KGL's Strong Q1 Results Raise Earnings Forecasts, But Long-Term Concerns Linger
Aa
Share
Financial results of KGL in the first quarter were better than our expectations, but above all they indicated a noticeable improvement compared to the poor last year. Particularly noteworthy is the return of the margin in the key production segment to a level slightly exceeding 20%.
If we combine this with a similarly satisfactory distribution margin of 12.6%, the company managed to achieve the highest gross profit on sales in history. There are many indications that a successful Q1 heralds a good year, although we remain cautious about the company's long-term prospects and the possibility of maintaining margins in the longer term.
Nevertheless, after a successful start to the year, we are raising our earnings forecasts for the full year. The company's results are supported both by the market situation in the form of a decrease in the prices of raw materials and energy, but also by the positive results of the optimization carried out. We are therefore increasing our valuation per KGL share from PLN 14.2 to PLN 16.6. At the same time, at the current price of PLN 14.5 per share, we maintain our accumulate rating.
Our valuation and recommendation assume stabilization of margins in the coming years at lower levels than at present. The strategic position of the company remains difficult due to the fact that its key suppliers and customers remain much larger than it, which means their strong negotiating position.
At the same time, the recently observed favorable environment due to the decline in the prices of petroleum products will not last forever. On the other hand, the company improved the management of selected risks that hit it last year and moved margins in the manufacturing segment to record lows.
In the medium term, KGL also benefits from the SUP directive adopted by the Polish parliament, which forces the replacement of polystyrene packaging used in gastronomy with products manufactured by the company. In distribution, a higher share of technical plastics in sales improves margins, albeit at a noticeably lower value of the segment's revenues.
In the longer term, however, the risk related to the possibility of introducing restrictions on selected categories of plastic products remains high. The Management Board of KGL undertook actions which led to the reduction of the company's debt. The concluded sale and leaseback transaction will result in a one-off profit on the transaction in the amount of approx. PLN 5 million, which will be booked in the second quarter. Therefore, it seems that the first half of this year will be very successful for the company.
Only later will it be possible to verify whether the optimization measures introduced by the company will actually achieve lasting success. Especially if in the meantime they were put to the test by changing the market environment to a less favorable one.
Risk factors:
The most important risk factors that may affect the operations of KGL company include:
❑ Regulatory risks. The EU tries to influence the limitation of the use of plastic and increase the share of its recycling through restrictions and taxes. The impact of these regulations on the company is difficult to determine at the moment without knowing the details of the regulations being implemented. The fact that plastic is negatively perceived by lawmakers is certainly a threat to the industry.
❑ Risk of exchange rates and commodity prices. A significant part of goods and materials is purchased in foreign currencies (mainly EUR). Due to higher liabilities in EUR than receivables in EUR, the unrealized negative exchange rate differences with a 1% increase in EUR / PLN would amount to approx. PLN 0.5 million (sensitivity at the end of 2022). The prices of raw materials depend to a large extent on oil prices. As a result of the increase in oil prices, the company's revenues and costs are rising, but at the same time the margin decreases and the net effect is negative.
❑ The risk of rising remuneration costs and shortage of employees. The share of employee costs in total costs in 2022 remained above 19%, despite a significant increase in the share of energy prices in the total cost. As a result of employee shortages and wage pressure, the increase in the cost of salaries reached as much as 27% in 2021. As a result of optimization, the company managed to reduce the growth dynamics in 2022, but it remained at a two-digit level of 10%. Due to demographic trends and high inflation, tensions in the labor market will continue.
❑ The risk of a conflict of interest. In the company, four long-term managers and founders hold a total of 85.1% of votes at the company's AGM. Additionally, four members of the supervisory board have family ties to them. In such a situation, there is a risk of a conflict of interest at the expense of minority shareholders (mitigated by two independent members of the supervisory board).
❑ Risk of over-indebtedness. After 4 years of intensive investments, the company significantly increased its interest debt, which reached the level of 5.1x EBITDA at the end of 2022. This ratio fell in Q1 to 3.8x EBITDA, but it should still be considered elevated. However, the company took steps to reduce it by concluding a sale and leaseback transaction.
The risks that we consider to be high include regulatory issues (political decisions are quite unpredictable and have a large impact on the company), indebtedness and the risk of commodity prices.
