Unmasking Avon Rubber

Updated: Mar 4

Avon Rubber is a UK-listed provider of specialist defence equipment to governments, militaries, law enforcement and health and fire services. It is known for its respiratory equipment, where it is a market leader in the provision of gas masks and other technical breathing systems. Avon has delivered stunning returns for shareholders, with the stock up 300% during the last 5 years. Its operating results continued to deliver until a recent stumble reported in December 2020. This article aims to analyse whether now is an opportune moment to buy shares in Avon.



Soldier in foreground in front of an army barracks wearing Avon Rubber's M50 Mask System
Avon Rubber's M50 Mask System

Avon Rubber started its corporate history in 1885 as a rubber manufacturer, making tyres, conveyor belts and agricultural equipment. In the 1940s, Avon secured British government contracts to supply gas masks for the war effort and rapid global expansion followed in the years thereafter. Avon then specialised in two separate fields with some acquisitions in the early 1990s — the respiratory protection segment, and the dairy segment, which provided seals and rubber liners used in the milking process under the brand name ‘Milkrite’. The business went from strength to strength, and in 2008 Avon won a 10-year sole-source contract to supply the US government with M50 respiratory masks. Several bolt-on acquisitions followed, beefing up both respective business lines. In 2019, a transformational acquisition occurred, Avon purchased the ballistic protection business from 3M — the American industrial conglomerate for an initial cash consideration of $91m, with a final value of up to $116m dependent on winning various contracts. This enhanced the fast-growing protection business under Avon’s growing roster of products and eventually led to the decision to spin off the dairy business in 2020 for a consideration of £180m. With the remaining cash left over from the disposal of the Milkrite dairy business, Avon purchased a protective helmet manufacturer — Team Wendy, in 2020. These recent acquisitions have re-shaped Avon Rubber from a fragmented supplier of respiratory protection and agricultural equipment into a leading defence product supplier with global scale.


In terms of recent performance, Avon has been focused on digesting its most recent acquisitions. Orders received in 2020 were up 23% and the order book (a precursor to revenue), was up 117%, largely due to the integration of order books from acquisitions. A key benefit to a business such as Avon’s is that trading is underpinned by multi-year contracts to supply government bodies. A major win in this regard recently was the 10-year contract to supply NATO with FM50 Mask systems. The first order received in 2020 was for $33 million. Focusing on the protection business (stripping out results from the dairy business which has been sold), military, first responder and fire business segments performed -£3.1m, +£8.2m and -£5.0m respectively to deliver roughly flat organic growth in 2020. The addition of £40.8m of revenues contributing from 3M’s ballistic ‘Helmets and Armour’ business means as a whole 2020 revenues delivered 30.8% growth. On the balance sheet, Avon ended the year with net cash of £93.2m, bolstered by the sale of the dairy business, which will swing to a small net debt position in 2021 after the Team Wendy acquisition is paid for.


However recent updates from Avon Rubber have not all been positive. In Mid-December, Avon gave investors a double-barrelled update of negative news (if only we were wearing our helmets!) as the stock price consequently fell by 20%. The shares had already fallen from their peak by around 17% prior to the announcement (an unfortunate sign — maybe some market participants were already aware of the negative news coming) so the additional fall compounded losses for investors. The worst of the news pertained to significant delays in a key contract with the US government for the procurement of body armour plates and protective armour inserts. A failure in First Article Testing has scuppered Avon’s chances of getting these products approved for use in 2021 and thus contracts will be deferred to 2022. Whilst deferred revenue is better than lost revenue, the market will rightly be concerned as to whether this testing failure persists and the contracts will be won by other suppliers. Separate news of a protest to a sole-source contract for US Army helmets was equally unwelcome news, especially regarding Avon’s chances of winning lucrative sole-source contracts in the future. These updates likely reflect teething issues with new acquisitions, showcasing the increased risk of purchasing other companies where the operating environment is less well known to management.


A detailed table containing financial statistics for Avon Rubber.

Avon is switching to reporting in USD for 2021, thus financial data and estimates have been provided in dollars.


Looking at the financials, on an underlying basis, performance has been good. Revenue growth has been boosted by acquisitions, but growth looks set to continue at high rates through 2022, even adjusted for the delays to contracts mentioned above. Adjusted EBITDA margin reflects the profitable market Avon has carved out for itself, with projected growth in margins to continue into 2022. Looking at these metrics there are 3 points of concern. Firstly, organic revenue growth. Results in 2020 strip out the contribution from the dairy business, and therefore reflect the growth rates of the underlying protection business. On an organic basis, 4.2% in 2019 and 0.1% in 2020 is paltry growth compared with the total result, reflecting the integration of acquisitions. Reading the company website, Avon looks to target a 3% organic growth rate, which, if acquisitions were halted, would not make for spectacular results — especially when Avon trades at a premium ‘growth’ multiple to the wider market. The second flag is highlighted by the official return on capital employed (ROCE) figures, which the graph below can better depict.


Avon Rubber ROCE (Return on Capital Employed) showing roughly 60% in 2017, roughly 40% in 2018, roughly 20% in 2019 and roughly 5% in 2020.

ROCE is a measure favoured by many well-known investors, due to its ability to show how productive a company is with its capital allocation. Whilst the company report their ROCE figures annually, showing 2020 ROCE on an adjusted basis at 22.7%, on an unadjusted basis ROCE has been declining for the last four years. Although ROCE in 2017 is un-realistically high, the decline is likely a symptom of acquisitions, something Avon has plans to pursue over the medium term. Acquisitions have been kind to Avon, however, without enhancements from these acquisitions, delivering long term organic growth, Avon’s ability to acquire their way into revenue growth may be limited.


Lastly, there is a flag around research and development investment. The 5.4% R&D to sales ratio in 2020 resulted in a net spend of approximately $9m. On a global stage, with other much larger conglomerates battling for contracts, I think Avon is critically underspending. You could argue Avon is choosing to spend in research and development with its acquisitions, and that its peers have a similar ratio, but if one day Avon looks to reduce acquisitions and boost organic growth, $9m will not be enough.


In summary of Avon’s financials, things are far from bulletproof. The investment proposition works for Avon on an adjusted basis, but as an aggressive acquirer, Avon will need to have a cycle of success to prove it can deliver growth and digest its recent purchases. I am also not convinced of the companies adjustments, as if acquisitions were excluded, R&D would have to be much higher, therefore denting the level of profitability.


On a balance, I think Avon presents an interesting opportunity. The recent stumble has reduced the valuation from the recent average of around 35x earnings to 23x approximate estimates for 2022. Avon operates in an attractive industry with long-term contracts and best in class products, and now the dairy business has been offloaded, Avon is a much more focused business. However, recent contract delays and protests could get worse. It could be a sign of Avon’s management not being fully aware of the challenges related to recent acquisitions. At the time of the transaction, market commentators were quick to proclaim 3M sold the ballistics business too cheaply. Could this testing failure be the reason? Considering its reliance on acquisitions, low organic growth prospects and muted efforts in research and development, I think investors should consider the facts before considering adding Avon Rubber to a portfolio. I think the recent price drop provides a nice entry point into the business, but I would be keeping any position to a small holding and wait for more news on the execution of acquisitions and organic growth improvement.


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For disclosure, The Twenties Trader does not own shares in Avon Rubber.