Renold - can't break the chain

Investment summary

• Renold (RNO) trades on a very low valuation: a March 2025 p/e ratio of 7.9x; ev:ebitda of 3.5x and sales multiple of 0.5x
• Operating margin is 12% and remains on an improving trend; while ROCE is in the low to mid-teens
• The company is increasingly cash generative, allowing it to reduce gearing and make accretive acquisitions
• The pension fund deficit will cease to be an issue on a five-year view.
• After building a base for three years, the shares have started to perform, making a new six-year high
• If the market begins to see Renold as a value-added engineering business, the shares would be valued much more highly

The business

Unlike many of its AIM peers, Renold is a venerable company which traces its origins back to 1864. Today it is a global business with manufacturing plants in eight countries and over 1,800 employees. Around 80% of revenue and profit comes from industrial chain, which is a fragmented £3bn market of which Renold has a ca 7% share. This makes it the world number two behind Japan’s Tsubaki, which has a share roughly double that of Renold. There are a few companies in the £100-150m turnover range followed by a long tail, which provides plenty of scope for consolidation.

Renold has a well-diversified customer base by sector and geography. The latest sales split has North America 43%, Europe 40%, Australasia 9%, China 5% and India 3%. The company focuses on higher quality products which command a premium price and sells to a wide range of customers, the largest accounting for no more than 3% of sales. Supplying these customers from a manufacturing base spread around the world reduces risk and allows Renold to be a local as well as global business - which is important in benefiting from the reshoring trend, especially in the US. Manufactured products is the biggest end sector (24%), followed by materials handling (13%), construction (9%), transport (8%), food and drink (8%), energy (7%), and agriculture (6%). Renold does not sell automotive chain. 

This means the business is not unduly exposed to a particular customer, sector, or geography. The best proxy for overall demand would be global industrial production which is growing at around 3.5% pa. Renold should outperform the market by taking share and leveraging its infrastructure by making in-market acquisitions.  

Chain wears out; so the company benefits from having a relatively stable stream of replacement equipment sales, which accounts for around 75 per cent of the division’s total. Chain is a critical but relatively low cost component within a machine or production process, so customers tend to stick with their suppliers. The downside to this is that it can be hard to persuade a potential customer to switch their supplier to Renold. A key strategy to overcome this and gain share is to offer premium, value-added products.

For example, Renold supplied a premium chain to a global escalator manufacturer which was more expensive in terms of up-front costs but provided over double the life of the basic alternative. By extending maintenance intervals it reduced the total cost of ownership and its quality allowed the customer to cut its costs further by removing an auto-lubrication system from the unit.  

Renold’s broad spread of business means there are plenty of opportunities to fill in gaps. It is strong in conveyor chain in the US and transmission chain in Europe - so there is scope to sell more transmission product in the US and conveyor in Europe. Market share will also come from product range extensions and penetrating new market segments. Having a much improved balance sheet has also enabled an acquisition strategy to be put in place and CEO Robert Purcell is adamant that any deals will be in the industrial chain market where the company’s expertise lies. 

Being a global operator and market leader means it already has regional knowledge and domain expertise, which reduces risk and allows it to gain scale economies from an acquisition. Last year it made the bolt-on deal of Davidson for £3m which added to its already strong position in Australia. Ideally, management would like to do a deal each year of similar size to 2022’s €24m purchase of family-owned YUK in Spain. This increased penetration in the Iberian region, added a competitive conveyor chain manufacturing platform and brought sales synergies from adding YUK products into Renold’s sales network. 

Around 20% of group revenue and profit comes from torque transmission products (TT). This division currently makes similar margins to chain, but sales are lumpier and tend to be later-cycle given the capex nature of the product. Lead times are longer, contracts larger and the product is more bespoke than industrial chain. Management focus is on growing the chain division and acquisitions will be focused on that business, so TT’s importance to the group will diminish over time. 

Finances 

A glance at Renold’s share price, which traded over 300p in the 1990s, tells us that the company has endured a challenging quarter of a century. There was an emergency rights issue in 2009 and an extended period of restructuring and investment. Happily, the company is now on the up. Revenues for the year to March ‘24 are 27% above the FY20 pre covid-19 level. Crucially, margins have improved to 12% in the year just ended, having been stuck in the high single-digit region. Robert Purcell says there are no ‘funnies’ influencing this improvement and that the target is to raise the operating margin into the mid-teens, which does not seem unreasonable for value-added, engineered products. Scale economies and manufacturing efficiencies from automation will bring productivity gains and there is a focus on pricing and sales processes to drive further margin expansion.

Cash flow has benefited from improved profitability and good working capital control. Capex is stable in the £10m area. Year-end net debt peaked at £29.8m in FY23, reflecting the YUK deal; it had fallen to £24.9m this March (after spending £3m on Davidson) which represents a comfortable 0.6x net debt:ebitda ratio. The bank leverage covenant is 3x and the board would take net debt up to 2x in the context of an acquisition - there is no option of issuing equity at current valuation levels. The acquisition pipeline is said to be active and we should expect a deal during FY25. 

The pension fund deficit might have been an issue for investors but this should fade away over the next few years. The IAS19 measure, which is influenced by the discount rate derived from bond yields, fell to £52.7m in September from £62.2m the prior year. More importantly, the company’s ca £6m pa cash contribution is affordable, and projections have the UK scheme’s deficit disappearing by 2031, which means those contributions will revert to free cash flow. The German scheme’s liability will also have halved to just £8.4m at that point. 

Management

Robert Purcell (60) joined as CEO in 2013 from Essentra where he was a divisional MD. Jim Haughey (55) has been CFO since 2020, having held finance positions in a number of engineering companies including FKI, Bridon, Bodycote and Mpac. The company is chaired by David Landless (62) who initially joined the board as a non-exec in 2017, having been Group FD of Bodycote for almost 20 years. It is a conservative and experienced team, with a strategic focus on margin improvement and growing chain division revenue organically and by acquisition. Major shareholders include Canaccord (10%), Jupiter (10%), Janus Henderson (9%), Tellworth (8%). 

Outlook

The year-end trading update issued on 15 April led to 30% eps upgrades for FY25. This reflects overly conservative broker forecasting and the strong margin performance discussed above. Revenue was a shade light for FY24 - the first half was up 8%, implying a second half decline of almost 6%. Robert Purcell pointed out the unusual strength in the comparative period, especially the final quarter of FY23, and the normalisation of inventory and order patterns post covid-19 were also influences. The company had also imposed some energy surcharges the previous year which flattered the top line and were reversed during FY24. Purcell notes that order intake improved in the second half (up 8% on the first half) and that while Europe is a little soft currently, the US is strong.      

Broker forecasts for the current year and FY26 continue to look conservative with only low single-digit revenue growth expected. The trend in eps upgrades has been in place for four years and there should be scope for further upgrades, especially if management is correct in stating that ‘progress continues to be made… driving sustainable margin and profit improvement’ (RNS 15/4/24). Cash flow has ample scope to surprise on the upside and a return to the dividend list is a strong possibility this year. 

Valuation

Renold’s low valuation is a key component of the investment case. The shares have recovered strongly from the distressed covid-19 lows of 2020, but this has mainly been down to upgrades - the stock remained on a miserable rating in the 5-6x p/e range until very recently and took the best part of three years to break above 30p. This created a long base for the chart, with the shares now firmly in an uptrend after breaking out last November. The last couple of months have seen a strong move as small cap sentiment has improved. 

Some consolidation would not be surprising in the near term therefore; but Renold is one of the cheapest shares in the lowly-rated universe of UK small caps. If the company is able to go on and demonstrate margin stability in the 12-15% area while executing an effective debt-funded acquisition strategy, then it could justify a double-digit multiple. Meanwhile the stock has been acting well and making new highs - value combined with momentum is usually a winning combination.             

Ticker: AIM: RNO

Sector: Industrial Engineering

Mid-price: 56.8p

Spread: 56.2p - 57.4p

12 month high/low: 58.5p / 27p

Market cap: £119m

Notes: We interviewed CEO Robert Purcell on 24/4/24. The writer owns shares in Renold.