Well equipped for the future

SMALLER COMPANIES

ATLAS Converting Equipment is a growth star of the 1980s that hit hard times in the 1990s recession. It is a manufacturer of capital equipment, so turning points for the group's business come late in the cycle. The second half of last year was poor, but the group ended the year with such a dramatic improvement in its order book that it is building new capacity. The pros-pect is for a sustained upswing in demand to take profits steadily higher. Allied to a 4.5 per cent yield at a price of 608p, the shares look an attractive investment.

There is some argument over just how good the outlook is for a company that prefers to attend to business rather than talk to analysts and journalists. The question-mark is over margins. If sales volumes pick up as expected and margins return to anywhere near the levels achieved in the late 1980s, profits could be heading towards pounds 10m by calendar 1997 against the pounds 3.7m reported for 1994.

But a more conservative view is that the balance of power in the industry has shifted from suppliers to customers, and this will keep margins under pressure. Even on this view, there should be mileage in the share price, but it may take longer to come through.

The group was founded in 1977 - when it operated from a garage - by current chairman and managing director Chris Rogers. Its principal activity is the manufacture of slitting and rewinding equipment to go on the end of packaging lines for a wide range of mass consumer products, such as cigarettes. The key feature of the 1980s was the spectacular growth in the size and value of these machines.

By the end of the decade, the group was making 8-metre monsters selling for up to pounds 1.5m to customers more concerned with reliability and performance to keep their production lines rolling than with fierce haggling over price. Between 1983 and 1991, sales grew from pounds 3.8m to pounds 48.5m and profits from pounds 390,000 to pounds 6.7m.

The next three years were much tougher, as a handful of companies in a niche business fought to maintain market share against a background of recession. The group's main rivals are in Germany and Japan. Some 90 per cent of group output is exported. Last year, for example, 37 per cent of sales went to the Americas and around 20 per cent to the Far East and Europe. The Germans, in particular, had been fighting desperately to maintain market share and are believed to be making losses. These have been exacerbated by the strength of the deutschmark. These trends underpin the belief that at some point the Germans and the Japanese are going to have to target profit rather than turnover, enabling everybody to achieve higher gross margins with dramatic benefits for the already solidly profitable Atlas.

The group also has the benefit of a strong balance sheet, having raised money by a rights issue earlier in the 1990s. This means the group has been able to keep investing both in its factories and in marketing. There are sales offices in Singapore, Hong Kong and Charlotte, USA, which have become increasingly important as business develops.

A further factor that should boost future performance is a turnaround at the group's General Vacuum Equipment subsidiary. This has been a trouble- some business since it was acquired in the 1980s, but it finally returned to an acceptable level of profitability last year.

It uses vacuum techniques to produce metallised packaging for keeping short shelf-life foods, such as crunchy bars and peanuts, crisp and fresh.

An encouraging feature of the improved order book is a better mix of business. In particular, there has been a notable improvement in demand for larger, more standardised machines. This is good news for profits because it means there will be a tendency for gross margins to improve. Better sales, better gross margins and contained overheads then lead to the operational gearing effect, by which a given increase in sales can lead to a much sharper increase in profits. Atlas looks well placed to benefit from just such an upswing over the next two or three years.

Forecasts for this year are pitched around pounds 6m, rising to pounds 7m-plus for 1996, with earnings per share going from last year's 23.5p to 38p and then 45p. Those numbers would drop the p/e ratio to 16 and then 13.5, which would look attractive if there is more good growth to come through in 1997. Atlas is a classic late-cycle share, and its prospects took good.