Closing in on Metalrax

So, Metalrax coats steel, engineers machinery and makes bakeware, and it’s had a calamitous few years. It’s also cheap, appears to be recovering, and is uncomfortably indebted.

All that remains is to confirm my suspicion that unprofitable acquisitions did it in, and that management has a credible recovery plan including debt reduction.

I didn’t have to look much further than chief executive Andrew Richardson’s comments in the preliminary results announced in March to establish what went wrong:

When the new management team took over in 2007, the Metalrax Group was already in severe decline with a number of damagingly loss making businesses. The Group had been paying an uncovered dividend that had weakened its cash position leading to borrowings of £19.4m; and that was before the credit crunch, the ensuing financial market uncertainty and economic recession. Over 2008 and 2009, six loss making or non-core businesses were sold and three were closed. The Group has been restructured and refocused. The Group started 2010 in a much leaner shape and this structure is reflected in these financial statements.

In his 2009 annual report, he went further, devoting page 10 to answering the big question:

Where has the shareholders’ value gone in the last decade?

The chart on the left, plucked from page 10, is an analysis of the movement in shareholder value between 1999 (when shareholders’ funds were £46.4m) and 2009 (when shareholder’s funds were £16.5m) so we can see the management errors that lead to the shrinkage of the company.

There were two big errors: £22.9m in losses associated with four business Metalrax acquired in 2005 and 2006 and the continued payment of a dividends worth £19.4m between 2005 and 2007 when the company only made a net profit of £2m. Over the ten year period it paid out more in dividends than it earned in profit.

It seems to have taken a change in management for Metalrax to appreciate the hole it was burying itself in. Richardson has sold off loss-making businesses and rationalised and combined others so there are now nine, where once there were 23. Within the remaining businesses Metalrax is reducing costs, strengthening management teams, and re-focusing on niche markets, actions summarised in a table taken from the 2009 annual report (right).

Reassuringly, considering my reservations about the debt the company has run up, Richardson says his priority is to pay off debt from the cash the company earns, and assets it can sell.

These are exactly the words I want to read, and I think a chief executive who can so clearly and candidly explain what went wrong with his business, and what he’s doing about it is a. unlikely to make the same mistakes again and b. probably worth backing.

My only concern is that some of the properties Metalrax is selling aren’t vacant. Metalrax intends to lease them back. But paying off bank debt with money obligated to landlords and leasing companies is just replacing one kind of debt with another kind of debt as Anderson acknowledges:

The board believe that reducing the Group’s debt is imperative and with that objective embarked on a property sale and leaseback plan despite the longer term lease liabilities The Board believe that the Group can generate better long term returns with the headroom generated by the debt repayment.

I’m not sure how to interpret the second sentence in his statement. The bigger the gap between Metalrax’s debt and the amount it’s allowed to borrow by its banks, the less likely they are to withdraw funding. If Metalrax can’t increase the gap quickly enough by earning the cash and selling off assets it doesn’t need, sale and leaseback smacks a bit of desperation.

I had hoped I would get a feel for how much of total borrowings Metalrax is repaying, and how much it’s transferring into lease commitments by charting its borrowings and lease commitments over time, but unfortunately lease commitments are not documented in the preliminary results.

That’s one of the reasons I prefer to base decisions on the information in annual reports and Metalrax is due to distribute its 2010 annual report on Tuesday. Then I’ll get an opportunity to complete the tables and charts on the left.

Hopefully it will convince me debt is coming down and not just being moved around because I like Metalrax, its prosaic businesses, its straight talking chief executive, and the rest of his recovery plan.

Sorry to drag the Metalrax saga into one further instalment. At least you get to read about every twist in the tale!