World-leading thread and structural components maker Coats (COA) has set its sights on delivering accelerated cash flow and shareholder returns after de-risking its pension liabilities and divesting non-core assets.
We believe this high-quality business can deliver mid-teens percentage total shareholder returns, which looks very attractive against a PE (price to earnings) ratio of only 10 times and a free cash flow yield of 9%.
Our expectation is based on EPS (earnings per share) growth of 10% a year over the next five years (see more below) and a starting dividend yield of 4%. There is added appeal should investors recognise the company’s attractions and re-rate the shares.
For example, the cyclically adjusted PE is currently depressed and trading close to 10-year lows. Should the rating ‘mean revert’ over the next 12-months, the shares offer 53% upside.
In short, we believe there is tremendous value on offer at Coats which is not being recognised.
NEW MID-TERM TARGETS
David Paja was appointed chief executive in October 2024 and was previously head of GKN Aerospace (part of Melrose Industries), where he played a key role in the successful turnaround of the business and the delivery of profitable growth.
At Coats’ full year results (6 March), Paja laid out new medium-term financial targets for the group following a review of its operations including delivering high-single-digit organic EPS growth and expanding EBIT (earnings before interest) margins to between 19% and 21% from 18% in 2024.
Including acquisitions and share repurchases, the company expects to deliver a CAGR (compound annual growth rate) in earnings of more than 10% per year while maintaining a progressive dividend policy.
The company is targeting $750 million in cumulative free cash flow over the next five years, and intends to make additional returns to shareholders should net debt fall below one times EBITDA (earnings before interest, tax, depreciation, and amortisation).
PENSION HAS BEEN DE-RISKED
One of the drivers of higher free cash flow is the removal of the group’s pension liabilities under its defined benefit scheme. These schemes, also known as final salary schemes, guarantee a fixed income for life based on salary and number of years’ service.
In 2022, the company purchased a bulk annuity policy covering 20% of its liabilities and in 2024 it purchased a £1.3 billion bulk policy from PIC (Pension Insurance Corporation) for the remaining 80%.
The agreement with PIC is anticipated to require £100 million of additional funding by Coats, involving a £70 million upfront payment.
Chief financial officer Jackie Callaway said: ‘From having $3 billion of liabilities across three schemes in 2016, with a Technical Provisions deficit of circa $750 million, we are now securing fully-insured benefits for our pensioners and removing volatility and uncertainty for our investors.’
‘Now the scheme is fully funded and cash contributions have ceased, this will lock in a significant improvement in the group’s free cash generation.’
On 3 April, Coats announced its intention to exit the Performance Materials division’s US business in North Carolina following a strategic review which had already resulted in the closure of the firm’s Mexican facility in December 2024.
The US exit is expected to have a positive annualised impact on EBIT margins not just at the Performance Materials division but across the group.
A RESILIENT, QUALITY BUSINESS
Coats has a strong heritage and has been in business for more than 250 years. The company is the market leader in more than 85% of its product portfolio, and in apparel it is substantially larger than all its competitors combined with an estimated market share of 26%.
The sheer scale of the business, operating in over 50 countries with more than 100 manufacturing sites, gives it a major advantage over its competitors.
The company can provide unrivaled customer service and timely product delivery from its robust supply chain, allowing it to earn superior margins and returns on capital.
In 2024, Coats reported an 18% operating margin and a 38% return on capital employed which, meaning returns have averaged 33% over the last three years.
Meanwhile, healthy cash generation allows the company to invest in research and development which has led to many innovations such as its EcoVerde recycled thread.
In summary, we believe the market is not giving Coats enough credit either for the quality of the existing business or the new CEO’s growth ambitions.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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