Last Saturday’s glorious sunshine saw me wheeling out my trusty barbecue and tucking into a few crispy sausages, burgers and kebabs. Yet like my overly charcoaled lunch, shareholders in Devro, the world’s largest producer of sausage skins, could also claim to having had their fingers burned; the stock has fallen more than 50% from its peak of 145p back in February 2007.
Devro (DVO)
Last year, Devro suffered from a poor summer in Europe, technical difficulties at its factory in Scotland, adverse foreign-exchange movements and the loss of contracts in the US. But I suspect that the City’s savage mark-down has been overcooked, and here’s why.
Firstly, demand for Devro’s products strengthened in the fourth quarter of 2007, driven by the increasing popularity of Western-style sausages in China, the Czech Republic, Russia and Latin America.
The overall industry is expanding in volume terms by 4.5% a year – and Devro, with shares of around 50% and 80% respectively of the global and UK markets, is well placed to benefit. Next, a new management team has been appointed. It has fixed the manufacturing issues and pushed through a series of price hikes (2%+ in 2008), to offset higher raw material costs.
Lastly, the outlook is also improving, with house broker Investec estimating 2008 revenues and underlying earnings per share of £161m and 6.9p, rising to £164m and 7.3p in 2009, putting the shares on corresponding earnings multiples of 11.6 and 11.0 . What’s more, the stock pays a tasty 5.5% dividend yield, which although thinly covered, appears secure assuming there are no more hiccups. On 5 March the company commented that 2008 “has started well, with good demand in most of our markets”.
Fine, but what do we need to watch out for? Well, there are risks associated with the turnaround plan, while Devro is also exposed to the uncertainties of an international food company, such as health scares (eg, BSE), changing consumer tastes and regulatory interference. Also, net debt of £36m, including an £8.8m pension deficit, needs to be monitored – even if interest payments are covered a healthy 6.5 times.
Nonetheless, in an environment of belt-tightening, I believe more price-conscious families like mine will choose to save money by having BBQs rather than eating out, underpinning Devro’s prospects. Three of the directors seem to agree, as together they picked up £123,000 worth of stock in March at an average price of 85.6p per share. The annual general meeting is due to take place just as this issue goes to press.
Recommendation: BUY at 81.5p (market cap £132.7m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments