Mincon: Acceptable 2018 Results Show 10% Organic Growth And Outline ‘Disruptive’ New Drilling Product

20 March 2019
By Maynard Paton

Results verdict on Mincon (MCON):

  • Acceptable double-digit growth supported by encouraging organic sales and the purchase of Driconeq.
  • New ‘Greenhammer’ product appears to offer attractive possibilities through “disruptive technology”.
  • Year ahead to focus on consolidating operations after bumper orders created production constraints during 2017 and 2018. Recent trading not buoyant.
  • Accounts offer scope for improvement as hefty stock build-up unwinds, capital expenditure falls and cost savings are found.
  • The underlying P/E of 19 is not an obvious bargain. I continue to hold.

Contents

Event: Final results for the twelve months to 31 December 2018 published 19 March 2019

Price:
105p
Shares in issue: 201,541,102
Market capitalisation: £221m

Why I own MCON

mcon mincon head office
  • Designs and manufactures industrial drill bits, with sales supported by established reputation, quality engineering, product patents and technical services.
  • Boasts veteran family management with 42-year tenure, 57%/£126m shareholding and long-term perspective.
  • Offers financials that include respectable margins, a cash-positive balance sheet and opportunities for greater efficiencies.

Further reading: My MCON Buy report | All my MCON posts

Results summary

Revenue and profit 

  • In the event, total revenue gained 21% while operating profit before exceptional items advanced 16%.
  • The purchase of Driconeq — a Swedish drill-pipe specialist — this time last year made MCON’s underlying growth harder to determine.
  • The table below includes my best interpretation of Driconeq’s revenue contribution:
H1 2017H2 2017FY 2017H1 2018H2 2018FY 2018
Revenue (own brand) (€k)*35,21139,75474,96539,30743,02082,327
Revenue (third party) (€k)11,74510,64822,3938,3159,05417,369
Revenue (Driconeq) (€k)*---8,0999,89317,992
Revenue (total) (€k)46,95650,40297,35855,72161,967117,688
Operating profit (€k)6,7897,25114,0408,0878,26516,352
Exceptional costs €k)(3,047)(127)(3,174)(298)879581

(*estimated)

  • I am not sure my Driconeq sums are correct. First-half sales of €8m reflect only the first three months post-acquisition, while second-half sales of €10m represent a full six-month contribution.  
  • MCON had initially claimed Driconeq would create extra sales of €21m during 2018.
  • Nevertheless, my table does show (estimated) 2018 revenue from own-brand products gaining 10% — which matches the comments given by the chief executive.
  • Reading between the lines, I am not sure Driconeq has performed as well as expected (my bold). 

“Driconeq represents good value for the Group, but it has taken some work, which will continue into 2019. Overall, we are happy with the businesses, their teams, the trading and the additions to the product line-up.”

  • At least the overall results set new revenue, profit and dividend highs:
Year to 31 December20142015201620172018
Revenue (€k)54,54470,26676,18197,358117,688
Operating profit (€k)10,3509,99010,17814,04016,352
Exceptional charges (€k)---(3,174)(166)
Exceptional gains (€k)---3,124747
Other items (€k)364(481)1,125(1,273)(618)
Finance income (€k)53511430(79)(31)
Pre-tax profit (€k)11,2499,62311,33312,63816,284
Earnings per share (c)4.343.794.394.796.45
Dividend per share (c)2.002.002.002.052.10
  • The final dividend was maintained at €0.0105 per share, which left the full-year payout 2.4% higher. The dividend announcement was hidden within notes 21 and 30 of the accompanying accounts. 

Drill strings

  • These results were the first in which I noticed the term “drill string”.
  • A drill string combines a drill pipe, a bottom hole assembly and any other tools used to make the drill bit turn correctly.
mcon mincon fy 2018 results diagram of drill string
  • MCON has traditionally developed and made industrial drill bits.
  • Driconeq and some previous acquisitions manufacture drill pipes. These results explained the strategy to develop other drill parts (my bold):

“In recent years we have set out to assemble the full range of the drill string for different types of mining and construction piling. This provides us with the opportunity to deliver a full-service offering to end customers, as we now design and manufacture the key elements in the drill string.

We are differentiating ourselves from the less developed businesses in low margin activities in the sector, and
we are positioning ourselves to deal directly with end customers and to win large contracts.

Going forward we plan to… seek long-term partnerships and multi-year contracts with end customers incorporating direct delivery to their sites.”

  • MCON appears to sell its drill bits to intermediaries, who in turn seemingly supply the end customer with the full drill string. I had always assumed MCON sold direct to the end customer.
  • Driconeq’s drill pipes are not as profitable as drill bits. These results claimed Driconeq’s gross margin was 23% versus 40% for the ‘core’ group.
  • Driconeq was acquired for €7.8m, incurred further transaction costs of €166k and contributed earnings of €396k during the nine months of ownership. 
  • Driconeq’s contribution ought to improve during 2019:

We do not expect acquisitions to add much to profitability in their first year due to acquisition and transition costs, but we expect to improve the gross and net margins in the full year coming

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Greenhammer project

  • Comments about MCON’s ‘Greenhammer’ project appeared encouraging (my bold):

“We believe we are moving towards the commercialisation phase of the hydraulic hammer systems (or “Greenhammer” systems) in 2019. 

The system on the rig, prior to the drill string being added, weighs about eight tonnes, and eleven tonnes when the full drill string is added. This is not a small system or easily replicable, and we have placed patents around the system to protect it. 

The system is more than just the hydraulic hammer; it includes all the drill string and the supporting on-rig infrastructure and handling.

It is a disruptive technology, offering tremendous savings in fuel, with an ambitious planned partnership programme in our customer base, and there is growing interest from other potential customers with the problems that this technology can address, such as hard rock, and high-altitude drilling. 

It is the current embodiment of our challenger brand strategy.”

mcon mincon fy 2018 results greenhammer project
  • Greenhammer has been seven years in the making and to date has involved capitalised development costs of €3.4m, of which €0.7m was capitalised during H1 and €1.0m capitalised during H2.
  • These results revealed exactly where the Greenhammer development costs reside within the cash flow statement.
  • Previous statements had not declared any intangible expenditure, and I assumed such costs were lumped in with ‘other non-cash movements’:
mcon mincon fy 2017 results cash flow
  • My assumption was correct. ‘Investments in intangible assets’ have been introduced for 2018 and the prior year’s ‘other non-cash movements’ have been restated accordingly:
mcon mincon fy 2018 results cash flow
  • Amortisation has yet to commence against the capitalised expenditure:

Working capital

mcon mincon hy 2018 results cash flow
  • This full-year statement revealed stock levels had increased by a further €5.5m:
mcon mincon fy 2018 results cash flow
  • MCON gave three reasons for the substantial stock build-up:
    • The placing of Driconeq products throughout the group’s distribution network;
    • Advance orders of raw materials to ensure reliable supplies and to avoid price increases, and;
    • Delivery backlogs due to customer demand exceeding manufacturing capacity during 2017 and 2018.
  • At €49m, year-end stock levels represented a huge 42% of revenue. 
  • MCON’s stock-turn history is shown below:
Year to 31 December20142015201620172018
Stock turn (days)276263269206203
Note: Stock turn = (average stock held / cost of sales) * 365 days
  • Stock in the factory and warehouses is now held on average for six months rather than the nine months seen during 2014.
mcon mincon warehouse stock
  • MCON reckons approximately €10m could be released from working capital during 2019:

“In the coming year we intend to realise all of the €2.3 million tied up in rigs, to reduce raw material inventory by approximately €4 million, and depending on the sales level, reduce the work in progress and finished goods inventory by, perhaps €4 million. We will review this plan through the year as we unwind the working capital.”

  • MCON may always carry relatively high stock levels because such levels could support a competitive advantage. 
  • The group’s flotation document cited “customers now demand effective service, spare parts and consumables” and “stock availability in remote locations enhance[s] Mincon’s reputation in the marketplace.

Capital expenditure, cash and debt

  • Capital expenditure was €7m during H2 to total almost €13m during the year.
  • MCON explained: 

We substantially completed the build out of the factories during the year, and capital equipment has been installed and commissioned in our factories through the period. The heat treatment plants, exceeding some €5 million in total investment were commissioned over the year end period and they should facilitate the delivery of consistent quality in our products across our key factories…”

  • At least capex is set to reduce to the c€4m depreciation charge for 2019:

“We are planning that our capital expenditure in the coming years will be in the region of our depreciation charge for the maintenance of our current production and product ranges.”

  • The total cost of the hefty capex, the substantial stock investment, the Driconeq acquisition, the notable Greenhammer expenditure and the dividend came to €40m.
  • Of that €40m, €14m was funded by earnings, €5m funded by extra debt, €1m funded by other cash movements and the remaining €20m funded by cash in the bank.
  • Cash in the bank therefore dropped from €28m to €8m, while debt advanced from €2m to €7m. Net cash ended the year at just €1m — excluding €5m earmarked for possible acquisition earn-outs. 
  • The following table puts the working-capital movements and capex into perspective:
Year to 31 December20142015201620172018
Operating profit (€k)10,3509,99010,17814,04016,352
Depreciation and amortisation (€k)2,0532,3462,3323,0143,896
Net capital expenditure (€k)(1,750)(1,768)(5,246)(5,639)(12,552)
Working-capital movements (€k)(6,503)(2,837)(1,152)(4,408)(14,870)
Net cash (€k)41,75438,61034,96026,142846
  • Of MCON’s €61m aggregate operating profit from 2014 to 2018, an enormous €30m was absorbed into working capital.
  • During the same five years, total capital expenditure has been double the total depreciation charged against earnings.
  • Five years ago MCON raised €47m through its flotation. Those proceeds have now all been spent. 

Margins and ROE

  • MCON’s operating margin and return on equity (ROE) remain reasonable but not spectacular:
Year to 31 December20142015201620172018
Operating margin (%)19.014.213.414.413.9
Return on average equity* (%)18.612.713.012.612.6

(*adjusted for net cash and deferred considerations)

  • MCON said the operating margin excluding Driconeq was 15.2%.
  • Margins may have scope to increase. MCON claimed:

We plan to review the overheads that we have built up with a view to improving efficiency across the Group.” 

  • ROE could improve if/when the aforementioned stock levels reduce and/or when the aforementioned recent capex generates a suitable return. Stock and property, plant and equipment represented a significant 72% of the year-end balance sheet.
  • MCON admitted:

We have yet to see the expected returns on some of these investments. We understand that we have to increase revenue and improve the returns on these investments. We have made the investments, and, in the coming year, we expect to build out the income streams.”

  • MCON carries no pension obligations.
mcon mincon surface drill in action

Outlook

  • MCON anticipates growth will pause during 2019 (my bold): 

We have ramped up overheads over the last two years, much of it necessary as part of the Group build-out and through our acquisitions, and we will spend much of 2019 consolidating our operations, reducing our overheads and moving strongly back into cash generation.

  • Current trading does not appear buoyant:

Trading in the new year to date has been fitful and flat.” 

  • This time last year, MCON claimed 2017 had looked “very much like the first [year] of the current upturn”. 
  • MCON did not say whether its customers continue to enjoy an upturn while the group consolidates its acquisitions. 

Valuation

  • MCON’s €16.4m operating profit for 2018 translates into £14.0m at £1:€1.17.
  • Taxed at the 15.5% rate applied in these results gives earnings of £11.8m or 5.6p per share.
  • Adjust the £221m market cap for the net cash and potential acquisition earn-outs, and the P/E is approximately 19.
  • No adjustment has been made for the capitalised Greenhammer expenditure.
  • The 19x multiple may be justified if:
    • Organic sales growth can continue at 10%;
    • Margins improve as overheads are reduced, and/or;
    • Capital is released from stock and leads to a greater ROE.
  • The trailing €0.021 per share dividend equates to 1.79p per share and supplies a 1.7% yield (before Irish withholding taxes for UK-resident investors).

Maynard Paton

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Disclosure: Maynard owns shares in Mincon.

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