Turkey of the week: toiletry-maker about to take a hammering

By Paul Hill Apr 10, 2009

Paul Hill

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Given how sceptical I am about the sustainability of the juicy operating profit margins (EBITA, often over 20%) enjoyed by many branded-goods manufacturers, it may seem odd advice to sell McBride. It is Europe's leading supplier of private-label household and personal care products, and is benefiting from cash-strapped families buying cheaper goods. With lower oil prices starting to feed through to the bottom line, together with most supermarkets launching line after line of new distributor own-brands (Dob), surely this means happy days for McBride?

McBride (LSE:MCB), tipped as a BUY by Numis

In the near term, yes. But McBride is set to become a victim of its own success. First, Dobs deliver lower profit margins (about 5%) than their branded cousins. This is not usually a problem, but in recessions these tend to shrink as supermarkets demand a bigger slice of the action. This doesn't become an issue as long as the extra turnover more than compensates for the lower unit prices (although working capital levels can get stretched as payment terms tend to be 60-90 days).

The real trouble begins later – when the Dobs are taking up so much shelf space that big branded players such as Unilever  and Reckitt Benckiser are forced to retaliate. Although McBride is the biggest Dob player, it's still a relative minnow compared to these giants, who generate much greater economies of scale. So I can almost guarantee that when the inflection point is reached (I suspect towards the end of 2009), then the branded guys will fight tooth and nail to regain market share by slashing prices. Worse still, they will also selectively offer Dobs themselves, possibly selling these at marginal cost. It's good news for thrifty consumers, but the likes of McBride will be hammered. Canadian Dob drinks supplier Cott endured the same fate in the early 1990s when Coke and Pepsi went for the jugular.

In a savage price-war like this, it will be crucial to have a solid funding. Yet this could be a worry for McBride, because as of 31 December it had a £104.7m debt burden, equating to a hefty 3.5 times EBITA (operating profits). The City is forecasting revenues and underlying earnings per share (EPS) of £779m and 9.8p respectively for the year ended June, rising to £806m and 11.5p in 2010. As such the stock trades on frothy EV/EBITA multiples of 11.3 and 10.4, which look far too rich. Regardless of the lift from the weaker pound, I would value McBride on an eight times multiple, giving a share price of around 80p. The next trading statement is scheduled for 30 April.

Recommendation: SELL at 135p

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

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