MPG - Metro Glass

[Beagle]

"Other costs are likely to keep increasing."?????? If MPG used to run full capacity in plant, now as sales come down, they don't need to run full capacity, thus power, water, maintenance, etc will surely come down.

I assumed power and any other direct raw materials are included in the 50% cost of raw materials and I think 50% is an extremely generous guess. If its less, and I think it is, the effect on EBIT of sales reducing by $44m could be considerably more than $22m. e.g. if direct raw materials costs are 33%, a $44m loss of sales and other costs remaining the same would reduce EBIT by ~ $29.5m.

The cost of most commercial leases have ratchet clauses so they go up by a minimum of the inflation rate, usually more, most I have seen are a minimum of 2 or 2.5% per annum reviewed at least biannually.
Most staff want annual increases in their remuneration at least in line with the inflation rate. When was the last time management of any company didn't keep raising their salaries at least in line with the inflation rate ?

I suggest you have a very close look at how their Australian operations turned toxic. Key operational staff leaving, key customers lost and margin pressure were the 3 key reasons going purely off memory. What makes you think that won't happen here ?

[BlackPeter]

"Other costs are likely to keep increasing."?????? If MPG used to run full capacity in plant, now as sales come down, they don't need to run full capacity, thus power, water, maintenance, etc will surely come down.

Maybe some hints related to their cost structure and flexibility in adapting it:

1) They do run actually a very sophisticated factory. Lots of money is in the initial setup (all computer controlled machinery with lots of robots). If volumes go down, than this will do nothing to the initial setup cost and the write offs they will need to continue to earn.

2) They still do need staff with quite specific skills (handling glass and programming / maintaining these amazing machines). I remember they always found it difficult to hire and train this staff and I am pretty sure they don't want to let them go if they see a (what they might think) temporary slump. It would be very difficult and expensive for them to rehire suitable staff. I.e. very limited cost saving potential if times get tough unless they know that they want to wind down.

3) One of their competitive advantages is still that they are still able to supply custom cut glass basically overnight anywhere in NZ. This requires a large factory network and a large fleet with high base costs. Same cost whether you move that truck no matter whether it carries 50 or just 25 sheets of glass. Not sure it would do their business any good if they reduce the number of their tours when volume goes down, because this would mean that customers are supplied slower than before. Time is money in the building industry. Just one less competitive advantage they might not want to lose when times get tough.

To be honest - I do not see a lot of fat they could cut out of their operations without removing essential muscles ...

I think a better strategy for them could be to build on their strength (market share and large customer and supplier network) and take on the competition by providing as well complete window solutions instead of just glass. However - this would mean a significant investment and I am not quite sure either where the money would come from (big CR at rock bottom prices = terrible dilution?). I am as well not sure whether the current board and management would have the vision and skills to pull this through.

While I am as well sort of wondering whether there are currently some bargains available in the building industry - I am not sure, whether MPG might be currently the best bet for a dog of the NZX strategy ...

[mikeybycrikey]

Your argument is valid but I can't agree. If sales were down, labour cost would be surely come down and other costs as well. This is the way of running business. I understand MPG will face big challenges but thanks to the recovering property market and now construction activities are much stronger, thus I don't think MPG won't survive.

TA means nothing to me. When I bought THL at 66C in 2009, the chart was very similar to the one MPG is now. And then you know what happened to THL in later years.

I would have to agree with Beagle here.

Cutting staff and other expenses is always going to lag falling sales. Even if MPG are successful in keeping the business afloat and getting EBIT margin to 14%, there will a significant period where that margin will drop. Maybe a couple of years or so?

The other risk in cutting staff numbers is that, if you decide to cheerfully fire a quarter of your employees because sales are down by a quarter, you will then start losing all your best employees too because they will get out while they can.

I was working somewhere a few years back where morale was low. Every week there was someone with 20 years experience leaving. Cutting expenses is hard and very risky.

It's too soon to know the final outcome here but it's going to be a difficult few years for the company.

[Balance]

"Other costs are likely to keep increasing."?????? If MPG used to run full capacity in plant, now as sales come down, they don't need to run full capacity, thus power, water, maintenance, etc will surely come down.

Economics 101 - fixed vs variable & marginal costs of production.

Basically, past the inflection point, gross & net margins go through the roof.

Best example my university professor used - think of the airline or hotel business.

They work on a rather simple formula:

- at 60% to 65% load or occupancy factor, they break even

- at 65% to 80%, they start making increasing returns on their operations

- at 80% and above, they start making super profits.

Why? Fixed vs variable & marginal cost of providing the service on additional sales.

[Lease]

I assumed power and any other direct raw materials are included in the 50% cost of raw materials and I think 50% is an extremely generous guess. If its less, and I think it is, the effect on EBIT of sales reducing by $44m could be considerably more than $22m. e.g. if direct raw materials costs are 33%, a $44m loss of sales and other costs remaining the same would reduce EBIT by ~ $29.5m.

The cost of most commercial leases have ratchet clauses so they go up by a minimum of the inflation rate, usually more, most I have seen are a minimum of 2 or 2.5% per annum reviewed at least biannually.
Most staff want annual increases in their remuneration at least in line with the inflation rate. When was the last time management of any company didn't keep raising their salaries at least in line with the inflation rate ?

I suggest you have a very close look at how their Australian operations turned toxic. Key operational staff leaving, key customers lost and margin pressure were the 3 key reasons going purely off memory. What makes you think that won't happen here ?

Power , water, maintenance are overheads that are not cost of sales, which are not included in the 50% cost of raw materials.

Commercial leases no longer have impact on bottom line as IFRS 16 took effect on 1 Jan 2019, which rules all commercial leases need to be capitalised.

Salaries, as I said, labour costs will come down with reduced sales.

THL is a very different company? But you said "Long, hard earned experience has taught me never to buy stocks with charts like that. You almost always lose."

[Lease]

I would have to agree with Beagle here.

Cutting staff and other expenses is always going to lag falling sales. Even if MPG are successful in keeping the business afloat and getting EBIT margin to 14%, there will a significant period where that margin will drop. Maybe a couple of years or so?

The other risk in cutting staff numbers is that, if you decide to cheerfully fire a quarter of your employees because sales are down by a quarter, you will then start losing all your best employees too because they will get out while they can.

I was working somewhere a few years back where morale was low. Every week there was someone with 20 years experience leaving. Cutting expenses is hard and very risky.

It's too soon to know the final outcome here but it's going to be a difficult few years for the company.

Agree. There are timing differences. I don't deny MPG are facing difficulties. But unless it goes bust, MPG will eventually find its position.

It has 50% market share. How can they get this large scale of shares if they provide bad quality products and services? Therefore I really think people are overreacting the issues and totally ignore its competitive advantages.

Plus the construction activities have picked up since 2nd half last year. The marco environment is also favourable.

[Lease]

Economics 101 - fixed vs variable & marginal costs of production.

Basically, past the inflection point, gross & net margins go through the roof.

Best example my university professor used - think of the airline or hotel business.

They work on a rather simple formula:

- at 60% to 65% load or occupancy factor, they break even

- at 65% to 80%, they start making increasing returns on their operations

- at 80% and above, they start making super profits.

Why? Fixed vs variable & marginal cost of providing the service on additional sales.

The biggest fixed cost I can think is commercial leases. But as I mentioned above, commercial leases need to be capitalised so no longer affect bottom line.

[Balance]

The biggest fixed cost I can think is commercial leases. But as I mentioned above, commercial leases need to be capitalised so no longer affect bottom line.

Head office costs, depreciation & amortisation (plants & equipment actually do wear out & need to be replaced), sales & marketing costs, insurance, interest (especially when penalties are imposed for breach of covenants) - they all have to be covered first to stay in business.

[Beagle]

The biggest fixed cost I can think is commercial leases. But as I mentioned above, commercial leases need to be capitalised so no longer affect bottom line.

The reality of this new IFRS standard if you read through a few company reports is that commercial lease expenses are ostensibly simply reclassified and I can assure you the cost still exists and very much affects the bottom line. Have a look at HLG's 2019 annual report, (possibly one of the more straightforward annual reports out there that covers this subject well enough).

Balance's analogy with hotel and airline operations is bang on the money.. Once you lose a certain amount of business and / or margin (for whatever reason) you start losing money hand over fist, that much is abundantly clear from their Australian acquisition. Anyone who wants a case study in how things turn sour need look no further than that example for further detailed evaluation.

[Lease]

The reality of this new IFRS standard if you read through a few company reports is that commercial lease expenses are ostensibly simply reclassified and I can assure you the cost still exists and very much affects the bottom line. Have a look at HLG's 2019 annual report, (possibly one of the more straightforward annual reports out there that covers this subject well enough).

Balance's analogy with hotel and airline operations is bang on the money.. Once you lose a certain amount of business and / or margin (for whatever reason) you start losing money hand over fist, that much is abundantly clear from their Australian acquisition. Anyone who wants a case study in how things turn sour need look no further than that example for further detailed evaluation.

In HLG case, IFRS 16 make them worse off-$2m extra expenses on P & L. But for MPG, it will increase EBIT by $1.7m(see interim report page 6)