as thesis is playing out as expected at this stage. Would like to see the buyback accelerate given the cash available.

General notes:

•  CEO comments: volume and earnings in line with expectations: residential demand was weaker than prior year due to low commencements and reduced pipeline, industrial demand remained solid, margins maintained through effective cost management and recovery.
• Not much information provided besides outlook comments and results figures, hence short notes.
• Headline figures:

• Capex planned at $10m.

Positives:

• NPAT, while down on PCP in line with expectations of $23-27m for the year which has been reiterated by management.
• Will continue to buy back shares. Already bought back the equivalent of 18c per share.
• Net cash $67.8m
• FCF $17.4m.
• NTA per share $10.43.

Negatives:

• Weak outlook for the residential sector. Generally, tough conditions ahead.
• Generally, numbers down on a PCP basis. However, this was expected.

Has the thesis been broken?

• No, will continuing adding to position as per my buying plan. Results beat my expectations. Management will continue to distribute capital through share buyback. 

Valuation:

Maintaining EV/NPAT of 8 with NPAT at lower end of guidance of $23m. With increase in cash and reduction of shares this now gives a valuation of $14.52.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• Management meets guidance set out of $23-27m
• Aggressive use of buy back and/or dividend at end of year.

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.