RPC Group came to my attention due to its recent acquisition of Superfos. What attracted me was the fact that the company appeared to have pulled off a modestly successful acquisition, extraordinary in itself. In addition, RPC also records RNOA which is a favourite measure of mine. I found that whilst I was broadly correct on the first point, which makes RPC an interesting stock to look at, I was quite mistaken in thinking that they think about RNOA the way I do.
RPC Group is a very difficult company to analyze. For one, although the company does use “RNOA”, it does not use it at all like I would expect. If we use a measure that equates more with invested capital, i.e pure operating items like PPE and trade, then RPC looks far “less good” than it suggests on a first reading of the financials. If we include taxes, which unquestionably should be done for RNOA, then it gets worse.
The good thing is that we can always just look at leverage and ROE and work out what is really going on underneath. The company has loans worth 73% of equity, it is comfortably making the returns needed to finance that debt, and ROE was a respectable ~16.5% in FY’12 (adding back “one-time” charges maybe ~24%). Therefore, RPC’s suggestion that it makes an RNOA of 25% when the company has significant net debt and only has an ROE of 25%, generously defined, is quite misleading. Thankfully, that was the low point of the analysis.
The other difficulty is working through the effects of the Superfos deal. The deal closed early last year and so, as the company reports in June, this is the first full-year that Superfos has been included in the results. The deal was worth about £205m and the net effect in FY’12 was to add some ~£310m in sales. My very approximate calculation suggests that the uptick in sales alone boosted the EV of the company by £400m* although from a very low level.
In FY’12, the company benefitted hugely from an increase in margins. Operating margins almost doubled with large reductions in both raw material and staff costs. It isn’t clear if this is related to the Superfos deal however, I would argue that complicated calculations and margin growth aside the deal was broadly good, although RPC is lucky in having large margin growth in the first year Superfos is included.
Unfortunately, the market has moved quickly to recognize this fact. RPC has been rather troubled historically and has a poor margin record. The closest comparison is probably with Rexam’s plastic packaging division which has operating margins near 10%. Another comparison is Amcor which achieves just over 7.5% however, it seems likely that Amcor operates in quite different markets. RPC still clearly lags the competition but the share price has already jumped 56% since 2010 to price in this modest improvement in conditions. So what is the upside from here?
My calculation of fair value for RPC’s equity is only £7m below the current price however, this doesn’t include the possibility of further growth in revenue or margins. As mentioned already, some of the improvement in margins was down to raw materials, predicting further changes here is difficult. What has been more important are the changes in staff costs. Comparison with competitors suggests there may be further room to move here and the company cites further synergies with Superfos. Revenue growth is hard to predict but although organic growth through FY’12 was flat it is worth highlighting that the original RPC had achieved 27% top-line growth over the 5 years until FY’11.
To conclude, the Superfos deal does appear to have been beneficial to shareholders. A very pedantic person could spot some minor issues but given how bad companies are generally at making deals, this was a huge success. However, the market has priced in not only the effect of this change but also the improvement in raw material costs seen over FY’12. Therefore, the question for investors looking to get involved around this price is: Can the company continue to cut staff costs? Will raw material costs continue to fall? Are there more synergies with Superfos? Can the company achieve further sales growth? I would say that the gap with competitors suggests there is some opportunity to grow margins and that RPC’s recent record suggests there may be room to grow sales.
*Working anything like this out is obviously fraught with danger so it perhaps shouldn’t be taken too seriously. However, if we use NOA/RNOA as the basis for valuation (i.e a company with £200m in NOA making 10% RNOA is worth £200m, using a 10% discount rate and, therefore, a 1x NOA multiple) and project forward FY’10 margins (so the only thing that changes is NOA turns) we get a change in NOA/RNOA-implied EV of £400m. Of course, this change in EV doesn’t mean equity is worth that much more (given added debt and the rights issue it clearly isn’t).