Rising scale

Focusrite 9 March 2018 Update
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Focusrite

Rising scale

Interim pre-close statement

Consumer Electronics

9 March 2018

Price

355p

Market cap

£206m

Net cash (£m) at 28 February 2018

19.7

Shares in issue

58.1m

Free float

58%

Code

TUNE

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

7.6

11.8

76.2

Rel (local)

6.5

14.2

76.7

52-week high/low

367.5p

201.5p

Business description

Focusrite is a global music and audio products group that develops and markets hardware and software products, used by both audio professionals and amateurs to realise the high-quality production of recorded and live sound.

Next events

Interim results

24 April 2018

Analysts

Paul Hickman

+44 (0)20 3681 2501

Neil Shah

+44 (0)20 3077 5715

Focusrite is a research client of Edison Investment Research Limited

Focusrite’s trading statement indicates constant currency sales growth of over 25%, even better sales growth than the headline 19%, because of the US dollar’s depreciation. The background is a continuation of widespread demand for the full product range across all the main geographies. Although trading patterns may be shifting to the first half, we are upgrading our forecasts by c 5%.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

EV/EBITDA
(x)

Yield
(%)

8/16

54.3

7.7

11.8

2.0

30.1

19.6

0.5

8/17

66.1

9.5

14.8

2.7

24.0

14.6

0.8

8/18e

74.6

10.4

15.9

3.0

22.3

13.2

0.8

8/19e

79.9

11.1

16.8

3.3

21.2

12.5

0.9

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

Strong Christmas drives positive half year trading Focusrite has released a very encouraging pre-close half-year trading statement. Revenue, cash and profits have all grown y-o-y, the latter implying costs are not expected to be out of line. Trends seen in FY17 have continued, with growth spread across product groups and in all major geographies. Strong sales had a “particularly strong boost” through increased demand over the Christmas holiday period, which may signal a wider consumer appreciation of the products, with a sign of a change in the phasing of revenue. End February 2018 net cash was £19.7m, up from £14.2m at end August 2017.

Underlying sales exceed headline growth

Guidance of H118 revenue of at least £38m implies growth of 19% y-o-y. This is spread across all regions and sales in US$ regions, amounting to around 60% of revenue, led growth in FY17. Given that the US$ has depreciated by c 8% y-o-y, underlying sales growth has been even stronger, at over 25%.

Underlying upgrade of 5%

We upgrade our FY18e EBITDA by 5.3% and PBT by 3.7%. The latter is lower because we believe the relative strength of sterling in H1 will bring some currency losses on the translation of US$ cash. For FY19e, we upgrade PBT by 5% and EBITDA by 3.9%. We now forecast year-end net cash of £20.4m (previously £17.6m) carrying forward the H1 advance.

Valuation: 379-400p

Our DCF valuation is 379p/share, which would put the shares on an FY18e P/E of 23.8x and EV/EBITDA of 14.1x. A comparison against peers, taking into account £20m of excess cash, suggests a somewhat higher level of 400p.

Positive half year trading: Strong Christmas

Focusrite has released a very encouraging pre-close half-year trading statement which, though brief, bears some analysis.

Revenue, profits and cash have all grown compared with the first half of the last financial year. The extent to which profit as well as revenue and cash have grown will not be confirmed until results are released. However, we take this to mean that costs are not expected to be out of line.

We understand that trends seen in FY17 have broadly continued. Those were, firstly, growth in all geographies, but led by the US and Rest of World (mainly Asia), and secondly growth in both divisions, led by Novation. Focusrite continues to build its leading international positions in its specialised markets of audio interfaces and sound generation.

It is reassuring that growth has also been widely spread across product groups and that both the Scarlett and Launchpad ranges have grown strongly. Accelerating growth in the Novation group was one of the positive features of FY17, so that it increased its share of total revenue from 25% in FY16 to 29% in FY17.

Strong sales had a “particularly strong boost” with increased demand over the Christmas holiday period, and management raises the idea that this may signal a wider consumer appreciation of the products, with a sign of a change in the phasing of revenue. The trend has been towards high profile products, such as the Novation’s Launchpad, being selected as Christmas presents. This may have been helped by their availability more widely, for example on Amazon, rather than the previous concentration in specialist music dealerships.

Forecasts: Underlying upgrade of 5%

We upgrade our forecasts in line with guidance of H118 revenue of over £38m, up 19% y-o-y, as well as end February 2018 net cash of £19.7m, up from £14.2m at end August 2017. We estimate that the strengthening of the US$ against sterling from an average rate of 1.26 in H117 to c 1.38 in H118 will have meant an 8% depreciation in the sterling value of US$ sales making up c 60% of total revenue, so that underlying constant currency growth, at over 25%, was even stronger than the headline 19%. However, the natural hedge that the company enjoys against the US$ means that there should be no material effect on margin.

Exhibit 1: Changes to forecasts

£m

FY18e old

FY18e new

%
change

FY19e
old

FY19e new

%
change

FY20
old

FY20e new

%
change

Revenues

72.7

74.6

2.5%

78.6

79.9

1.7%

84.9

85.9

1.2%

Gross profit

30.3

31.0

2.6%

32.7

33.3

1.8%

35.3

35.9

1.6%

Gross margin

41.6%

41.6%

0.0%

41.6%

41.6%

0.0%

41.6%

41.7%

0.1%

Adjusted EBITDA

13.8

14.6

5.3%

14.8

15.4

3.8%

15.6

16.2

3.9%

Adjusted EBITDA margin

19.0%

19.5%

0.5%

18.8%

19.2%

0.4%

18.4%

18.9%

0.5%

Normalised operating profit

10.0

10.7

7.1%

10.5

11.1

5.3%

11.0

11.6

4.9%

Normalised PBT

10.0

10.4

3.7%

10.6

11.1

5.3%

11.1

11.6

4.8%

Normalised EPS (p)

15.3

15.9

3.7%

15.9

16.8

5.3%

16.4

17.2

4.8%

Net cash

17.6

20.4

15.5%

20.6

23.5

14.2%

24.3

27.4

12.6%

Source: Edison Investment Research

We are cautious in our forecast for the second half, as a result of the possibility that trading patterns may have changed, giving a seasonal boost to Christmas. Our H2 revenue forecast now only represents 7.5% y-o-y growth which on the face of it looks cautious. On the other hand, it represents a 51:49 split of sales between H1 and H2, against a 48.5:51.5 split in FY17.

Cash forecast – at least £20m

The £5.5m increase in net cash compared with August 2017 implies a further improvement in our previous FY18 full year net cash flow forecast of £3.4m. We now forecast £20.4m net cash at end August 2018. In part, this represents the £0.6m improvement in our forecast EBITDA. More importantly, it reflects efficient utilisation of working capital, particularly inventory, which we now expect to turn 4.9x, close to FY17’s level of 4.8x, which we had treated as temporarily low. Given that year end has in the past seen a higher cash balance than H1, we would not be surprised to see this level exceeded.

Valuation: 379-400p

Focusrite is market leader in its specialist technical field. Its rating is dependent on the market’s confidence in its ability to remain at the forefront of a competitive field of technical developments and to service a demanding user group. The company is showing an ability to sustain this reputation and for this reason we use a DCF projection to place a value on the longer-term income stream available to investors.

DCF valuation of 379p

We make no change to our DCF projection which extends our forecasts out to 10 years on growth fading in the last three years to a terminal rate of 2%. We assume a terminal EBITDA margin of 21% (2017 actual: 19.8%) and capex investment (including R&D) at 7% of revenue, reducing to 5% in the terminal period. We assume an equity-only cost of capital of 8.4% (risk-free rate 3%, risk premium 6%, beta 0.9), resulting in a valuation of 379p/share (of which 234p is in the terminal value). That would put the shares on an FY18 P/E of 23.8x and EV/EBITDA of 14.1x.

Peer group comparison: 400p

As there is no close small-cap peer, we define the relevant group as UK smaller-cap tech, electronics and consumer companies in relevant subsectors, as well as relevant companies in US and European markets. This is far from an exact comparison, but does give some context in terms of market valuations in adjacent sectors.

Exhibit 2: Peer valuation

All calendarised to August

Country

Mid-price
(ccy)

Mkt cap
(ccy) m

Mkt cap
£m

P/E (x)
Yr 1e

P/E (x)
Yr 2e

EV/EBITDA
(x) Yr 1e

EV/EBITDA
(x) Yr 2e

Universal Electronics

US

52.7

742

570

15.4

12.8

8.9

7.6

Tivo

US

15.0

1836

2160

9.1

7.5

9.5

8.5

Morgan Adv. Materials

UK

326.6

933

920

13.4

12.6

5.6

5.3

Photo-Me International

UK

178.4

672

672

18.2

17.0

6.1

5.7

Oxford Instruments

UK

765.0

439

561

14.4

13.4

7.9

7.6

Bang & Olufsen

DK

168.2

7275

871

134.7

29.6

101.5

75.6

XP Power

UK

3390.0

644

655

20.0

18.9

10.5

10.0

Avid Technology

US

5.1

210

162

15.3

6.8

7.7

N/A

Gooch & Housego

UK

1382.5

340

337

24.7

23.4

10.0

9.5

Dialight

UK

537.0

176

212

17.8

12.7

6.5

5.0

Quixant

UK

387.5

256

276

24.1

21.1

12.4

10.6

Judges Scientific

UK

2160.0

133

119

17.0

16.2

8.4

7.5

B&C Speakers

IT

11.8

129

112

18.1

17.3

10.3

9.4

Trakm8 Holdings

UK

96.0

34

54

13.3

9.6

5.6

4.6

Gear 4 Music (Hldgs)

UK

639.0

133

153

81.9

52.8

25.7

18.7

Average

29.2

18.1

15.8

13.3

Focusrite

UK

360

209

22.6

21.5

13.4

12.7

Premium/(discount)

-22.4%

18.6%

-15.1%

-4.3%

Source: Bloomberg. Note: LSE subsectors: Electrical Components & Equipment, Computer Hardware, Recreational Products; Retail: relevant audio/video companies from US and European markets. Market cap £25m-2bn. Outliers excluded from table. Prices as at 8 March 2018. N/A: data not available.

Focusrite trades at an average FY18e 22.4% discount and FY19e 18.6% P/E premium to the group. On an EV/EBITDA basis it trades at an FY18e 15.1% and an FY19e 4.3% discount to the group. However, we note the now significant excess cash of £19.7m, for which the P/E measure gives no credit (the EV/EBITDA valuation does). Adjusting to average peer multiples and allowing for that cash in the P/E comparison values Focusrite shares at 418p on a P/E basis and 382p on an EV/EBITDA basis, a blend of 400p, somewhat above our DCF valuation.

Exhibit 3: Financial summary

£'000s

2016

2017

2018e

2019e

2020e

31-August

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

54,301

66,055

74,552

79,890

85,882

Cost of Sales

(33,439)

(39,704)

(43,503)

(46,618)

(50,028)

Gross Profit

20,862

26,351

31,049

33,272

35,853

EBITDA

 

 

10,249

13,109

14,563

15,360

16,239

Operating profit (before amort. and except).

 

7,677

9,470

10,674

11,072

11,573

Amortisation of acquired intangibles

0

0

0

0

0

Exceptionals

(537)

0

0

0

0

Share-based payments

0

0

0

0

0

Reported operating profit

7,140

9,470

10,674

11,072

11,573

Net Interest

(14)

42

(300)

50

50

Joint ventures & associates (post tax)

0

0

0

0

0

Exceptionals

0

0

0

0

0

Profit Before Tax (norm)

 

 

7,663

9,512

10,374

11,122

11,623

Profit Before Tax (reported)

 

 

7,126

9,512

10,374

11,122

11,623

Reported tax

(870)

(959)

(1,245)

(1,501)

(1,743)

Profit After Tax (norm)

6,793

8,553

9,129

9,620

9,880

Profit After Tax (reported)

6,256

8,553

9,129

9,620

9,880

Minority interests

0

0

0

0

0

Discontinued operations

0

0

0

0

0

Net income (normalised)

6,900

8,553

9,129

9,620

9,880

Net income (reported)

6,256

8,553

9,129

9,620

9,880

Basic average number of shares outstanding (m)

53.2

55.4

56.0

56.0

56.0

EPS - basic normalised (p)

 

 

13.0

15.4

16.3

17.2

17.6

EPS - normalised (p)

 

 

11.8

14.8

15.9

16.8

17.2

EPS - basic reported (p)

 

 

11.8

15.4

16.3

17.2

17.6

Dividend per share (p)

2.0

2.7

3.0

3.3

3.7

Revenue growth (%)

13.1

21.6

12.9

7.2

7.5

Gross Margin (%)

38.4

39.9

41.6

41.6

41.7

EBITDA Margin (%)

18.9

19.8

19.5

19.2

18.9

Normalised Operating Margin

14.1

14.3

14.3

13.9

13.5

BALANCE SHEET

13,748

13,717

16,687

18,820

Fixed Assets

 

 

6,367

6,332

6,897

8,395

9,948

Intangible Assets

4,792

4,963

5,701

7,371

9,073

Tangible Assets

1,575

1,369

1,196

1,024

875

Investments & other

0

0

0

0

0

Current Assets

 

 

28,191

36,126

43,313

50,341

56,802

Stocks

11,361

9,000

8,939

10,728

11,650

Debtors

11,224

12,952

14,005

16,102

17,781

Cash & cash equivalents

5,606

14,174

20,369

23,510

27,371

Other

0

0

0

0

0

Current Liabilities

 

 

(9,256)

(8,663)

(9,686)

(10,697)

(11,254)

Creditors

(8,612)

(8,204)

(9,227)

(10,143)

(10,611)

Tax and social security

(644)

(459)

(459)

(554)

(643)

Short term borrowings

0

0

0

0

0

Other

0

0

0

0

0

Long Term Liabilities

 

 

(282)

(245)

(285)

(375)

(467)

Long term borrowings

0

0

0

0

0

Other long term liabilities

(282)

(245)

(285)

(375)

(467)

Net Assets

 

 

25,020

33,550

40,239

47,664

55,029

Minority interests

0

0

0

0

0

Shareholders' equity

 

 

25,020

33,550

40,239

47,664

55,029

CASH FLOW

Op Cash Flow before WC and tax

10,249

13,109

14,563

15,360

16,239

Working capital

(6,009)

407

(635)

(2,971)

(2,132)

Exceptional & other

(417)

137

(0)

(0)

(0)

Tax

(165)

(633)

(1,245)

(1,501)

(1,743)

Net operating cash flow

 

 

3,658

13,020

12,683

10,888

12,364

Capex

(3,675)

(3,614)

(4,535)

(5,914)

(6,435)

Acquisitions/disposals

0

0

0

0

0

Net interest

(111)

(42)

(300)

50

50

Equity financing

172

258

0

0

0

Dividends

(976)

(1,138)

(1,653)

(1,882)

(2,118)

Other

365

84

0

0

0

Net Cash Flow

(567)

8,568

6,195

3,141

3,860

Opening net debt/(cash)

 

 

(6,173)

(5,606)

(14,174)

(20,369)

(23,510)

FX

0

0

0

0

0

Other non-cash movements

0

0

0

0

0

Closing net debt/(cash)

 

 

(5,606)

(14,174)

(20,369)

(23,510)

(27,371)

Source: Company accounts, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

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London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

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NSW 2000, Australia

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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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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

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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