This time last year, I put FTSE 250 stock Avon Protection (LSE: AVON) on my list of best shares to buy. However, since reaching an all-time high of 4,625p on 1 December, the company has issued a series of share-price-hammering updates. The shares are now trading at sub-1,800p — over 60% below the high. A marked contrast with the strong performances of many stocks.
Here, I’ll explain why I was so impressed by Avon’s business that I put it on my buy list. I’ll then discuss the subsequent string of disappointing news. Finally, I’ll consider whether the business remains fundamentally attractive. And whether I should take advantage of the 60%+ discount to buy the stock.
Transformation
Up until September last year, Avon owned two distinct businesses. Avon Protection, which is a global leader in respiratory and ballistic protection for the world’s militaries and first responders, was responsible for over 70% of group revenue. Its other business, in agricultural technology, provided comprehensive milking-point solutions to dairy farmers across the world.
Avon disposed of the latter business for £180m. It was generating EBITDA (earnings before interest, tax, depreciation, and amortisation) of £10.5m. At the same time, it acquired a leading US supplier of helmets and liner systems for military and first-responder markets. It paid £100m for the company, which was generating EBITDA of £10.3m.
This looked smart business to me on the numbers alone. But I also liked that management’s energies would now be focused entirely on the protection business. And that the acquisition further entrenched its relationship with the likes of the US Department of Defense and NATO.
My sums suggested the transformed Avon could generate EBITDA of £65m in its financial year to 30 September 2021. The stock was priced at around 20 times my EBITDA forecast. I thought this could prove cheap, and make it one of the best shares to buy. Especially as the company had significant firepower to make further earnings-accretive acquisitions.
Then its troubles started.
Best share to buy — really?
On 17 December, Avon announced a delay to body-protection product approvals for two customers. It said it was confident of resolving the issues, but it now expected first deliveries to be six months later than previously envisaged. Separately, it said a protest had been made against it being awarded a sole-source contract (worth up to $93m) for ballistic helmets. The shares slumped 18% by the end of the week.
Interim results on 25 May provoked another negative market response. The shares fell over 10% on the day. But this was nothing compared with what was to come. On 13 August, the shares crashed 28% following a dire trading update.
Revenue and profit warning
The trading update was for Avon’s current financial year (ending 30 September), and it began encouragingly enough. The company said it had continued to see “good commercial progress” and had a record order book of $146m (up 21% year-on-year).
It was all downhill from there. Management revealed: “Notwithstanding the positive demand backdrop, the impact of delays in the receipt of orders, supply chain disruption and a tight US labour market has increased significantly through the second half of the financial year.”
It slashed its revenue and EBITDA guidance. It also said that while it’s confident the delayed orders will be received in the coming months, it expects supply chain disruption and the tight US labour market to persist into next year. Management said it was prudent to reduce revenue guidance for fiscal 2022 too.
Valuation
So much for that £65m EBITDA I’d figured on for 2021. The current analyst consensus is for less than half that. Namely, $44m (£32m at today’s exchange rate). For fiscal 2022, it’s $69.9m (not much above £50m), and for fiscal 2023 it’s $85.2m (£62m).
Avon was trading at around 20 times my 2021 EBITDA estimate when I put it on my list of best shares to buy last year. After the crash of the share price since, but also the big downgrades to financial guidance, how do the EBITDA multiples look now? They work out as follows:
- 2021: 17x
- 2022: 11x
- 2023: 9x
As you can deduce from these multiples, Avon’s share price has fallen much further than the reductions in EBITDA expectations. Even on the current annus horribilis EBITDA, the rating is lower than the 20 times multiple I was looking at this time last year. And the fiscal 2022 and 2023 multiples look a steal in comparison.
Lower rating deserved?
I think Avon remains a fundamentally attractive company with, as management says, “world leading businesses and technologies” and “well set for growth in FY22 and beyond.”
However, should I have put it on my list of best shares to buy when it was valued at 20 times EBITDA? Perhaps a lower rating is justified. After all, I was anticipating it making further earnings-accretive acquisitions. But now, with its current issues creating cash constraints, I don’t see acquisitions being on the agenda for the foreseeable future.
Also, while there were risks I was aware of this time last year — such as Avon’s significant reliance on the US (particularly the Department of Defense) — there were others I’ve only come to appreciate since. The issues and delays in securing body-protection product approvals that hit the company last December is one. Likewise the challenge to one of Avon’s single-source contracts, which has recently been replaced by a dual-source programme.
Finally, while many companies have suffered from supply chain disruption and the tight US labour market, plenty seem to have done a better job of mitigating the impact than Avon. Was management slow to see the seriousness of the emerging issues and can its guidance for the coming year be relied on?
One of the best shares to buy now?
Maybe the risks do suggest Avon merits a lower valuation than the 20 times EBITDA I was happy with last year. Having said that, I reckon the 60%+ fall in the share price and current EBITDA forecasts offer me a margin of safety. As such, I do think Avon is still one of the best shares for me to buy now.
