Castings: Strong Balance sheet provides comfort in uncertain times

Castings plc is a market leading iron casting and machining group based in the UK, supplying both the domestic and export markets. The company is listed on the LSE main market and has a market cap of £170m. Results for the HY to 30th September 2021 were released on 12th November.

We were delighted to welcome the CEO, Adam Vicary and FD, Steve Mant, to a webinar for private investors to talk about how they are performing in the current environment. A recording of the webinar is available here.

Castings is structured into three operating businesses. The original Castings business is based at the Brownhills foundry in the Midlands, produces 30k tonnes/year and employees 385 staff. The company’s machining business is based on the same site and was acquired in 1996. The machining facilities operates over 100 CNC (computer controlled) machines and employ 355 staff. The largest foundry, William Lee, located at Dronfield in the Peak District, produces 40k tonnes/year and employs 435 staff. All divisions have added staff over the past year. The group produces ductile iron, SG iron, austempered ductile iron (ADI), SiMo and Ni-resist castings up to 45kg in weight. There is foundry capacity of 70,000 tonnes per annum from a mix of high volume and specialist lines.

The first half of the 2021 financial year can be described as a tale of two quarters with the first quarter when business as usual was the norm and the second quarter impacted by supply issues affecting their customers. Q1 experience good demand, sales volumes recovered to pre-covid years, and the machine shop returned to profitability. Prices for their core input, scrap metal, rose and there is a lag recovering these cost increases. In the second quarter demand for trucks remained high but well publicised issues in the supply of semiconductors impacted production rates and hence Castings’ sales. It was not uncommon for their customers to shut production lines/plants for a number of weeks intermittently throughout this period. There were some positives with a number of new customers coming on stream and an increase in the parts with value added content and hence higher profitability for Castings.

The financial performance showed sales increasing to £69.7m, a rise of 67% to just below the September 2019 figures. Profits were £5.4m, the net margin recovered to 7.8% and the interim dividend rose 2.5% to 3.66p. Free cash flow was again strong at £4.8m and the net cash position has risen to £34.7m. Steve Mant, the FD highlighted that increased raw material prices impacted profits by £900k and without this the margin would have been 8.9%. The higher raw material prices will be recovered but there is always a lag.

Looking at the Foundry operations, sales in tonnes recovered to 34,300 tonnes with Q1 in line with the average sold in previous years and Q2 below average. 70% of Castings sales are to the commercial truck sector and heavy truck registrations are rising again after a significant dip in 2020. The Foundry revenues make up the bulk of group revenues at £68.1m and generated a net margin of 7.1%. Again, without the steel scrap input price rises, this margin would have been over 9% This was an improvement on the previous year but still someway short of the 10.2% margin achieved in 2017.

After a period of time when the Machining business has generally been unprofitable it returned to profitability in 2021, albeit only marginally. It made a return of 6% in the first quarter with the majority of this wiped out in the second quarter. Management seemed confident though that profitability would improve further in the second half and in future years.

Looking in more detail at the breakdown of revenues, 71% comes from the heavy truck sector, 11% from automotive (Toyota and JLR) and 18% is categorised as Other, which includes agriculture, rail and wind power. Within heavy trucks, 34% comes from engines and 37% from Chassis. The geographic split is Europe 70%, UK 24% and rest of world 6%. The US business suffered from a lack of face to face meetings but this has since recommenced and the US business is beginning to pick up.

There has been some concern about the future attractiveness of the markets in which Castings operates and management spent some time explaining their view of the world divided into the short to medium term future and the long-term future. In the short to medium term they see truck companies manufacturing more efficient internal combustion engines and this will provide good demand for Castings products – at least for the next 8-10 years. There will also be more opportunity in other sectors including Wind Energy, Agriculture, Material handling and Battery Electric Vehicles. Alternative materials, such as Aluminium, which are lighter, may also be an area that Castings looks to move into. The company looked at acquiring a couple of Aluminium businesses but nothing materialised in the end and organic growth into Aluminium is now being considered. The company is also looking at providing more added value components inhouse.

Looking further into the future the company sees battery electric vehicles and hydrogen fuel cell technologies replacing ICE’s. Specifically Castings customers are saying very similar things about how they see the transition to cleaner trucks. Scania say that by 2025 10% of vehicle sales in Europe will be BEV and by 2030 this will have risen to 50%. Long distance electric trucks will be possible within a few years and these trucks should be able to run four 4.5 hours before fast charging in 45 minutes while the driver has a break. Volvo have a similar progression and believe that by 2040 the whole fleet will be fossil free and at Daimler they predict that by 2039 100% of vehicles will be zero emission. Castings has started to supply some ductile steel to BEV’s where it is used to ensure the battery is firmly secured to the chassis.

Castings has always taken close consideration of its environment impact and this has increased in recent years. They are already a recycler of scrap metal, and in fact use no virgin steel in their factory. They also only use electric melting technology, unlike many European foundries which still use coal and 90% of electricity comes from renewal sources. They are also looking to reduce supply chain miles by bring finishing processes inhouse and reducing waste and improving their own recycling.

In summarising the investment attractions of the group Adam talked about the strong net cash balance sheet, a progressive dividend policy, a pension which has been derisked and is in surplus and very well invested foundries and machine shops. He was also upbeat about the opportunities looking ahead which include having secured new engine parts for their largest customer, a new manifold system for their second largest customers, supplying more value-added parts and the potential to grow more rapidly in US market. There are also likely to be some opportunities in bolt on M&A which they will consider opportunistically.

Current trading though lacks visibility at the moment. October started strongly but November has since been weaker. Demand schedules from their customers for Q4 show a large uplift in demand but whether this is still the case in January is very difficult to predict. However, the business remains profitable and cash generative. The large amount of cash on the balance sheet is predicted to grow to £40m by the year end and there is possibility that some of this surplus cash will be distributed to shareholders.

A recording of the webinar is available here. If you would like further information on other webinars organised by Yellowstone Advisory, please contact info@yellowstoneadvisory.com