Sausage skins maker Devro (DVO) could become a takeover target after it lost one-fifth of its market value today.
Shares in Devro slumped 21.5% to 177.5p on a warning 2017 profits will disappoint and debt is close to breaching commitments given to lenders.
Analyst Sahill Shan at Broker N+1 Singer takes a dim view of the news, downgrading the stock's rating from 'buy' to 'sell'. But Shan says 'corporate activity is probably the best saving grace for long-suffering shareholders.'
Shan adds Devro's ratio of debt to earnings before interest, tax and non-cash items (net debt-to-EBITDA) could hit 2.8 at the end of 2016, just shy of a covenant at 3 times.
'The more worrying issue is around leverage given the debt the company has taken on to invest for growth in China and USA,' writes Shan.
'We expect our leverage ratio for 2017 to nudge up towards 2.5 times vs 2.1 times previously. This compares to a covenant of 3 times. Our 2016 leverage estimate is 2.8 times.'
WEAK TRENDS
Seeking to mitigate weaker volume trends, Devro is accelerating restructuring plans to improve its competitive position, a move that will hurt profitability next year.
In August, Devro said a transition period would be needed to extract benefits from £110m worth of new plant investment in the USA and China. Chief executive Peter Page said 'complexity' in the US and competitive pressure in China were key factors.
Today, Page says third quarter volume trends were broadly similar to the first half, helped by improvements in Russia and South East Asia 'but impacted by further reductions in Latin America'.
Latin America continues to be a drag because of technical issues around supplying the market from Devro's facility in the Czech Republic.
Devro's investment and manufacturing overhaul is having a knock-on impact on sales to the region as it attempts to transfer customers on to new products. Capacity constraints during the transition have also been a factor.
MEATY DOWNGRADES
Based on current trends, Devro expects 2017 sales volumes will be around 10% lower than expectations, with an under-utilisation of its manufacturing footprint set to result in lower margins.
'Management is guiding to no change to 2016 expectations but clearly 2017 numbers will need to be pulled back,' Shan writes.
'Our initial stab would suggest a profit-before-tax downgrade of circa 20% towards £32m - implying a flat outlook vs 2016.'
In order to improve Devro's competitive position, management is pressing ahead with further restructuring plans to reduce unit costs as well as making new investments in next generation products.
