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$AVON.L Protection equipment manufacturer hit with 💥GLITCH💥
World leading ballistic and respiratory protection business hit with glitch
Avon Protection announced Friday morning that they will be proceeding with a strategic review of their Body Armour business. The wording of the announcement was rather painful😢
Body armor update
Following the contract awards for the U.S. Defense Logistics Agency ("DLA") Enhanced Small Arms Protective Inserts ("ESAPI") and U.S. Army Vital Torso Protection ("VTP") ESAPI body armor plates, we have been engaged with our customers to complete the necessary product approval processes. Disappointingly, the VTP ESAPI plates have encountered a failure in First Article Testing which will significantly delay the likely approval timetable for this product.
Separately, we have experienced further delays in obtaining final product approvals for the DLA ESAPI body armor plates, with approvals for this product now expected in the second quarter of our financial year ending 30 September 2022 ("FY22").
Strategic review of body armor business
In light of these challenges, the Board has initiated a strategic review of our body armor business.
Our FY22 revenue guidance included approximately $40 million of body armor revenue. In light of the above, the financial contribution from our body armor business in FY22 and beyond will be significantly reduced, with the ultimate impact, including any associated cost savings, depending on the outcome of the review process.
These issues and the strategic review are restricted to the body armor business, with the Group's leading respiratory protection and helmet product portfolios unaffected.
Delay to FY21 results announcement
Our underlying trading results for FY21 are expected to be in line with the guidance set out in the post close trading update of 13 October 2021.
We have delayed the announcement of our FY21 results, initially planned for 23 November 2021, to allow for a review of the carrying value of the assets related to the body armor business and the additional audit work arising from this post balance sheet event.
We will confirm a revised announcement date, which we expect to be in early December, as soon as practicable. We will include an update on our strategic review of our body armor business and provide updated guidance for FY22 and beyond alongside our FY21 results announcement.
Now, the VTP ESAPI (the new generation one, the DLA ESAPI being the outgoing Body Armour) also failed First Article Testing last December.
The company had prepared for almost a year to pass this testing and did their own internal tests which had passed. They were shocked to find out it failed again, and the company has no insight as to what might have caused this.
They did mention in the first half 2021 earnings call that they made upgrades to both ESAPI products and were positive in terms of the second testing. The VTP ESAPI testing has failed though and they are faced with a serious glitch.
Avon might decide to close down this business and take the loss, or it may decide to allocate more resources to get it to pass testing in the next quarters.
Financial Year 2022 guidance included $40 million of Body Armour revenue. To be on the safe side let’s consider that the company loses all that, leaving us with the other two business lines. Helmets and Respiratory.
Total FY22 revenue was expected at $320-340 million. Body Armour was expected to contribute $40 million (15%) of that. That leaves Avon with ~$300 FY22 revenue, targeting operating margins of 20%. Hardly a disaster..
But let’s take a small step back.
What is the Avon strategy?
The Avon strategy can be summarised in three points.
Growing the Core
Selective Product Development
Value Enhancing Acquisitions
This strategy has transformed Avon since 2017, as the company has not only developed products internally and grown organic sales but also executed two acquisitions.
In the past 12 months Avon has completed the acquisition of Team Wendy (head protection) and 3M’s Ceradyne (ballistic protection).
The product that failed ESAPI testing belongs to the Ceradyne Body Armor unit. However Ceradyne also sells helmets which take up the bulk of its business. So let’s scratch off one of the two Ceradyne segments and analyse the remaining business.
The Ceradyne Helmet business makes ballistic helmets. Team Wendy makes non-ballistic impact protection helmets. And legacy Avon is a leader in respiratory equipment.
All these lines are strong and stable, with predictable cash flows from contracts with NATO, DoD (U.S. Department of Defense) and RoW (Rest of World) clients.
Margins on these businesses are expected to expand further as increased sales from new clients and synergies drive margin expansion. To illustrate, operating margin was 14.3% in the first half of 2021, while the target is 20% for the medium-term.
In the first half of 2021 revenues were $122 million and operating profit was $17.5 million.
Avon spends more than 5% of sales on R&D to grow the current product line and achieve more clients and sales. The future looks bright for the business.
💰We have a credit facility and we’re not afraid to use it 🔫
Avon holds no significant cash balances at the time, having completed two recent acquisitions, but Value Enhancing Acquisitions is one of the three strategic pillars of the company.
There is a $200 million credit facility in place and it can be used to fund further acquisitions. Acquisitions at previous valuation multiples (~10X EBITDA) could result in serious value creation for the company.
Avon is dominant in respiratory protection, less-dominant in helmets but pretty strong and not dominant in ballistic armour which is a pretty fragmented sector. Management has signalled that the space for M&A is vast, but that they are only willing to acquire high quality businesses.
With the friday morning drop, share repurchases could also create significant value for shareholders. We look forward to see in the coming weeks how management will decide to play this whole Body Armour debacle.
It is worthwhile to note that a strong mindset and emotional resilience is possibly the most important strengths to have as an investor.
"In the stock market, the most important organ is the stomach. It's not the brain."
And God knowns Friday’s drop was sickening!
Uncertainty may be high for Avon, as the company goes through the strategic review of Body Armour and tries to resolve what to do with the failure. But without uncertainty it’s hard to get a good price when investing in a company. High uncertainty usually comes with a high discount.
Looking at the 5 year chart makes one think that it’s going to 0. I doubt it.
Too Long, Didn’t Read
High quality growing business with robust balance sheet fails first article testing twice, on top of supply-chain issues and approval delays. The short-term has not been easy for Avon but the long-term seems rather good.
Organic/Inorganic growth as well as share repurchases are expected to increase the company’s bottom line further.