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Is this recovering company still too cheap to ignore?

The market likes today’s full-year results release from Epwin Group  (LSE: EPWN), which is one of the UK’s largest manufacturers of PVC windows, doors and fascia systems. The share price is up more than 6% as I write, close to 78p.

The first things to strike me when looking at the share is that the valuation looks low. The price-to-earnings ratio for 2019 sits close to 7.5 and the forward-looking dividend yield is just over 6.8%. Why might that be?

The firm has had its problems

Well, I reckon the company operates in a highly cyclical sector and many cyclicals have low valuations after a long period of high profits because the stock market fears the next downturn in business. The firm also has a low market capitalisation around £105m and, generally speaking, small-cap companies attract a lower valuation than many larger names. I think that could be because investors perceive smaller companies to be riskier than large ones.

But those factors don’t tell the whole story with regard to Epwin’s valuation. Delving into today’s figures suggests the firm has endured some particular challenges that could have driven the valuation down. Indeed, revenue during 2018 came in 4% below that achieved the year before, underlying operating profit plunged 23%, the underlying operating margin slid by 19% to just 6.7%, and earnings per share rolled back by 7%. At first glance, there’s something to worry about here.

However, the report trumpets the headline, “A year of robust performance and strategic delivery,” so what’s going on? You don’t have to read far to find the root cause of the company’s problems. Epwin lost its two largest customers during 2017, which has knocked more than £27m from the revenue figure reported today. There was also a hit to revenue of just over £7m because the firm closed down its plant in Cardiff. Those things took the operating profit down too, but profits were also affected by “some unrecovered material cost inflation.”

Turning itself around

The loss of major customers is a clear blow, but Epwin reckons it made “significant” progress getting out of lower margin and unprofitable activities during the period. The report also asserted that the firm enjoyed “strong” underlying growth in revenue and gains in market share in all the company’s “key” product areas. I think this rather upbeat message has encouraged the market today with shareholders looking for a turnaround in Epwin’s fortunes.

And the firm has been busy rationalising its operations and adjusting the set-up for the future. Chief executive Jon Bednall said in the report that the strategy of site consolidations and closures to “deliver a more focused and valuable business” is going well.  2019 is off to a good start, he said, and selling prices have been going up to counter the effects of rising input material prices.

Epwin’s cheap and is in full recovery mode, but it remains a cyclical outfit and a small-cap company. There’s both high upside potential and big downside risk with the share today, in my view. Over to you…

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.