Spotlight on FY17

Solid State 8 February 2016 Update

Solid State

Spotlight on FY17

Reinstating FY17 estimates

Electronic equipment

 

8 February 2016

Price

517.5p

Market cap

£43m

Net debt (£m) end September 2015

4.0

Shares in issue

8.4m

Free float

73%

Code

SOLI

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(14.8)

13.7

(31.5)

Rel (local)

(10.2)

23.3

(21.4)

52-week high/low

922.5p

390.0p

Business description

Solid State is a high value-add manufacturer and specialist design-in distributor to the electronics industry. It has expertise in industrial/ruggedized computers, electronic components, antennas, microwave systems, secure communications systems and battery power solutions.

Next event

Prelims

July 2016

Analysts

Anne Margaret Crow

+44 (0)20 3077 5700

Roger Johnston

+44 (0)20 3077 5722

Solid State is a research client of Edison Investment Research Limited

Solid State’s diversified platform gives a stable base for delivering another year of results at FY15’s record profit levels, despite delays in deliveries under a major contract with the UK Ministry of Justice (MoJ) for offender tagging. While this contract has not gone away, there is still no clarity on when deliveries will resume. We therefore reiterate our FY16 estimates and reinstate FY17 estimates assuming that MoJ deliveries resume post year-end FY17. This prudent approach gives a small year-on-year decline in top-line revenues during FY17 (revenues excluding MoJ sales are expected to be in line with FY16e) accompanied with modest profit growth.

Year end

Revenue (£m)

PBT* (£m)

EPS* (p)

DPS (p)

P/E (x)

Yield (%)

03/14

32.1

2.4

28.5

8.5

18.2

1.6

03/15

36.6

3.2

37.4

12.0

13.8

2.3

03/16e

44.0

3.2

35.4

12.0

14.6

2.3

03/17e

39.6

3.4

36.8

12.0

14.1

2.3

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

Diversified platform provides resilience

As discussed in our November note, we expect the range of activities in which the group is engaged to deliver a second year of profits at the record levels achieved in FY15. Sales of next-generation ticketing equipment, resumption of antenna deliveries for a major airborne programme and initial sales of product from Luminus, combined with a seasonally stronger second half, should enable the group to achieve this result without relying on a resumption in MoJ deliveries.

High profile MoJ contract on hold, not cancelled

Our reinstated FY17 estimates take a prudent view, assuming that revenues excluding MoJ sales will be in line with FY16 levels with new product introductions being offset by general market weakness, and that deliveries under the MoJ contract will not resume until after the year end. This drives our forecast 10% year-on-year revenue decline during FY17e. Noting the programme to realise c £0.5m annualised cost savings we model a 4% year-on-year rise in adjusted PBT.

Valuation: Undervalued even if MoJ delays persist

The share price has picked up from the 390p low since the announcement of delays to the MoJ contract, although it is not back at the 725p immediately before the announcement. Our scenario analysis suggests the current share price factors in a modest level of revenues from MoJ deliveries in FY17e, with potential for further share price appreciation as confidence around deliveries strengthens.

Financials
FY16e – benefit from Ginsbury and mobilisation phase of MoJ contract

We last revised our FY16 estimates at the time of the trading update at the end of October. This advised that the group had encountered delays to the delivery schedule for the three-year, £34m contract to supply offender tagging technology to the UK MoJ. We assumed that, even if further orders under the contract were received soon, it would not be possible for Steatite to fulfil them by the end of FY16. We adjusted our estimates so that profits were held at the record levels achieved in FY15, rather than showing strong growth associated with the MoJ contract. At the interim stage, we noted that H116 revenue growth had been held back by delays to an airborne antenna programme at Q-Par and a shift to short-term ordering patterns in the distribution operation (excluding Ginsbury). However, sales of next-generation ticketing equipment, a resumption in antenna deliveries for the major airborne programme and initial sales of product from Luminus, combined with seasonally stronger second half pointed to a recovery in underlying revenues during H216, encouraged us to leave our estimates unchanged. While there is no sign of a recovery in the markets served, the new product initiatives give plenty of potential for overcoming market weakness, so we continue to leave our FY16 estimates unchanged.

FY17e – underlying revenues steady as new products and programmes offset market weakness

The MoJ contract is a high profile one for the customer and Solid State is confident that it is fulfilling its obligations, so it is reasonable to assume that deliveries under the contract (estimated at £29m outstanding) will pick up at some point. However, as a junior partner in a large programme, Solid State is not able to influence when resumption of deliveries will occur. Our FY17 estimates take an ultra-prudent view and assume that deliveries will resume after the FY17 year end, although our valuation section models some less conservative scenarios. With regard to underlying revenues, i.e. excluding MoJ sales, we assume that revenues from new programmes and products will offset continuing market weakness, rather than being incremental to FY16 levels. Given the absence of any product deliveries under the MoJ contract assumed by us during FY17 compared with low levels associated with programme mobilisation during FY16, we forecast a 10% year-on-year decline in revenues. We reduce costs to reflect substantially lower levels of activity in the Electronic Monitoring operation and management’s programme, which is intended to realise c £0.5m annualised cost savings. This gives our estimated 4% year-on-year rise in adjusted profit before tax.

Dividend strategy

We maintain dividend payments at FY15 levels for both FY16e and FY17e. We expect management to prefer to conserve cash to support the continuation of its acquisition programme.

Balance sheet and cash flow

We have adjusted our FY16 cash flow slightly, so that some of the capital expenditure associated with equipping a new facility for the antennae and sub-systems activity (previously £1,000k total), which was modelled as falling entirely within FY16, is shifted to Q117 which is when the facility is scheduled to be opened. The new equipment will enable pre-compliance testing to be carried out in-house.

Valuation

Exhibit 1: Listed peers

Company

Market cap 

Current EV/S

Next EV/S

Current EV/ EBITDA

Next EV/ EBITDA

Current P/E

Next P/E

Arotech Corp

£37m

0.6x

0.5x

20.6x

6.3x

42.6x

7.6x

Cobham PLC

£2,821m

1.9x

1.9x

9.2x

9.1x

12.5x

12.1x

Cohort PLC

£143m

1.1x

0.9x

9.8x

8.2x

15.6x

13.0x

Concurrent Technologies PLC

£46m

-

-

-

-

17.5x

16.6x

Cubic Corp

£749m

0.7x

0.7x

7.6x

6.3x

25.3x

14.4x

Elbit Systems Ltd

£2,525m

1.3x

-

11.2x

-

18.0x

15.2x

Rockwell Collins Inc

£7,416m

0.4x

0.4x

1.6x

1.4x

14.8x

13.9x

Saft Groupe SA

£482m

1.0x

0.9x

6.5x

6.0x

12.9x

11.4x

Ultra Electronics Holdings PLC

£1,332m

2.0x

1.8x

11.0x

10.0x

15.7x

14.6x

Mean manufacturing companies

1.1x

1.0x

9.2x

7.6x

16.5x

13.9x

Acal PLC

£167m

-

-

-

-

16.0x

14.3x

Brammer PLC

£219m

-

-

-

-

10.9x

10.0x

Diploma PLC

£756m

-

-

-

-

16.7x

15.9x

Mean value-added distributors

14.5x

13.4x

Source: Bloomberg. Note: Prices at 1 February 2016. Grey shading indicates exclusion from mean.

We continue to use a sum-of-the parts analysis to value this stock. An analysis based solely on our estimates for FY16e gives an indicative value of 514p (previously 513p). However, this approac does not ascribe any value to the outstanding revenues under the MoJ contract, so we supplement it with a scenario analysis that models a range of FY17 revenues.

Exhibit 2: Sum-of-the-parts analysis

% FY16e profits from Manufacturing

68%

% FY16e profits from Distribution

32%

Year 1 PER Manufacturing

16.5x

Year 1 PER Distribution

14.5x

Weighted PER

15.9x

FY16e EPS-FRS3

32.4p

Indicative value/share

514.3p

Source: Bloomberg, Edison Investment Research

The base case of our FY17e scenario analysis assumes that revenues do not resume until after the FY17e year-end, as assumed in our estimates. The higher bound of £10m annually is the level achievable in FY17 if orders under the contract are placed relatively soon. This is lower than the £15m estimated for FY16e and FY17e before the October announcement noting delays to the programme because of the inevitable timelag incurred ordering components and raising staffing levels to fulfil orders.

Exhibit 3: FY17e share price

 

 

Base case

Implied by share price

Low

 

High

MoJ product revenues (£k)

0

2,500

5,000

7,500

10,000

Group revenues (£k)

39,591

42,091

44,591

47,091

49,591

Group operating profit (£k)

 

3,200

3,491

3,783

4,075

4,360

Adjusted EPS (p)

36.8

40.0

43.1

46.3

49.4

% FY17e profits from Manufacturing

62%

64%

66%

68%

70%

% FY17e profits from Distribution

38%

36%

34%

32%

30%

Year 2 mean P/E manufacturing companies

13.9x

13.9x

13.9x

13.9x

13.9x

Year 2 mean P/E value-added distributors

13.4x

13.4x

13.4x

13.4x

13.4x

Weighted P/E

13.7x

13.7x

13.7x

13.8x

13.8x

Indicative value/share (p)

504.8

548.9

592.9

636.9

680.0

Source: Edison Investment Research

The scenario analysis indicates that, depending on when deliveries under the MoJ contract resume, FY17e EBIT could be up to £1,160k (36%) more than that modelled in our estimates, which are shown as the base case. This gives a range of indicative valuations from 505p/share to 680p/share. This indicates that the current share price factors in a modest level of revenues (£2,500k) from MoJ deliveries in FY17e with potential for further share price appreciation once there is more visibility on the delivery schedule.

Exhibit 4: Financial summary

£'000

2014

2015

2016e

2017e

Year end 31 March

PROFIT & LOSS

Revenue

 

 

32,085

36,559

43,989

39,591

Cost of Sales

(22,729)

(25,396)

(28,328)

(26,201)

Gross Profit

9,357

11,164

15,660

13,390

EBITDA

 

 

2,809

3,766

3,844

3,997

Operating Profit (pre amort. of acq intangibles & SBP)

 

2,461

3,273

3,297

3,450

Amortisation of acquired intangibles

0

0

0

0

Share-based payments

(235)

(211)

(250)

(250)

Exceptionals

0

0

0

0

Operating Profit

2,226

3,062

3,047

3,200

Net Interest

(72)

(48)

(75)

(90)

Profit Before Tax (norm)

 

 

2,389

3,224

3,222

3,360

Profit Before Tax (FRS 3)

 

 

2,154

3,014

2,972

3,110

Tax

(278)

(122)

(266)

(279)

Profit After Tax (norm)

2,111

3,102

2,955

3,081

Profit After Tax (FRS 3)

1,876

2,892

2,705

2,831

Average Number of Shares Outstanding (m)

7.4

8.3

8.4

8.4

EPS - normalised (p)

 

 

28.5

37.4

35.4

36.8

EPS - normalised fully diluted (p)

 

 

28.4

36.3

34.7

36.1

EPS - FRS 3 (p)

 

 

25.3

34.9

32.4

33.8

Dividend per share (p)

8.5

12.0

12.0

12.0

Gross Margin (%)

29.2

30.5

35.6

33.8

EBITDA Margin (%)

8.8

10.3

8.7

10.1

Operating Margin (before GW and except.) (%)

7.7

9.0

7.5

8.7

BALANCE SHEET

Fixed Assets

 

 

5,995

6,643

7,974

8,046

Intangible Assets

4,936

5,400

5,845

5,615

Tangible Assets

1,059

1,243

2,128

2,431

Current Assets

 

 

15,744

16,142

17,663

15,620

Stocks

4,575

5,402

6,207

5,586

Debtors

10,484

9,003

10,072

9,078

Cash

685

1,738

1,384

956

Current Liabilities

 

 

(10,926)

(10,039)

(10,795)

(7,296)

Creditors including tax, social security and provisions

(7,888)

(5,838)

(6,995)

(6,296)

Short term borrowings

(3,038)

(4,201)

(3,800)

(1,000)

Long Term Liabilities

 

 

(405)

(355)

(355)

(355)

Long term borrowings

0

0

0

0

Other long term liabilities

(405)

(355)

(355)

(355)

Net Assets

 

 

10,407

12,391

14,487

16,015

CASH FLOW

Operating Cash Flow

 

 

2,214

2,680

3,400

4,913

Net Interest

(72)

(48)

(75)

(90)

Tax

(161)

(476)

(476)

(476)

Capital expenditure

(305)

(487)

(800)

(600)

Capitalised product development

(8)

(661)

(270)

(20)

Acquisitions/disposals

(2,323)

0

(731)*

(350)**

Financing

2,618

(308)

0

0

Dividends

(603)

(810)

(1,000)

(1,005)

Net Cash Flow

1,359

(110)

48

2,372

Opening net debt/(cash)

 

 

2,304

2,353

2,463

2,416

HP finance leases initiated

0

0

0

0

Other

1,408

0

0

0

Closing net debt/(cash)

 

 

2,353

2,463

2,416

44

Source: Edison Investment Research. Note: *Net of cash, **deferred consideration

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United Kingdom

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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

245 Park Avenue, 39th Floor

10167, New York

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Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

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Wellington 6011

New Zealand

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