Description

Long: Tyman, PLC (Ticker: TYMN.GB)

Tyman, PLC (“Tyman”) supplies door and window components including locks, handles, weather strip, hardware, other components, and related assemblies. The company is built by acquisition; the prior CEO and CFO did 17 deals between 2010 and 2019, only 4 of which were sales.

In late 2015 the now departed management began a long-term project to consolidate the sprawling North American plant footprint. They mismanaged the effort resulting in employee turnover, customer losses, and ultimately C-suite turnover in 2019. The stock price subsequently fell from ~3.70 GBP in early 2018 to just 1.50 in March/April 2020 or nearly a 60% contraction.

With both earnings expectations and valuation multiple in long-term free fall, the current residential construction boom sets up for positive surprises on a dirt-cheap valuation. Taking a flyer on the new management team (which is unlikely to be as poor as their predecessors), we believe that the company can generate a low to mid-teens free cash yield for the next two years.

Low estimates for the second half 2020 and full year 2021 could catalyze an upward rerating of both estimates and multiples, especially if management chooses to guide.

We estimate the stock is worth 4-4.25 GBP per share or 45-55% upside to the price of 2.75 at this writing. It has limited debt at 1.4x TTM EBITDA and is only valued near the sum of the deal prices that assembled the firm.

Prior Management: Plant Consolidation = Face Plant

Louis Eperjesi and James Brotherton took over as CEO and CFO in February and June 2010, respectively. At the time the group was named “Lupus Capital”, and they intended to build a leading construction products group via acquisition. 

The strategy appeared to work for the next five years, but it is likely that results simply rode the housing recovery; they did not outperform their end markets by any stretch with organic revenue growth slower than US and UK housing indicators. Margins expanded in response to both management’s portfolio actions and price increases exceeding cost inflation, and they clearly benefited from the commodity bear market of 2015-2016. Cash generation was strong and the capital was deployed into acquisitions, which were partially financed with equity issuances.

In early 2015, the company announced a “Five-year project to rationalise [the] AmesburyTruth [North American] manufacturing footprint”. The goal was to generate 10 million GBP in cost savings that would hypothetically grow operating profit by over 20% from the 2014 result. The effort was broken into two multi-year phases. From 2015 to early 2017 the firm would build two brand new facilities and expand two others into large “centers of excellence”. From late 2017 to 2019, they would close or consolidate 8 of the 15 existing facilities in North America.

Results began to deteriorate. Organic growth turned negative by 2019 as the firm lost high margin customers, and margins compressed with assistance from commodity costs. All the while their end markets were strong as indicated by US starts, UK home prices, and the UK Leading Indicator of Remodeling activity.

In November 2018, the firm announced the “retirement” of CEO Louis Eperjesi and his replacement by an outsider named Jo Hallas. This occurred in advance and probably in anticipation of 2019, a true annus horribilis with organic declines despite growing end markets and falling margins despite declining input costs.

Ms. Hallas, who was amazingly not asked to speak in the full year 2018 earnings call despite the November announcement of her role, explained the situation in the interim 2019 earnings call as follows:

“… two issues have risen with the – from the execution of the U.S. program. These issues are very fixable... During the site moves, recruitment and retention of experienced personnel was a challenge. And as a result, production ramp up to stable yield levels has been slower than expected... Accordingly, production processes were initially less efficient with more downtime from machine setup and maintenance, more scrap and ultimately low yields. And these issues compounded to give rise to poor stock availability.

… the stock outages drove more frequent line changeovers of production, expedited freight expenses and additional temporary staffing to get on top of the problems. And these compensation measures have added to our production costs in the first half. Customer losses are followed from this.

… this is being further exacerbated by specific issue related to the door seals product line. Taking advantage of the relocation of door seals manufacturing from Rochester to Statesville in late 2018, [Tyman] introduced a new type of door seal that required a more environmentally friendly extrusion process…

… initial customer take of the new seal product has been slower than expected in part due to the significant efforts required by customers to test and transition their door systems to the new products. With continued demand for the legacy product and yet the lack of capacity now available, customers have clearly been testing alternative supply sources…

The delayed impact is being pronounced by the fact that customers stockpiled the old product in advance of transition with a consequential stronger impact on sales...”

It’s clear from Hallas’ forthright explanation that many relocation decisions did not consider the full impact on customers and employees. As you might expect in the modern era of adjusting out every negative mark under the Sun, Hallas and her new CFO separated the footprint impacts in reports to show a stronger underlying company. Since the initial disclosure of the negative footprint impacts, Tyman reports lost revenue of 19.7 million GBP as of 6/30/20 and 10.6 million of lost operating profit, a staggering 54% of lost sales against a the typical mid to low teens margins of the firm. Excluding these issues, 2019 underlying margins expanded to 14.9% instead of falling to 13.9%, in line with input commodity movements.

Why All This Matters: A Low Bar for 2020 and 2021, and Strong End Markets / 3Q Results

All the while, Wall Street was punishing the stock with ever lower earnings estimates and significant multiple compression.

Footprint issues are about to hit the rearview mirror, end markets are as strong as ever, and the third quarter trading update revealed strong organic sales growth. We believe both 2021 and second half 2020 profit expectations are too low. Positive surprises and estimate revisions will catalyze the stock towards our 4 GBP per share target or higher. The surprise will be supercharged if the new management team chooses to initiate formal profit guidance for the first time since 2017.

Expectations as the Catalyst

Like most British PLCs, Tyman reports semi-annually. Analysts expect 562.6 million of sales for the full year 2020. That implies 308.5 million for the second half or -1.1% growth over 2019. FX will likely be a 2% headwind and the footprint issues should also drag results by about 3 million or 1%. That means consensus is for +2% organic growth when the company just reported 3% for the 3^rd quarter and 9% for the month of September.

All indicators are positive. US housing starts are up 11%. Average prices are up 15% and transactions up 21% according to the NRA. The UK Leading Indicator of Remodeling activity is up low single digits and UK home prices are up 7.5% as reported by the Guardian. Furthermore, Tyman’s 3Q interim trading update was upbeat on all geographies. To report below 308.5 million GBP of sales in the 2^nd half, housing markets would need to have a severe and sudden reversal. We think 4-5% organic is more realistic or 315 million.

On top of that, the 2021 expectation is only 591.6 million of sales which is only 4% total growth, or half of the Covid related volume decline in first half 2020. Housing markets and Tyman current sales are already tracking over the 2019 pace. Shutdowns in the month of April drove a 93% decline in UK, or about 9 million if you simply divide first half 2019 regional sales of 54 million by 6. Put a different way: the reopening of UK & Irish production for Tyman, a region that only generates 18% of the firm’s sales, would bridge almost half the expected 2021 sales growth in a single month. Add the absurdly easy compares in the much larger North American segment, and this 2021 sales estimate looks far too low. We think sales will grow to match 2019 levels or nearly 8% over 2020. That will include -1.5% on FX, +1.5% from footprint related customer recovery, and another 7% on organic market strength. The holiday on stamp duties in the UK should also support the market at least through March 31, 2021 and potentially longer.

Finally, profit margin expectations are also pessimistic. Analysts expect 72.5 million of operating profit for 2020, or 41.2 million for the 2^nd half. That is 13.3% of their sales estimates. Last year’s margins were 14.0% in the same period or 14.7% excluding footprint transition problems. So analysts expect almost a point and half of margin compression while sales are growing organically, raw materials are cheaper, and facility consolidation is expected to have a positive influence on profit for the first time. This makes no sense.

On to 2021 profit expectations, analysts expect 78.2 million of profits or 13.2% of their sales estimates, or 30 basis points of margin expansion and a simple 20% incremental. That compares to 13.9% in 2019 or 14.9% excluding plant consolidation problems. We estimate 2021 will see 90 million of profits or 15% higher than consensus. We assume a recovery of half the footprint profit headwinds and a similar incremental flow through of our higher sales estimates.

If management chooses to guide in line with these estimates, the stock will have a near-term catalyst for the market to reconsider the cheap valuation.

Valuation

Behind the operational issues, aggressive deal making, and growth underperforming end markets, Tyman generates significant cash flow. Cash from operations averages over 100% of both underlying operating profit and net income before depreciation and amortization. The firm should still finish 2020 having generated over 10% of its current market cap in free cash for 4 of the last 5 years.          

The 3Q interim trading update reports the firm reduced leverage by 0.4x or about 36 million since the last balance sheet report. Taking this into account, the stock trades at 6.1x our 2021 EBITDA estimate. Door component peers Jeld-Wen and Masonite trade at 7.5x and a match of their multiple would get the stock to 3.75 GBP or 29% upside. However, all the door component peers have seen some longer-term multiple compression. Another turn higher would get the stock over 4 GBP.

Alternatively, with the firm consistently generating over 100% of operating profit into cash from operations, we believe free cash to equity could regularly reach 75 million or a min-teens yield on today’s market cap. A new management team may use capital more wisely and reach a more appropriate balance between selective deals and returning cash to shareholders. If that turns out to be the case, a 50% increase in the stock brings the free cash yield to a more normal 10%. These yields look even more attractive in a country with lower interest rates than ours.

The downside is protected by the sum-of-the-parts value of all the businesses Tyman has purchased. The firm bought 713 million GBP and sold 121 million GBP of businesses in the last 20 years. If the firm were valued at the difference of 592 million GBP, the stock would have only a 12% downside. Book value is also only 20% below the current stock price, but that includes significant acquired intangibles.

Risks

-          The firm has done deals in lieu of capex and may have a deferred maintenance piper to pay.

-          Door and window components may become even more commoditized and force Tyman into smaller niche markets and prevent growth.

-          Bigger and better capitalized peers mean tough competition.

-          Dollar weakness impacts profitability.

-          Relevant commodities are up right now

Catalyst

Catalysts

-          Strength in housing lasts longer than expected

-          International growth is more durable than people expect (IE not just channel restocking).

-          Management guides above consensus expectations (if they are below consensus… they will not guide. This is asymmetric.)