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.

There’s much to be said for a non-tax paying ‘cannibal company’ like Capral Aluminium.

It’s a cannibal because it has used up its franking credits, despite having an almost bottomless pit of tax losses from a past era – and – its capital allocation policy is to buy back shares – aggressively! I’m figuring at a rate of 325,000 per half year which, given there are only 17m+ shares of which the top twenty tightly hold some 66.5%, this is an exercise of shaking out the weak retail hands.

My rough calculations suggest this buy-back program will add an automatic 3.7%+ to eps alone. This, and the likely unfranked dividend of 70c or 6.5%, isn’t a bad deal for a company which has proved its steadiness over the past years.

The companies policy is to continue to buy back aggressively when the SP is under the NTAV which I have updated to a potential current today figure of $11.49 – and the SP is $8.52!

An attempt was made a few years to take this private which had the backing of the current management (unfortunately) and I’m thinking this cannibal exercise isn’t a bad way of trimming the register for another tilt. But don’t listen to me, I still think the JFK fatal shot in 1963 came from the grassy knoll.  

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.

Just some quick thoughts following today's meeting.

Capral is in a tough business -- cyclical, capital intensive, and facing pressure from 'irrational' competitors in SE Asia that have been prone to dumping product here at below cost (effectively as a means to get capital out of their local jurisdiction -- Tony seemed to suggest it was then funnelled into residential housing investment, but let's not go there).

All that being said. During Tony's 11 year tenure, he's improved the efficiency and profitability of the business and grown revenues. The balance sheet is in excellent condition (zero debt, $60m in cash) and due to prior tax losses (a result of a loss-making expansion from 15 years ago, before Tony's time) the company wont have any tax liability for about 8 more years.

Some other points:

• Contracts with major customers (about 70% of the total) are repriced regularly, allowing the company to pass on increasing Aluminium costs
• Investments in value-added products and distribution have been a key part of the company's strategy, and has shown good results.
• Government regulation and legislation has reduced the impact of dumping.
• Not as dependent on residential construction as it was historically (was 50% now 30%), although Tony expecting good demand for construction materials given the current housing supply shortages.
• Look for 2-4 year payback on investments. Half their CAPEX is maintenance capex.
• The company's near death experience not long ago, a result of their failed Bremer venture, has made the company one that is very conservatively managed.

In a lot of ways, it's not the kind of business that would get me too excited. But my inner value investor can see some potential when you consider the PE of 6, a yield (unfranked) of 5.8% and the company below NTA -- a figure that tony thinks is understated due to lease provisioning (he seemed to think it was around $11.50/share).

These measures can, however, move around quickly -- a deeper dive may suggest a drop in profit or some asset write-downs are on the horizon (although nothing obvious from what i can see). But you can bet the company will be a lumpy performer.

Still, it seems cheap. What do others think?

Should you be a supporter of the view that critical metals and manufacturers need to be jealously guarded and supported in Australia for general future security concerns, then Capral Aluminium (CAA) is one small, non-flashy manufacturing company which should command your attention. Plus, it has no analyst coverage, and yet the value on offer is SUBSTANTIAL by almost every metric.   

 Who are they?

 CAPRAL is a long-established, national manufacturer and supplier of aluminium extrusion and rolled products. In fact, they dominate the market with a 27% share and the main competitors (thought to be 4) are privately owned. CAA has open discussions with them about consolidation and it will occur in due course. Aged owners eventually retire.

 It’s a company with a checkered history of substantial tax losses, which is an absolute bonus for shareholders in the present-day business model. No physical tax needs to be paid for at least the CY24 and 25 years and I’ve enjoyed tax free NPBT dividends for at least 5 years – Ned Kelly would have loved investing in Capral, as do I! What’s more, depending upon the tax deductibility validity of the remaining tax losses, this might be extended.

 Yes, CAA is leveraged to the cyclical building and construction industry (particularly detached residential), but not entirely so. In fact, 46% of its revenue is generated from ‘industrial’ (read trucks, ships etc) and this is running very strongly presently.

 Of course, housing & construction must pick up once it shakes its way through the horrors of Covid and materials and labour shortages causing bankruptcy because of the offering of fixed price contracts which has doomed many a builder to a guaranteed loss.  

 The industry expects pick up in CY24 and CY25 after a softer CY23, if for no other reason than placing a roof over the head of all the immigrants here now and coming; so, buying now at the cycle low isn’t a silly investment decision.  

 Why Buy…or not buy?

 ·       The company owns 27% of an essential marketplace (even nationally important) with possibilities of extending this further via acquisition & natural growth. The 3yr CAGR revenue growth is 18% & reported EPS have an average CAGR over 5 years of 24%

·       Fully franked dividends have a 5yr CAGR average of 13%. Presently the likely CY24 ff dividend will be 70c against a share around the $8 mark; that’s a grossed-up return of 12.5%. But, note CY24 is likely to be the last franking year and the company has already begun capital value enhancing measures with an aggressive buy-back program in place.

 ·       The Balance Sheet is strong. At the half yearlies just announced the company had cash of $41m and no debt - having paid off some $24m from strong cash flows in 1HCY23 as they unwound working capital requirements. Plus, the company has unused credit facilities of $49m to fund acquisitions should they arise.

 ·       This strength underpins the aggressive buyback program of 370k shares by CY23 end out of a pool of just 18.05m shares - that’s worth an additional 15c per share. Plus, the buyback provides market price stability for this seriously undervalued company subject to the volatility of small cap companies.

 ·       A CY23 eps – based upon the companies half yearly estimates – will be around $1.66 (that’s the NPBT because no tax, remember) for a PE less than 5x

 ·       The company is exposed to the aluminium industry with its extremely high energy usage at a time of rising prices; not to mention pressure in the cost areas of wages packaging and freight. That said, the company-maintained margin in 1HCY24.

·       The company is well managed and has worked diligently to derisk & diversify the company’s product offerings. It now has a significant industrial division focusing on supplying aluminium for truck & ship build, now some 46% of revenue, as well as the housing and construction industry (42% residential dwellings and 12% commercial).  

·       Of no slight significance is Capral’s ‘approved supplier status’ to major defence contracts and its development of lower carbon emission aluminium options.

·       Presently, both book value and net tangible value per share are around $10.95 and it’s not difficult getting a DCF value of around $15 per share.

 Disclosure: I hold in real life and am a fan, so best you conduct your own analysis but take note, a number of institutions have cottoned onto the value offered here. Specifically self-styled contrarian investors Allan Gray own 21% and there are at least five others starting to build stakes over 5%.    

Capral (CAA) is an old-world company which produces aluminium extrusion; boring, I know, to you ‘tecchies’ who get moist and glaze over on technology disruption. But it is Australia’s leading supplier with 26% of market share and with the capacity to buy more share from the remaining suppliers who are largely private companies owned by boomers who will want to retire and drive the Winnebago around Australia before ascending to whatever exists on the other side. CAA have admitted they are in talks with these people.

Yesterday CAA issued an upward revision to their CY22 results and CY22 will be a cracker. As best as I can determine, eps before tax will be around $1.90 – and before tax is as good as after tax, because this company is in the most unusual situation of having some $240m in tax losses, yet they have some $14.8m in franking credits as at June ‘21.

Sure, CY22 is an extremely upbeat year and CY23 will be more muted, with expectations of residential construction where they derive the majority of their income (think aluminium windows, and frames etc) to come off some 5%.

But for crying out loud, CAA is a stealth bomber flying well under the radar – no analyst coverage and even though the share popped up to $8.95 on the announcement, that’s still a PE of 4.7x

For those wanting an income stream, you can bank on a 70c to 80c fully franked divvy – again that’s not bad as a grossed up divvy of between 11.1% and 12.8%

Morningstar reacted overnight by adjusting the IV from $9.28 to $9.74 – but this is worth north of $10 all day every day, and so says Allan Grey, noted contrarians with ownership of some 20% when they vehemently defended the company from a punt $7 takeover in recent times.

There are two other reasons why CAA – apart from buying market share as discussed above – will be okay going forward:

(1)  The decision of many to return to Aussie manufacturers and end the supply chain lunacy and uncertainty. As chair of a medium sized private manufacturer, I know first- hand the dramas of escalating material prices and freight + the delays in China, on the seas, and most recently, tied up on the wharves in Australia.

(2)  CAA is a leading company fighting anti-dumping, and with considerable success in recent times.     

Another reason to think of CAA as an investible proposition is its strong Balance Sheet; companies with no debt, don’t go broke! In fact, I do believe by the December balance off date, they will have just short of $50m in good old Johnny CASH! As the company presentation states – quote – “Robust Financial Position that Supports Dividends & Reinvestment’. I think even Warren Buffett and his sidekick, Charlie Munger, might be drooling over that statement!  

16-Nov-2020:  Taylor Collison: Capral Ltd (CAA): Initiating Coverage - Outperform

Analyst:  CAMPBELL RAWSON, [email protected]  +61 415 146 725  www.taylorcollison.com.au

• Market Capitalisation: $84.5m
• Share price: $5.10
• 52 week low: $2.34
• 52 week high: $5.25
• TC's Recommendation: Outperform
• TC's Valuation: $7.40-$8.00 (see below)

Our View

Capral operates in a difficult industry with competition from low-cost, imported product placing pressure on volume and price. The Anti-dumping commission continues to investigate importers and is slowly but gradually ramping up measures on offenders. Despite being a low-margin manufacturing and distribution company, Capral is in a strong position with a low cost base, 25%+ market share and the only national network of production and distribution facilities. A restructure at the largest plant, Bremer Park, has removed a cost burden from the business and now ensures profitability, even at the bottom of the current housing and economic cycle. Current government housing and infrastructure stimulus is underpinning steady volume recovery with CAA’s manufacturing plants currently operating at full available capacity. Any increase to import duties or consolidation within the aluminium extrusion industry will likely disproportionately benefit Capral. With no debt, trading at a 45%-57% discount to our valuation and a 7.4% forecast dividend yield, we are attracted to Capral on valuation grounds.

Key Points

• Attractive valuation and no debt
  • CAA trades at a 55% discount to global listed aluminium extrusion peers with the discount widening to 65% when compared with peers who also operate a distribution network. Whilst all the peers are far bigger due to operating in much larger markets, CAA shares the trait with many of easily being the largest player in their market. Customer switching costs are not insignificant and help underpin CAA’s competitive position. With 50-55% of CAA’s production flowing directly into residential and commercial construction, we have compared valuation with Australasian building products suppliers and also found a ~65% discount. A notable difference in all the comparisons is CAA’s lower EBITDA margin and subsequently we have attributed a 15-25% discount to peers as an appropriate current valuation. This implies an EV/EBITDA multiple of 5.0-5.5x and a share price of $7.40-$8.00. We see this valuation as attractive given no debt obligation and a lower earnings risk profile with significant cost removed from operations.
• Dominant market position
  • CAA accounts for a third of Australia’s aluminium extrusion capacity with more than double the capacity of its nearest competitor. Although market excess capacity of 20%+ exists currently (bottom of housing cycle), CAA is well positioned relative to competitors having recently completed a restructure of the largest plant, Bremer Park, resulting in $8m of cost savings p.a. CAA’s size and lack of debt provides opportunity to consolidate the market with downturns expected to create financial stress for competitors. Meaningful market share gains are likely should the Australian government lift duties on low-cost importers out of Asia.
• Greatest risk remains the influence of low-cost imported product
  • For over a decade, aluminium importers from China have faced duties on excess import volumes into Australia. With many of these offenders receiving various forms of subsidies from the Chinese government, incentive remains to find ways around Australia’s current anti-dumping laws. Duties currently cap out at 60% and whilst they have helped stem market share growth of importers, eradication of dumping is a long way off. We look to the USA where duties are as high as 400% and import market share fell from 20% to <1% in five years. Until the Australian government ramps up duties further, the disturbance to volume and pricing from dumping provides the greatest risk to CAA earnings.

--- click on the link above for the full TC report on CAA ---   [I do NOT hold CAA shares.]