Carclo 10 Jul 08

CAR

  • GBP £0.80
  • Investment Type: Core
  • Risk: Medium
  • Action: Sell

Fat Prophets take profits

 

There are many reasons to remain optimistic with respect to the outlook for technical plastics manufacturer Carclo (LSE, CAR). However, the UK manufacturing sector’s malaise outweighs them all. In our view, the organic initiatives at Carclo will not be sufficient to offset the ever increasing economic slowdown in the UK and America. Given such headwinds we therefore believe it prudent to exit at this point and book a healthy profit.

Looking back our decision to recommend Carclo in January 2005 (FAT 68) was vindicated by the company’s operational excellence and astute management. Indeed, looking ahead the company has prepared itself as best it can to face its imminent challenges. However, industry conditions can never be ignored no matter how well a company’s specific fundamentals stack.

For Carclo itself remains a strong performer.




Underlying operating profits in the year to 31 March 2008 rose an impressive 19 percent to £5.7 million. As well as increasing exposure to high end niche markets, Carclo has expanded low cost manufacturing operations across Eastern Europe as well as China. Furthermore, the company’s new technologies are advancing at a healthy rates and the much heralded ‘CIT’ (Conductive Inkjet Technology) is beginning to contribute to the bottom line.

However recent evidence points towards tougher times ahead for the UK manufacturing sector. Industrial output fell 0.8 percent in the month of May, and a rebound is not expected any time soon. A worsening economic picture domestically, combined with a gloomy state of affairs across the pond is clearly going to have an increasing impact on earnings at Carclo. Around 88 percent of revenue originates from the UK & North America. Fortunately future earnings downgrades have not been fully factored in by the market in our opinion…yet.

So on the charts, the harsh treatment that Carclo has been subject to does not look like abating.

Technical consolidation remains the major theme for Carclo. As evident on the daily chart, since January, prices have been contained between support at 78.5p and resistance at 92.5p. This period of consolidation follows six months of declining prices from the August high of 132.5p.



Carclo’s most recent results for the year ending 31 March 2007, were buoyed by the group’s Precision Products division. Underpinning the performance was the emergence of specialist automotive products business ‘Wipac’.

Indeed, 25 percent of sales are derived from the supply of manufactured systems to the automotive and aerospace industries. And with the outlook for the automotive industry looking bleak at best, Carclo’s bottom line in our view is sure to be impacted going forward.

Sales of vehicles in the US dropped to a 15 year low in June and the world’s largest automotive market looks set to struggle for some time to come. Record fuel prices, tighter credit conditions and a slump in the domestic housing market are of course shouldering much of the blame.

In the UK the Society of Motor Manufacturers and Traders reported new vehicle sales down by 12 percent since last year, illustrating further sector weakness.

The automotive industry is a pivotal part of the UK manufacturing sector. Carclo and its peers attract the world’s major automotive companies due to their engineering excellence. However, this is no longer enough to prevent the sector shrinking.

Management of course have doubled their efforts to reduce Carclo’s exposure to the automotive and telecom markets and focus on higher margin medical and optical businesses. However we do not believe they will be able to pedal fast enough to offset the rot in markets which are coming under increasing pressure.

Added to the mix is the fact the the value of dollars received from customers in the US, a key market, are set to weaken further. Members will be fully aware of our stance on the (mis)fortunes of the world’s reserve currency.

In the face of rising costs pressures, Carclo has wisely sought to shift operations to low cost regions. Encouragingly, the group now has a fifth of underlying operating profits earned in these regions.

However, with global inflation being spurred on by an ever weakening dollar, ramping up operations in these areas can not be done quick enough in our view.

Furthermore, from an investors’ viewpoint, the shares currently yield 2.4 percent which in our opinion is not high enough to offer support.

Focussing back on the charts, currently, prices are again testing the lower boundary of this range at 78.5p. While this level does offer considerable support, cannot rule out an extension of the 11-month downward trend, which would expose longer-term support at 63p.

As such, Fat Prophets recommend exiting Carclo for a gain of around 60 percent on our original recommendation, and sell at around 79.5p.
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Snapshot CAR

Carclo
Market Capitalisation £44.8m
  CY FY1
Price to Earnings 7.5 7.0
Dividend Yield(%) 2.64 3.0
Price to Book 0.8 0.76
Return on Equity(%) 9.5 9.7
EV/EBITDA 5.8 5.5