The 3 October Zotefoams (LSE: ZTF) trading update contained fewer than 200 words, but they were enough to send the share price into a free fall. ZTF hit 340p at the close on Wednesday, down from 540p, a one-day slump of a little over 36%.
Why did investors run for the exit? First, because it felt like an emergency – the update was delivered a month earlier than usual. Second, the company confirmed earlier warnings by announcing that sales for the second half of 2019 will be around £2m lower than in the first half.
Polyolefin foam sales account for just shy of 70% of the company’s revenues, but are facing continuing headwinds in Europe, particularly in Germany, as well as new ones in the US. Zote’s High-Performance Product (HPP) business unit is doing well, but given its smaller size, that is not enough to prevent expected year-on-year sales growth being essentially flat for the first time in years. Those headwinds gave investors a chill.
Zote’s share price has soared by over 1,000% since 2008, to hit an all-time high of 700p at the end of 2018. Although the dividend has grown by a fairly consistent 3% per year, yields are tiny as they could not keep up with the soaring share price trading at over 30 times earnings per share.
This was a growth story, and the next chapter was going to be about hitting £100m in revenues in 2020. However, that doesn’t look likely to happen now – the growth story looks to have ended, and now the share price is around 20 times per-share earnings.
Investing in extra capacity now looks misguided as operating margins will be squeezed while machines stand idle, and investors may be looking hard at a minor business unit that has been generating increasing losses.
But sifting through the wreckage of the crashed share price, not everything is a write-off. Zote’s polyolefin foams are used in a wide range of applications and markets. Extra foam capacity was added mainly in the US, where demand is not suffering as much as in Europe. A weaker pound has helped Zote’s exporting business. The company’s greater UK capacity will serve the growing HPP business.
Although new debt has been taken on in the expansion, the company generated enough operating income to cover its interest obligations at least 10 times over in the first half of this year. The loss-making business is expected to have a much stronger second half, and has green credentials as its technology uses up to 20% less material in manufacturing.
I believe Zote will cope with the slowdown. However, if sentiment has shifted, dividends become more important. The total dividend for the year is 6.18p per share, and assuming 3% growth continues (the dividend has not received any warnings) the forward yield is 1.81%.
I would not buy this stock just for its dividends, not would I buy it for its growth prospects because there is too much uncertainty. Although the price has stabilised, I am going to wait until the stock decides if it’s a growth story or a value one.
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James J. McCombie has no position in any of the shares 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.