Description

This is a riches-in-niches story that’s boring as hell (packaging distribution) unless you like 20% returns on capital with a long runway for continued growth.  Also boring is how they manage to grow through thick and thin - e.g. the GFC, Brexit, Covid, and inflation.  Price to forward steady-state FCF (ex change in working capital and M&A) is about 9x.  Hopefully that’s not boring.

MacFarlane is a distributor (89% by sales) and manufacturer (11%) of protective packaging with 38 locations in the UK, with one location in each of Ireland, Netherlands, and Germany (all leased).  Specialized packaging for e-commerce has grown in recent years to reach 26% of 2022 sales, but MacFarlane’s bread-and-butter remains custom-made packaging for industrial goods.

This is one of those great little niches where you’re selling something that’s only a small percentage of your customers’ costs, but if something goes wrong, the cost to your customer becomes really large.  Hence the need to spend a few quid to protect a £50,000 turbine blade or whatnot.  Thanks to MacFarlane, customers don’t need to worry about maintaining inventories of boxes, and keep in mind this stuff is pretty bulky and often oddly-shaped.  80% of boxes are customized for the client.  MacFarlane buys the raw cardboard, foam, etc. in bulk and passes on some of that savings as well.  Need a few containers today?  No problem - our truck will stop by this afternoon. 

Steady As She Goes…

Note that these margins are completely unadjusted.  MacFarlane doesn’t do pro-forma numbers at all.  They’ll often have one-off items weighing on results that they just lump in there and never call out.  It’s refreshing to see.

So how is this possible?  Part of the answer is that 70% of Macfarlane’s raw material purchases are priced off of an index called EUWID Test 2, with pricing visibility and security of supply. The other 30% of Macfarlanes box purchases are Custom box formats which are also Contractually 

Correlated to a similar Index.  The other part is just careful management of operating costs.

The revenue growth is partly due to an active M&A program (more on this below), as well as a smart incentive structure.  Depot Managers are incentivised on EBIT per depot and salespeople are incentivised on gross profit (not sales). 

They have a roughly 25% marketshare in the UK, up from 10% in 2005.  Competitors are all private, with the largest of them being around ⅓ MacFarlane’s size.  One can see from Companies House records that, like MacFarlane, all are consistently profitable, though MacFarlane’s margins are steadier and higher than all the others aside from Kite.  It’s a good niche.

Kite, by the way, is an interesting story - much smaller but with operating margins roughly 2x higher.  Its formation came about when a botched acquisition Macfarlane completed under the old management team led to the departure of a number of key executives.

Their largest customer is only about 4% of revenues.  Containers often feature that customer’s brand on the box, particularly for e-commerce.  In that segment, MacFarlane isn’t just about protection but also the “unboxing experience.”

The ESG-trend towards less packaging - or at least less harmful packaging - is actually a boon to the business, with MacFarlane serving in a consultant-like role to help customers meet ESG goals such as engineering reduced plastic in the containers.

History

Founded about 70 years ago in Scotland, MacFarlane went public on the LSE in 1973.  20 years ago the company was in disarray – money losing, faltering international operations, indebted, and with a large unfunded pension liability.  Current CEO Peter Atkinson took over in 2003 and realized that they should pare down the business and focus on UK packaging distribution.  

Thus far Atkinson has done an incredible job as one can easily see from the numbers.  His shareholdings are only around 2x his comp, which is a lot less than I’d like to see, but it’s hard to argue with two decades of success.

The non- executive membership of the Board was almost entirely overhauled in the early part of the last decade, including the addition of a former senior executive at DS Smith, and it seems likely that these changes are behind the new acquisitive approach.  Since 2014, the company has done 16 acquisitions, the most recent on the 6th of March for Sutton, which adds to the small but growing package manufacturing segment.  Management expects to do another deal this year and says the M&A pipeline is full.

Note that at the very end of last year they sold a sub-scale label making business doing around 22m in sales.  

So, MacFarlane is essentially a roll-up.  The algorithm is that they generate ~20% returns on capital, dividend a quarter of FCF and invest the rest in consolidating this fragmented sector.  Deals are usually done around 6x EBITDA, with earnout provisions that can take the multiple up to 8x.  

While the UK continues to be the main focus of M&A, they’ve recently entered Continental Europe using a “follow the customer” strategy.  After a small acquisition in the Netherlands, MacFarlane bought PackMann GmbH in Germany, which is intended to be the platform (if you will) for expansion in the region.  At approx 7.7x EBITDA before earnouts, this deal was a bit more pricey than usual, but I’m guessing they paid up for quality, and that seems sensible given the risks of foreign expansion.

Pension

I don’t see this as a risk today, but for a decade or so it was a millstone around the company’s neck.  In spite of the pension scheme having closed in 2002 and quite sensible management subsequently, the pension deficit grew materially as declining interest rates inflated liabilities.

At end-2014, the scheme was in deficit to the tune of 13.9m. The company then reached a deal with the trustees to pay this down, initially at a rate of 2.8m per year, but more recently at 1.3m per year.  By 2021 the deficit was down to 1.5m.  More recently, inflation has reduced liabilities such that it’s now showing an over 10m surplus.  New accruals to the plan were ended this past November.  Despite the surplus, I don’t adjust the EV downwards out of conservatism.

Catalyst

More acquisitons

Growth in e-commerce revenues