Category: Capral

See my original post on Capral here.

The floor didn’t cave in and the stock price went higher. When I wrote my original post, my opinion was that the market at that time was pricing in a bad result for FY2017. Turns out, the FY2017 result was actually pretty decent.

FY2017 results were pretty similar to FY2016’s results so there isn’t anything major to highlight. It was pretty much business as usual. Some notable developments include:

• Normalised net profit (normalised for inventory revaluations) was down 12.7%, this was mainly due to aluminium metal price rising in 2017.  Half of the sales volume is derived from sales contracts with LME aluminium pricing and there is a time lag between the spot price is when the price is charge to the customer.  As LME metal prices rose throughout 2017, Capral’s were unable to fully pass on the metal cost to the customer and therefore margin fell. However, when LME metal price falls, the opposite will happen.

• Housing starts are slowing with multi residential market falling by 9% and detached units falling by 2%. Capral’s main market is detached housing, so this slight fall has marginally affected sales volumes. The latest HIA reports forecast slowing housing starts for NSW and Victoria in FY2018/19 with the multi residential market falling significantly more than detached housing.
• Capral sales to the industrial sector have offset the decline in the housing market. Strong demand for truck trailers (e.g. Maxitrans), marine (e.g. Austral) and other infrastructure projects have contributed to a 4.2% increase in revenue (excl scrap revenue) in FY2017.
• Capral flagged higher capex at the AGM in March 2017 and capex increased by 41% to $5.8 million in FY2017. Capex is expected to further increase to $10 million in FY2018. Capral is introducing more automation in its factories which will further reduce operating costs.
• New anti-dumping cases have been launched against two of China’s largest aluminium extrusion importers into Australia. I understand that the anti-dumping commission has used a more advantageous cost formula to calculate a “fair price” for the extrusion products which should increase the dumping duties.

At the time of writing, the share price is 17 cents which imply a market capitalisation of $80.7 million.

Based on the current update, I don’t see any reasons why the dividends cannot be sustained as the payout ratio is at 50% and the company has cash of $34 million. I continue to hold this stock.

Over the last decade, Capral has seen some very tough times.  The start of its problems can be traced to the construction of its factory in Bremer Park, Qld in 2004 followed up quickly by the acquisition of Crane Aluminium for $124 million. Debt piled up at the same time cheap overseas products were coming into the market. The combination of slowing volumes and margins together with high debt levels hit Capral hard. A few capital raisings were done to pay down debt and keep the company afloat. The recipe of capital raisings, write downs and losses over the period resulted in a share price decline above 80% over the last decade.

So what is there to like?

• It is really cheap. At the current share price, it is an elusive “Graham net nets” (current assets less total liabilities > market capitalisation).
• Has been slowly reducing overheads over the past 10 years to increase its competitiveness.
• Posted a profit in FY2016 and has no debt.
• Managed to get anti-dumping duties applied to certain imported extrusions products coming into Australia.
• It has huge tax losses and at the same time is able to pay a franked dividend (a very unique situation).

Who is Capral?

Capral was founded in 1936 (formerly Alcan) and is Australia’s largest manufacturer and distributor of aluminium extrusions. It has a national footprint and operates five manufacturing plants. Its products are primarily used in the building industry for residential and commercial buildings (windows and door frames etc) but they also supply aluminium sheets for industrial uses (e.g. trailer and boat manufacturing).

This video shows the aluminium extrusion process.

A rough breakdown of their revenue source is 50% residential, 20% commercial and 30% industrial.

How cheap?

This is best illustrated by a comparison of its balance sheet (FY2016) and current market capitalisation:

Hypothetically speaking, you could liquidate Capral’s current assets and still have some leftover cash after paying off all the creditors. In addition, you would also get the fixed assets (book value $41.2 million) for free, among them the plant and equipment at the Bremer Park factory which was built at a cost of $90 million in 2004/05.

“Net nets” are very elusive in today’s market so there is huge pessimism about Capral’s future.

Why is the market so pessimistic?

The Australian aluminium extrusion industry is unable to compete with cheap overseas imports especially ones coming from China. China can produce aluminium extrusion relatively cheaper than Australia as their cost of labour in much lower, they enjoy huge economies scale given their market size relative to Australia and the aluminium industry receives subsidies and grants from the Chinese government, further lowering their costs.

The latest fall in share price was caused by a downgraded in Capral’s EBITDA range forecast for 2017 from $19m – $22m to $15m – $19m at the AGM on 11 May 2017. Management explained that this downgrade is due to the weak housing construction market in WA experience in Q1 2017.

So what’s there to like?

I basically like it because I think the market is overly pessimistic about its prospects. The market is valuing it on the basis that it will go broke slowly over time. This is possible but far from a foregone conclusion in my opinion. Capral has no debt and even managed to pay a 1.25 cents dividend for FY2016 (9.6% yield at current price). Not bad for a company being valued far below liquidation value. Over the past 5 years, it has managed to produce positive operating cash flow (ignoring acquisitions and financing flows).

Earnings have risen quite substantially since 2014. This can be attributed to an increase in residential construction activity, Capral lowering its cost base and countervailing duties being levied on certain imported products.

As shown above, there has been a massive increase in residential building approvals driven by “Other residential” category (mainly high rise apartments) over the past 3 years.  The building approvals for the “Other residential” category is at unprecedented levels. The data shows signs that building approvals are starting to cool off and if it happens, the Other residential category will be hit worse than detached housing. Capral only has a small exposure to the high rise apartment segment. I understand that windows and doors that go into most high rise apartment today come pre-fabricated from China so our local window and door manufacturers are cut out of that space.

Capral’s exposure is mostly in the detached housing or low rise apartment market whereby there is a lack of volume (orders are smaller) and uniformity in the product shapes and sizes.

Capral has been gradually lowering its costs over the past 9 years. The definition of cost below includes all expenses with the exception of finance cost and impairments.  Although aggregate cost has increased since 2013, it has actually declined on a cost per tonne basis. The sales volumes in 2008 were quite similar to 2016 and over this period, cost per tonne decreased by 15%.

As a result of the years of poor performance, Capral has accumulated tax losses of $286.6 million.  If Capral can make a consistent profit, it will not need to pay taxes for many years. In addition, Capral also has franking credits of $27.1 million.  Having both tax losses and franking credits at the same time is very unique and hugely beneficial for shareholders.

Capral has been the industry leader in championing the anti-dumping commission to investigate cases of dumping and applying countervailing duties to the delinquent overseas exporters.  Although the industry had some success with countervailing duties imposed on certain Chinese, Vietnamese and Malaysian exporters, circumvention activities are difficult to police. Nonetheless, Capral has credited the countervailing duties for reducing the market share for imports from 40% to 35%.

Risks

The main risk in my opinion to this company is its ability to survive in the face of cheap foreign imports.  I believe the company will survive as cheap imports are not really viable for markets where there is there is less design uniformity, smaller volume and shorter lead times.

Another interesting development is the implementation of China’s national emissions trading scheme (ETS). Aluminium production consumes a huge amount of electricity and an ETS may increase the cost of power which will lead to higher cost of production in China and possibly higher product prices. Having said that, electricity rates are also going up in Australia.

The other risk is a possibly supply disruption of aluminium billets sourced from Rio Tinto smelters in Queensland. There is a glut of global aluminium supply due to huge Chinese expansion which have already seen two of the six Australian based smelters shut in the last 5 years. I understand Capral has already started diversifying its supply of aluminium billets by purchasing a small quantity from the Middle East.

Overall

Capral is trading at very cheap levels (selling less than its working capital). Its current market capitalisation is $61.7 million and it has tangible net asset of $122.3 million and a potential tax benefit of $86 million (at 30% tax rate) from its massive tax losses. This business has low barriers to entry and relatively high fixed cost. Its sales volume is correlated to the building industry especially detached housing. Aluminium is being used more and more in the building industry as a replacement to steel due its lightweight, malleable properties and is 100% recyclable. This makes it a good choice for the trend towards green buildings.

Market share concentration of existing players is rising with the exit of Alcoa in 2014 and the acquisition of OneSteel Aluminium by Capral in 2013. Capral’s competitors are much smaller with G James Australia being the largest with about 8% market share (according to IBISworld) but their revenues have been declining and they have incurred losses between  FY2012 – FY2016 (source: Anti-dumping commission verification report – March 2017).  Scale is a significant factor and if the local industry goes down then Capral is likely to be the last man standing.

This is by no means a sure bet but in my opinion, at these share prices the stock offers lower downside risk and higher upside opportunity.