Down 15% in a day, is this my chance to buy shares in this UK small cap?

The best time to buy shares in a company is when other investors don’t want to. But this is easier said than done – when prices are low, there’s usually something that’s putting people off. 

That’s definitely the case with Macfarlane (LSE:MACF) – the firm announced a 10% decline in operating profits and the stock fell 15% as a result. But I’m seeing this as an opportunity.

Profit warning

Macfarlane manufactures and distributes packaging products. And its distribution business – which accounts for 85% of sales and 74% of operating profits – has been under pressure recently.

The firm reported increased caution from customers in terms of new orders, as well as pressure on margins as a result of increased competition and higher costs. That’s not a good combination.

The problem is the company’s distribution focuses on cardboard packaging for the e-commerce industry, which is largely undifferentiated. That leaves it open to the kind of challenges it’s facing.

The manufacturing unit – which makes up 15% of sales and 26% of profits – is doing much better. Tariff uncertainty aside, management reported strong momentum from the unit.

To my mind, that’s not a big surprise. This part of Macfarlane’s business focuses on products that are much more bespoke, technical, and add significant value for customers. 

As a result, margins in this division tend to be much higher. It’s also no surprise to me to see it faring much better in a difficult economic environment. 

Opportunity?

Before the latest news, Macfarlane shares were trading at a price-to-earnings (P/E) ratio of 12. That’s about where the stock has been trading on average over the last five years.

The share price has fallen 15%, which is roughly what I expect a 10% drop in operating income to mean for earnings per share. So I think the P/E ratio is essentially unchanged.

Given this, I think any positive signs from the business in future could very well move the stock higher. And there are reasons to believe some of the recent challenges are likely to be temporary.

Regardless of the macroeconomic environment, customers are likely only able to delay their orders for so long. So I expect demand to return sooner or later and sales to grow when it does.

There’s also an ongoing share buyback programme, which management has stated it intends to continue. And at a lower price, the effect on the number of shares outstanding should be greater. 

Over the long term, I also expect strength in Macfarlane’s manufacturing firm to offset short-term weakness in its distribution business. So I see a drop in the share price as an opportunity.

Manufacturing stocks

It’s an occupational hazard with this type of company that inflation can push up costs and slow sales at the same time. This is especially true with businesses that lack differentiated products.

That’s the situation with Macfarlane’s distribution business at the moment. But the thing I find attractive about the company is – and always has been – its manufacturing division.

It’s the smaller part of the business, but I think there’s a lot to like about it. And the opportunity to buy the stock at a 15% discount is one I’m looking to take advantage of.

The post Down 15% in a day, is this my chance to buy shares in this UK small cap? appeared first on The Motley Fool UK.

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Stephen Wright has positions in Macfarlane Group Plc. The Motley Fool UK has recommended Macfarlane Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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