Boosting North American presence

discoverIE Group 23 April 2019 Update
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discoverIE Group

Boosting North American presence

Year-end trading update

Electronic & electrical equipment

23 April 2019

Price

431p

Market cap

£348m

€1.15:NOK11.05:£1

Net debt (£m) at end H119

62.6

Shares in issue

80.7m

Free float

96%

Code

DSCV

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

7.2

9.3

0.2

Rel (local)

3.5

1.5

(0.3)

52-week high/low

455p

325p

Business description

discoverIE (formerly Acal) is a leading international designer and manufacturer of customised electronics to industry, supplying customer-specific electronic products and solutions to 25,000 industrial manufacturers.

Next events

FY19 results

4 June 2019

Analyst

Katherine Thompson

+44 (0)20 3077 5730

discoverIE Group is a research client of Edison Investment Research Limited

discoverIE has acquired two high-margin design & manufacturing (D&M) businesses for initial consideration of £15.9m, and raised £28m net from the issue of 7.3m shares at 400p per share. The acquired businesses strengthen discoverIE’s position in the magnetics and sensor markets, increase presence in North America and open up organic growth opportunities in the group’s target markets. The placing brings the group’s gearing down and provides headroom for further acquisitions.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

03/17

338.2

17.8

19.9

8.5

21.7

2.0

03/18

387.9

22.6

23.0

9.0

18.7

2.1

03/19e

438.5

27.0

26.9

9.5

16.0

2.2

03/20e

465.4

30.6

27.6

10.0

15.6

2.3

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Acquiring magnetics and sensor businesses

discoverIE has acquired two D&M companies, Hobart Electronics and Positek, for total initial cash consideration of £15.9m. Operating in the magnetics and sensor markets respectively, the acquisitions enhance the group’s international operations, add cross-selling potential, and bring higher operating margins to the group. The company has placed 7.3m shares at 400p per share to raise net proceeds of £28m, which will be used to reduce debt and for general working capital. The company expects the combined acquisitions and placing to be neutral to EPS in FY20 (it would have been c 2% accretive on a 100%-equity funded basis).

Positive trading update; estimates revised up

The company saw strong trading in Q419 to close the year with reported revenue growth of 13% (ahead of our forecast). Constant currency organic growth in orders of 9% for D&M and 5% for Custom Supply in Q419 positions the company well for growth in FY20. We have revised our forecasts to reflect the two acquisitions, the placing and the strong trading update for FY19. We lift our FY20 revenue forecast by 4.5% and, as both acquisitions have higher operating margins than the existing D&M division, group operating margin expands slightly in FY20. We have cut our net debt forecasts and now expect a net debt/EBITDA ratio of 1.3x by the end of FY20, down from our previous 1.8x estimate.

Valuation: Growth strategy supports upside

For FY20e, the stock is trading on an EV/EBITDA of 10.4x (at an 8% discount to its peer group) and at an 8% discount on a P/E basis. With continuing growth and higher margins, further progress in increasing the weighting of business towards D&M (including accretive acquisitions), combined with good control over the profitability of the CS business, should help to close the valuation gap. The stock is also supported by a dividend yield of more than 2%.

Two D&M acquisitions; one placing

discoverIE has made two acquisitions in the D&M business, Hobart Electronics and Positek, with initial consideration totalling £15.9m funded through debt. It has also placed 7,309,867 shares at 400p (at a 3.85% discount to the 416p closing price on 15 April) to raise gross proceeds of £29.2m and net proceeds of £28m. This represents 9.96% of the shares outstanding prior to the placing. Proceeds will be used to reduce debt and for general working capital purposes.

The company expects the combination of the two acquisitions and the placing to have a neutral impact on EPS in FY20. If the acquisitions had been 100% equity-funded, the combined deal would have been EPS enhancing by c 2%.

Hobart Electronics – boosting US magnetics presence

Coil-Tran Corporation, which is trading as Hobart Electronics, is based in Hobart, Indiana, and designs, manufactures and supplies customised transformers, inductors and magnetic components for niche applications. It has four manufacturing facilities: two in the US (Tempe, Arizona and Hobart, Indiana) and two in Mexico, and employs c 260 people in the US and Mexico.

The business is currently run by the founder’s son, Mr Gary Kriadis, who is also the sole shareholder of the company. Mr Kriadis and his management team will stay with the business, which will retain its brand identity within the Noratel division.

In CY18, the business generated revenues and profits as per Exhibit 1. In 2015, Hobart acquired a business called Imag, and since then has doubled revenues. The organic revenue growth rate is c 6%. 94% of revenues are generated in North America and c 74% of sales are into the energy infrastructure and industrial markets.

Exhibit 1: Financial performance of Hobart Electronics

CY18

$m

£m

Revenues

13

10

EBITDA

2.1

1.6

EBITDA margin

16%

16%

Operating profit

2.0

1.5

Operating margin

15%

15%

PBT

2.0

1.5

Gross assets

6.9

5.3

Source: discoverIE

Management’s rationale for the deal includes:

building the group’s position in North America. Adding Hobart’s revenues will double the amount generated in North America by the group’s magnetics business;

addition of a strong management team; and

addition of manufacturing facilities in Mexico, which should support expansion of the North American business.

Positek – strengthening the Variohm sensor business

Positek is a UK-based designer and manufacturer of rugged, high-accuracy linear, rotary, tilt and submersible sensors. Roughly 60% of sales are into the industrial sector. On a geographic basis, 15% of sales are generated in the UK, 50% in Europe, 20% in North America and the remainder in Asia Pacific. In the year to 31 August 2018, the company reported revenues of £1.5m, underlying EBITDA of £0.6m (40% margin) and reported PBT of £0.4m. Gross assets at this date were £1.3m. Positek will operate within the Variohm division and retain its own brand identity.

Initial cash consideration of £15.9m for both deals

For Hobart, discoverIE is paying initial cash consideration of $15.2m/£11.7m and contingent cash consideration of up to $4.0m/£3.1m subject to achieving certain profit and integration targets in the next 18 months.

For Positek, discoverIE is paying initial cash consideration of £4.2m and contingent cash consideration of up to £0.4m subject to achieving certain profit and integration targets in the next 18 months

The table below shows the enterprise value (EV) multiples for each acquisition and the same multiples for discoverIE based on our forecasts and the share price at close on 15 April.

Exhibit 2: Valuation multiples

Hobart

Positek

discoverIE

EV £m

11.7

4.2

372

EV/Sales (x)

1.2

2.8

0.9

EV/EBITDA (x)

7.3

7.0

10.5

EV/EBIT (x)

7.8

7.6

12.6

Source: Edison Investment Research

Positive FY19 trading update

The company also provided a trading update for the quarter and year just ended, with growth in revenues and orders as per Exhibit 3. In Q419, organic growth remained strong in both divisions, as did order intake. We note that our FY19 revenue forecast prior to this update was for growth of 10.5% on a reported basis.

Exhibit 3: Revenue and order growth rates

Revenues

Orders

FY19

Q419

FY19

Q419

Group growth

Reported

13%

12%

Constant exchange rates (CER)

14%

14%

Organic*

8%

8%

7%

8%

D&M organic

10%

9%

11%

9%

Custom Supply organic

5%

7%

3%

5%

Source: discoverIE. Note: *Organic growth is on a CER basis and excludes Santon and Cursor Controls acquisitions.

The company also noted that cash generation was good during Q4 and that net debt at the end of the year was lower than expected, with net debt/EBITDA of 1.8x (1.5x when factoring in acquisitions and placing), compared to our forecast of 2.0x.

Changes to forecasts

We have revised our forecasts to take account of the better than expected trading in Q419, the two acquisitions and the placing. In FY20e, D&M revenues as a proportion of total revenues move up from 61.9% to 62.7%, and the share of operating profit from D&M moves from 80.3% to 80.9%. On the basis of stronger trading in H219, we lift our FY19 normalised EPS forecast by 2.4% and FY20 by 0.3%.

We note that our estimate for net debt/EBITDA reduces to 1.3x from 1.8x by the end of FY20. The company commented that while no further acquisitions were imminent, they would continue to consider acquisition targets and now have more financing headroom to fund this.

Exhibit 4: Changes to estimates

£m

FY19e old

FY19e new

Change

y-o-y

FY20e old

FY20e new

Change

y-o-y

Revenues

428.5

438.5

2.3%

13.0%

445.4

465.4

4.5%

6.1%

Custom supply

168.0

171.9

2.3%

4.0%

169.7

173.7

2.3%

1.0%

Design & manufacturing

260.5

266.5

2.3%

19.7%

275.7

291.7

5.8%

9.4%

Gross margin

33.0%

33.0%

0.0%

0.4%

33.0%

33.0%

0.0%

0.0%

EBITDA

35.3

35.8

1.5%

22.1%

37.4

39.7

6.2%

10.9%

EBITDA margin

8.2%

8.2%

(0.1%)

0.6%

8.4%

8.5%

0.1%

0.4%

Underlying operating profit

29.4

29.9

1.8%

22.2%

31.6

33.8

6.8%

12.9%

Underlying operating margin

6.9%

6.8%

(0.0%)

0.5%

7.1%

7.3%

0.2%

0.4%

Normalised operating profit

30.4

30.9

1.7%

22.8%

32.5

34.7

6.6%

12.1%

Normalised operating margin

7.1%

7.1%

(0.0%)

0.6%

7.3%

7.5%

0.2%

0.4%

Normalised PBT

26.4

27.0

2.4%

19.7%

28.0

30.6

9.5%

13.2%

Normalised net income

19.8

20.3

2.4%

18.4%

20.8

22.8

9.5%

12.5%

Normalised EPS (p)

26.3

26.9

2.4%

16.8%

27.5

27.6

0.3%

2.6%

Reported EPS (p)

14.9

15.6

4.3%

(6.5%)

17.9

18.8

5.1%

20.9%

Net (debt)/cash

(72.7)

(66.7)

(8.2%)

27.3%

(65.7)

(51.0)

(22.4%)

(23.5%)

Net debt/EBITDA (x)

2.0

1.8

1.8

1.3

Source: Edison Investment Research


Exhibit 5: Financial summary

£m

2015

2016

2017

2018

2019e

2020e

Year end 31 March

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

271.1

287.7

338.2

387.9

438.5

465.4

Cost of Sales

(186.7)

(195.1)

(227.2)

(261.2)

(293.7)

(311.7)

Gross Profit

84.4

92.6

111.0

126.7

144.8

153.7

EBITDA

 

 

16.6

19.8

24.3

29.3

35.8

39.7

Operating Profit (before am, SBP and except.)

 

14.0

17.0

20.6

25.2

30.9

34.7

Operating Profit (before am. and except.)

 

13.4

16.3

20.0

24.5

29.9

33.8

Amortisation of acquired intangibles

(2.1)

(2.8)

(3.9)

(4.9)

(5.9)

(6.0)

Exceptionals

(5.2)

(2.1)

(8.4)

(1.1)

(4.8)

(3.2)

Share-based payments

(0.6)

(0.7)

(0.6)

(0.7)

(1.0)

(0.9)

Operating Profit

6.1

11.4

7.7

18.5

19.2

24.6

Net Interest

(1.6)

(1.8)

(2.8)

(2.6)

(3.9)

(4.1)

Profit Before Tax (norm)

 

 

12.4

15.2

17.8

22.6

27.0

30.6

Profit Before Tax (FRS 3)

 

 

4.3

9.4

4.8

15.8

15.1

20.3

Tax

(1.4)

(2.2)

(1.3)

(4.0)

(3.8)

(5.2)

Profit After Tax (norm)

10.0

11.8

13.6

17.1

20.3

22.8

Profit After Tax (FRS 3)

2.9

7.2

3.5

11.8

11.4

15.1

Average Number of Shares Outstanding (m)

57.6

63.3

65.4

70.8

72.9

80.3

EPS - normalised & diluted (p)

 

 

16.4

17.8

19.9

23.0

26.9

27.6

EPS - IFRS basic (p)

 

 

5.0

11.4

5.3

16.7

15.6

18.8

EPS - IFRS diluted (p)

 

 

4.8

10.9

5.1

15.8

15.0

18.3

Dividend per share (p)

7.6

8.1

8.5

9.0

9.5

10.0

Gross Margin (%)

31.1

32.2

32.8

32.7

33.0

33.0

EBITDA Margin (%)

6.1

6.9

7.2

7.6

8.2

8.5

Operating Margin (before am, SBP and except.) (%)

5.2

5.9

6.1

6.5

7.1

7.5

BALANCE SHEET

Fixed Assets

 

 

88.6

108.4

122.2

136.0

148.3

157.8

Intangible Assets

69.9

88.2

100.7

106.8

119.8

129.6

Tangible Assets

13.8

14.7

16.0

23.4

22.7

22.4

Deferred tax assets

4.9

5.5

5.5

5.8

5.8

5.8

Current Assets

 

 

127.3

128.3

148.4

168.4

186.1

213.1

Stocks

39.8

42.9

50.1

60.6

72.1

76.5

Debtors

60.2

65.5

77.3

84.6

90.1

102.0

Cash

26.7

19.9

21.0

21.9

22.6

33.3

Current Liabilities

 

 

(62.1)

(61.7)

(78.1)

(93.6)

(105.5)

(111.3)

Creditors

(61.9)

(60.9)

(77.1)

(87.2)

(99.1)

(104.9)

Short term borrowings

(0.2)

(0.8)

(1.0)

(6.4)

(6.4)

(6.4)

Long Term Liabilities

 

 

(61.1)

(73.1)

(68.7)

(81.5)

(93.5)

(88.5)

Long term borrowings

(45.5)

(57.2)

(50.0)

(67.9)

(82.9)

(77.9)

Other long term liabilities

(15.6)

(15.9)

(18.7)

(13.6)

(10.6)

(10.6)

Net Assets

 

 

92.7

101.9

123.8

129.3

135.3

171.0

CASH FLOW

Operating Cash Flow

 

 

6.6

14.6

20.5

21.7

27.9

27.4

Net Interest

(1.6)

(1.8)

(2.8)

(2.6)

(3.9)

(4.1)

Tax

(3.3)

(4.3)

(3.0)

(3.7)

(5.8)

(7.8)

Capex

(2.5)

(2.3)

(3.4)

(4.3)

(4.0)

(4.6)

Acquisitions/disposals

(37.3)

(19.8)

(11.8)

(25.4)

(22.0)

(15.9)

Financing

52.7

0.0

13.6

(1.5)

0.0

28.0

Dividends

(3.6)

(4.9)

(5.2)

(6.2)

(6.6)

(7.3)

Net Cash Flow

11.0

(18.5)

7.9

(22.0)

(14.3)

15.7

Opening net cash/(debt)

 

 

1.8

(19.0)

(38.1)

(30.0)

(52.4)

(66.7)

HP finance leases initiated

0.0

0.0

0.0

0.0

0.0

0.0

Other

(31.8)

(0.6)

0.2

(0.4)

0.0

(0.0)

Closing net cash/(debt)

 

 

(19.0)

(38.1)

(30.0)

(52.4)

(66.7)

(51.0)

Source: discoverIE, Edison Investment Research

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This report has been commissioned by discoverIE Group and prepared and issued by Edison, in consideration of a fee payable by discoverIE Group. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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This report has been commissioned by discoverIE Group and prepared and issued by Edison, in consideration of a fee payable by discoverIE Group. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the Edison analyst at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Australia

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New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

Neither this document and associated email (together, the "Communication") constitutes or form part of any offer for sale or subscription of, or solicitation of any offer to buy or subscribe for, any securities, nor shall it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. Any decision to purchase shares in the Company in the proposed placing should be made solely on the basis of the information to be contained in the admission document to be published in connection therewith.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document (nor will such persons be able to purchase shares in the placing).

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a) (11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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