There’s good money in widgets

“Just one word, Benjamin: plastics! There’s a great future in plastics.”

That’s the advice Dustin Hoffman’s character is given by a family friend in the 1967 film The Graduate.

It might seem a bit strange now, but back in the 1960s, plastics had a sense of promise. Since then they have become part of the everyday – and people are excited about newer, more exotic materials.

However, I recently spoke to an Aim-listed company that clearly believes plastics can still provide it with a great future.

It’s a British company operating in a very competitive area and it makes exactly the sort of thing the Chinese will always be able to do much more cheaply, and yet its shares have doubled over the last couple of years.

To top it off, it’s still trading on a rather modest price/earnings (p/e) ratio. Could this be a good little investment? Let’s have a look.

It’s a niche play

We all know how tough things can be as a UK manufacturer – especially for a small company making components for powerful customers.

Yet that’s exactly what Plastics Capital (PLA) does, and it’s positioned itself to thrive in what will always be a challenging environment.

It does this by producing niche items for specialist purposes – in the words of its chairman, Faisal Rahmatallah, “widgets”.

I’ve always had a lot of time for businesses that do something that seems fairly mundane and dull, but is actually quite specialised. By focusing on a particular niche, a company can build up a lot of know-how and make much more money than you might expect.

So, the company produces obscure, but vital precision components – like ‘creasing matrices’ and ‘mandrels’ – which are classic candidates for a niche approach. It then sells them on to the big industry players.

I’ve mentioned a couple already, but allow me to tell you a bit more about the company’s different ‘widgets’, and who’s buying them.

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First off, Plastics Capital has a 40% global market share in what are known as creasing matrices.

These are strips of plastic that are fitted into a packaging machine in order to crease cardboard. This is how boxes and covers can be efficiently and accurately produced. PLA sells these in 75 countries via a distribution network that it’s built up over a couple of decades.

Another product is mandrels. Mandrels are solid plastic tubes that make the hole in a length of hose.

This might sound a bit mundane, but global auto companies like BMW and Peugeot rely on PLA’s mandrels to make power steering hoses. JCB and Caterpillar also manufacture their hydraulic hoses around them.

Plastics Capital is the UK’s only mandrel producer and the division is growing strongly. Sales were up a hefty 39% last year.

The automotive industry is also a big customer for plastic bearings. These help steering columns and the knobs on a dashboard turn smoothly. Bearings also find their way into photocopiers, where big players like Xerox and Canon are customers.

And last, there is Plastic Capital’s industrial packaging division. This has less of a niche feel to it, but the approach is the same – to provide great customer service with short lead times.

Once an industrial product is manufactured, it is usually wrapped and boxed – that’s all that ‘industrial packaging’ means. PLA aims to supply thinner and lighter wrapping films, which save money and lessen the environmental impact of the process.

So, those are its main products – what does the future hold for this niche player?

Acquisitions could be on the way

Well, while some of PLA’s manufacturing is carried out in Thailand and China, much of the group’s output is exported from the UK – meaning the current strong sterling isn’t ideal.

But other financial measures are looking good. Operating margins are 12% and return on capital has averaged a very respectable 23%.

The balance sheet is also much improved, meaning we should expect to see some acquisitions.

PLA will need to find acquisition targets with the right niche characteristics that will allow it to carry on making good returns.

Now the really important stuff: PLA’s current valuation.

This company is much too cheap

Plastics Capital trades on a modest p/e ratio of 11 times current year earnings, and has a yield of almost 3%.

If we look out to March 2016, that p/e drops to around nine times – which seems much too cheap.

Faisal Rahmatallah told me that he has ambitions to at least double the size of the company from its current £42m market cap.

Some of this growth will come organically, but the right acquisitions will be key. I also think that some of the progress can be made through a re-rating of the shares.

Either way, at these prices I think it’s well worth keeping an eye on.

This article is taken from our FREE penny share investment email Penny Sleuth.
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