discoverIE Group — Resilience from focus on strategic growth markets

discoverIE Group (LSE: DSCV)

Last close As at 23/02/2024

GBP6.86

−2.00 (−0.29%)

Market capitalisation

GBP663m

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Research: TMT

discoverIE Group — Resilience from focus on strategic growth markets

discoverIE’s H124 results reflected improving profitability despite the expected lower demand due to customer destocking and the weaker economic environment. With normalisation of the order book effectively complete and strong growth in design win activity, the company is well positioned to grow as customer confidence returns. discoverIE is making good progress towards its margin targets and maintains its outlook for FY24. The company has an active pipeline of acquisition targets, which should further drive growth and operating profitability.

Katherine Thompson

Written by

Katherine Thompson

Director

discoverIE-Group_resized

TMT

discoverIE Group

Resilience from focus on strategic growth markets

H124 results

Electrical components

12 December 2023

Price

714p

Market cap

£688m

€1.17/$1.26/£

Net debt (£m) at end H124

111.3

Shares in issue

96.4m

Free float

96%

Code

DSCV

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

10.5

(1.4)

(9.4)

Rel (local)

7.4

(2.1)

(9.9)

52-week high/low

938p

593p

Business description

discoverIE is a leading international designer and manufacturer of customised electronics to industry, supplying customer-specific electronic products and solutions to original equipment manufacturers.

Next events

Trading update

February 2024

Analyst

Katherine Thompson

+44 (0)20 3077 5700

discoverIE Group is a research client of Edison Investment Research Limited

discoverIE’s H124 results reflected improving profitability despite the expected lower demand due to customer destocking and the weaker economic environment. With normalisation of the order book effectively complete and strong growth in design win activity, the company is well positioned to grow as customer confidence returns. discoverIE is making good progress towards its margin targets and maintains its outlook for FY24. The company has an active pipeline of acquisition targets, which should further drive growth and operating profitability.

Year
end

Revenue
(£m)

PBT*
(£m)

Diluted EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

03/22

379.2

37.6

29.4

10.80

24.3

1.5

03/23

448.9

46.3

35.2

11.45

20.3

1.6

03/24e

452.1

47.2

35.6

12.10

20.1

1.7

03/25e

477.3

49.8

37.1

12.50

19.2

1.8

Note: *PBT and EPS as per discoverIE’s underlying metric (excludes amortisation of acquired intangibles and exceptional items).

Underlying operating margin +1.4pp y-o-y to 12.9%

discoverIE reported flat revenue in H124, or 1% organic growth at constant exchange rates (CER). Underlying operating profit was up 12% y-o-y with a 1.4pp increase in operating margin to 12.9%. Underlying EPS was 8% higher year-on-year and the interim dividend of 3.75p was 6% higher year-on-year. The company maintained its earnings expectations for FY24 and our EPS forecasts are unchanged. We have slightly increased our FY24 dividend forecast and factored in lower working capital requirements, reducing net debt for FY24 and FY25.

Orders picking up; positive design win activity

While book-to-bill (B:B) was 0.87:1 in H124, Q224 orders exceeded Q124, the company exited H1 with a B:B approaching 1:1 and so far in H2, orders have exceeded sales. Management believes that the order book has normalised from its end-H123 peak. A lead indicator of revenue growth, design win activity was strong with the estimated lifetime value of contracts up 23% y-o-y and 89% from target markets. Despite the current higher interest rate environment, we expect discoverIE to continue to make accretive acquisitions to drive growth.

Valuation: Accretive M&A to drive upside

The stock has nearly recovered from the decline post the recent 2J Antennas deal and now trades in line with its broader UK industrial technology peer group on FY24 P/E but at a discount to peers with a similar decentralised operating model (such as Halma and Spirax). Considering that the earnings outlook has been maintained and the company continues to make excellent progress towards its margin targets, we believe this discount is overdone. Countering concerns on the market outlook, the focus on strategic growth markets should reduce cyclicality compared to the wider market and we note that the company has previously demonstrated its ability to manage costs and cash flow through periods of weaker demand.

Investment summary

Designing and manufacturing innovative electronics for industry

discoverIE is a leading designer and manufacturer of customised electronic components for industrial applications. Over the last 13 years, the company has broadened its product range, customer base and geographical presence via a series of acquisitions. It designs and manufactures differentiated products and expansion along the supply chain has helped the company to grow operating margins. discoverIE continues to target growth both organically and via acquisition with a focus on higher-margin business. To grow revenues well ahead of GDP, it is focused on four structural growth markets: renewable energy, electrification of transportation, medical and industrial automation & connectivity. Its capital-light business model supports strong cash flow generation, with the aim of increasingly self-funding acquisitions.

Financials: EPS forecasts unchanged

Despite the weaker macroeconomic environment, discoverIE reported strong H124 results. Revenue was flat year-on-year (4% higher CER, 1% organic), underlying operating profit was 12% higher (17% higher CER) and underlying EPS 8% higher. Magnetics & Controls reported 2% organic growth and a 14.8% underlying operating margin (+1.9pp y-o-y); Sensing & Connectivity saw 1% organic growth and a 17.4% underlying operating margin (+1.1pp). Net debt/EBITDA stood at 1.6x at end-H124 and we expect this to reduce to 1.4x by end-FY24. Management anticipates delivering underlying earnings in line with board expectations for FY24; we maintain our earnings forecasts. We have raised our FY24 dividend forecast and reduced our debt forecasts for FY24 and FY25.

Valuation: Accretive acquisitions to accelerate earnings growth

The stock initially declined 20% after the recent 2J Antennas deal, but since interims were announced, it has nearly regained all this ground. It now trades in line with its broader UK industrial technology peer group on FY24e P/E and at a discount to peers with a similar decentralised operating model (such as Halma and Spirax). Considering that the earnings outlook has been maintained and the company continues to make good progress towards its margin targets, we believe this discount is overdone. Despite the current higher interest rate environment, we expect discoverIE to continue to make accretive acquisitions to drive growth. Countering concerns on the market outlook, the focus on strategic growth markets should reduce cyclicality compared to the wider market and we note that the company has previously demonstrated its ability to manage costs and cash flow through periods of weaker demand.

Sensitivities: Economy, currency, pricing and acquisitions

Our estimates and discoverIE’s share price will be sensitive to the following factors. Customer demand: demand will be influenced by the economic environment in Europe and increasingly in North America and Asia. Supply chain: raw materials and components are sourced globally so the company must manage around availability. Currency: with c 90% of revenues generated in currencies other than sterling, discoverIE is exposed to the translation of euro, US dollar and Nordic-denominated subsidiary results into sterling. Pricing: discoverIE’s revenues and profitability are sensitive to its ability to include in price quotes engineering time spent on designing customer solutions. The company normally passes through supplier price increases and tariffs. Acquisitions: discoverIE expects to make further acquisitions, which could add integration risk, and larger deals may require equity funding.

Company description: Innovative custom electronics

discoverIE designs and manufactures customised electronics for industry, with operations throughout Europe and increasingly outside Europe. The last 13 years have seen the integration of a series of acquisitions and a focus on growing the percentage of higher-margin specialist products, resulting in higher profitability.

Company history

discoverIE was founded in 1986 and was admitted to the official list of the LSE in 1994 as a pure distributor of electronic components. After a change in management in 2009, through its strategy of specialisation the company has transitioned to become a designer and manufacturer of customised electronics with operations in Europe, Asia and North America. The company has made a series of design and manufacturing acquisitions since 2011 – we provide further detail in Exhibit 9. discoverIE sold its Custom Supply distribution business in FY22 and is now fully focused on higher-margin design and manufacturing. The group has c 4,500 employees across 20 countries.

Business model

discoverIE specialises in the design and manufacture of technically demanding, bespoke electronics for industrial applications and is focused on four target markets comprising 76% of group sales – renewables, electrification of transportation, medical and industrial automation & connectivity – all of which are long-term structural growth markets. The market for niche electronic components is very fragmented and discoverIE mainly competes against small, privately owned, country-specific manufacturers in one or two technology areas. The company expects to continue its active role in consolidating this market.

Industrial focus leads to longer product cycles, robust margins

discoverIE’s components tend to be a small but essential part of the systems they are designed into and as such, tend not to commoditise, supporting robust margins. discoverIE’s engineers work with customers throughout their product development process, from design concept to volume manufacturing. A customer will typically take six to 24 months to move a product from design to volume production, at which point the company should earn revenues for the life of the product, typically five to seven years.

We highlight that discoverIE is focused on industrial OEMs and does not serve the consumer electronics market (which tends to be highly commoditised with short lifetime products and often highly cyclical sales) or the semiconductor equipment market (which is highly cyclical). It also does not have high customer concentration.

Manufacturing footprint optimised for cost and flexibility

discoverIE’s custom electronic products are either designed uniquely or modified from an existing product. The large majority of products are manufactured at 34 sites across 18 countries, with the remainder manufactured by third-party contractors. This enables the company to support customers operating internationally and provides flexibility if a customer wishes to relocate production. Due to smaller batch sizes, production is either manual or semi-automated, which provides flexibility and results in a capital-lite model. discoverIE spends c 2% of revenue per annum on its manufacturing facilities to support organic growth and another 2% on R&D (all expensed).

Raw materials comprise largest proportion of product cost

The majority of products are manufactured in-house from raw materials and base components. Energy costs represent less than 1% of group revenue, as operations are mainly manual or semi-automated.

Diverse range of custom electronic products

Mainly through acquisition, discoverIE has built up its design and manufacturing capability in four areas of technology: sensors, magnetics, controls and connectivity. discoverIE reports through two divisions: Magnetics & Controls (M&C) and Sensing & Connectivity (S&C). Exhibit 1 shows the companies and brands reported within each division. M&C consists of one cluster plus seven further businesses across 17 countries with 21 manufacturing sites (main facilities in China, India, Mexico, Poland, Sri Lanka, Thailand and the UK). S&C consists of three clusters and four further businesses across nine countries with 13 manufacturing sites (main facilities in Hungary, the Netherlands, Norway, Slovakia, the UK and the US).

Exhibits 2 and 3 show the progression of revenue in each division and the timing of acquisitions.

Exhibit 1: Businesses by division

Source: discoverIE. Note: Orange dashed boxes denote clusters.

Exhibit 2: M&C – revenue and acquisitions

Source: discoverIE

Exhibit 3: S&C – revenue and acquisitions

Source: discoverIE

Group strategy

The group is focused on markets with sustainable growth prospects and increasing electronic content where there is an essential need for its products. It invests in initiatives and businesses that enhance design opportunities for customised products in targeted long-term structural growth markets.

Management has transformed the company into a technology led provider of customised electronics for industrial applications with design and manufacturing capabilities. The company has the following strategic objectives:

Grow sales well ahead of GDP over the economic cycle by focusing on the structural growth markets that form the company’s target markets.

Improve operating margins by moving up the value chain into higher-margin products.

Acquire businesses with attractive growth prospects and strong operating margins.

Further internationalise the business by expanding operations in North America and Asia.

This is underpinned by the objectives of generating strong cash flows from a capital-light model and delivering long-term sustainable returns, while progressing towards net zero carbon emissions and reducing the group’s impact on the environment.

To track progress with these objectives, the company has set key strategic indicators (KSIs) and key financial performance indicators (KPIs), which we discuss in more detail later in this report.

Experienced board supports growth ambitions

To support its growth ambitions, discoverIE has constructed a board with substantial experience in acquisitions and international growth. Executive directors include Nick Jefferies (CEO since 2009) and Simon Gibbins (CFO since 2010). The board is chaired by Bruce Thompson (non-executive director (NED) at discoverIE since 2018, ex-Diploma CEO 1996–2018, non-executive chairman at Avon Protection). Non-executive directors include Tracey Graham (also NED at Close Brothers Group, Nationwide Building Society and Link Scheme), Clive Watson (ex-group FD of Spectris 2006–19, NED at Breedon Group, Kier Group and Trifast, ex-audit chair of Spirax Sarco for nine years), Rosalind Kainyah (runs ESG consultancy Kina Advisory, NED at GEM Diamonds, Kew Soda, BTE Renewables and CalBank, previously VP external affairs and CSR at Tullow Oil) and Celia Baxter (previously group HR director at Bunzl for 13 years; currently NED at DS Smith and Dowlais Group).

Group executive management includes the CEO and CFO supported by, amongst others, group commercial directors for S&C (Paul Hill) and M&C (Martin Pangels), group head of corporate development (Jeremy Morcom) and group general counsel and company secretary (Greg Davidson).

Tracking strategic progress

Exhibit 4 summarises the steady progress discoverIE is making against its KSIs. We discuss below how it is meeting its strategic objectives.

Exhibit 4: Key strategic indicators

FY15

FY16

FY17

FY18

FY19

FY20

FY21

FY22

FY23

H124

FY25 target

Increase underlying operating margin

4.9%

5.7%

5.9%

6.3%

7.0%

8.0%

7.7%

10.9%

11.5%

12.9%

13.5%*

Build sales beyond Europe

12%

17%

19%

19%

21%

27%

28%

40%

40%

42%

45%

Sales from target markets

N/A

N/A

56%

62%

66%

68%

70%

76%

77%

76%

85%

Reduce scope 1 & 2 carbon emissions – from CY21 level

N/A

N/A

N/A

N/A

N/A

N/A

15%

35%

45%

65%

Source: discoverIE. Note: *Medium-term target 15% (FY28). Continuing operations only from FY22.

Expanding operating margins

discoverIE started life as a pure distributor of electronic components, but through a strategy of specialisation and acquisition it has transitioned to become a designer and manufacturer of customised electronic solutions. Since 2011, the company has acquired 23 businesses with design and manufacturing capabilities; these are typically much higher margin than the original distribution business, with recent acquisitions generating operating margins of 20% plus.

The charts below show the financial performance of the continuing business over the last five years and our forecasts for FY24–25. FY21 results were affected by pandemic-related demand weakness, although the underlying operating margin remained flat in FY21. The margin increased 1.4pp y-o-y in H124 to 12.9% and was also 1.4pp higher than the 11.5% achieved in FY23. The target is for a 13.5% underlying operating margin by FY25 and a 15% margin in the medium term (by FY28), to be achieved through a combination of organic growth and higher-margin acquisitions.

For FY25, we estimate that a 0.5pp organic increase in underlying operating margin from our current 12.8% forecast would increase our underlying EPS forecast by c 5%.

Exhibit 5: Revenue, FY19–25e

Exhibit 6: Underlying operating profit, FY19–25e

Source: discoverIE

Source: discoverIE

Exhibit 5: Revenue, FY19–25e

Source: discoverIE

Exhibit 6: Underlying operating profit, FY19–25e

Source: discoverIE

The company noted that one lever of margin growth has been optimisation of its manufacturing capacity. It has consolidated some sites such as in North America, consolidating three sites into one, in UK/Europe, consolidating and transferring production from high cost sites to low cost sites, and is increasing capacity at lower-cost sites. It has also optimised production, moving some US production to Mexico, some from the UK and the US to Hungary and is optimising the design of certain products to improve the gross margin. It is increasingly undertaking intercompany production, where spare capacity at certain sites is used by other businesses.

Build sales beyond Europe

Sales beyond Europe increased from 40% in FY23 to 42% in H124. Exhibit 7 shows organic revenue growth by geography in H124 on a group and divisional basis. Partly due to supply chain challenges over the last few years, but also due to the attraction of earning “Made in the USA” status, there is an ongoing trend to re-shore or near-shore manufacturing. The decline in Asia revenues is from a combination of production moving from China to the Americas and one large customer in India working through excess inventory (excluding them, India revenues grew).

Exhibit 7: Organic revenue growth, group and divisional

Source: discoverIE. Note: Divisional metrics combine Germany, Nordics and Other Europe into Europe category – shown here as Other Europe.

Targeting high growth markets

As part of the group’s goal to grow revenue well ahead of GDP on an organic basis, discoverIE is targeting higher-growth markets. These are markets that are exhibiting structural growth and depend on technology for product development, resulting in increasing electronic content. discoverIE aims to supply essential products to OEMs in these markets. With the increasing focus on ESG by investors and consumers alike, the company is keen that its target markets also align with the United Nations’ Sustainable Development Goals (SDGs).

The table below describes the four target markets, the growth prospects of each market and examples of products that discoverIE provides for each market.

In H124, the business generated 76% of its revenues from these four areas and is targeting this to grow to 85% by FY25. Typically, growth from target markets exceeds other markets; in H124, this situation was reversed, with growth from target markets down 1% y-o-y and growth from non-target markets up 10% y-o-y. This was due to lower sales in industrial automation (where four major customers were destocking), acquisitions with lower target market exposure at the outset and a recovery in some non-target market areas (aerospace and defence, some other industrial markets and distributor restocking).

While the company does not actively stop supplying customers in non-target markets, it encourages each business to focus its sales efforts on target markets and builds this approach into acquired companies’ three-year plans. As target markets typically grow faster than non-target markets, over time the contribution from target markets should grow as a percentage of total revenue. The company reported that revenue from target markets had increased cumulatively by 82% from FY17 whereas revenue from non-target markets had only increased by 27% over the same period, highlighting the benefits of focusing on structural growth markets. This focus should provide some insulation against a shorter-term economic slowdown, as it did during the COVID year FY21 when target market sales were down only 3% organically compared with a 9% reduction in other markets.

Exhibit 8: Targeted growth markets

Source: discoverIE, Edison Investment Research

Acquisitions core to growth strategy

From 2011 discoverIE started to make a series of acquisitions of companies with design and manufacturing capabilities (see Exhibit 9 below). The company has a dedicated M&A team focused on developing and pursuing opportunities.

Criteria for acquisition targets

discoverIE’s focus for future acquisitions is to target design and manufacturing companies with commercially viable technologies that can be applied to its target markets or with complementary product(s) and/or geographical capability supplying common markets and customers. The preference is to buy businesses that are successful and profitable, with good growth prospects, good margins and similar long-term growth drivers to discoverIE’s focus markets, but which need scaling up.

Management considers two types of acquisition: ‘platform’ to create a new position in a technology and/or geography and ‘bolt-on’ to expand the position of an existing business. The company’s M&A director is focused on sourcing new acquisition targets in discoverIE’s key technological and geographical markets, namely companies with design and manufacturing capabilities in any of the group’s technology areas, located in Europe, North America or Asia.

Integration strategy: Retain entrepreneurial approach

The acquired businesses are led by entrepreneurial managers and discoverIE is keen to retain this culture. To support this, acquired businesses typically continue to operate under their own brands and management, working towards agreed business plans. discoverIE has created technology clusters, where smaller businesses are taken under the wing of a larger business operating in the same product area. In September, a new cluster for industrial wireless connectivity was created with the acquisition of 2J Antennas Group, bringing the company together with Antenova.

Acquired businesses can take advantage of being part of the larger group, with access to the wider discoverIE customer base, support for product development and manufacturing, centralised finance and administrative support. Efficiency improvements are achieved through knowledge-sharing among the businesses and group guidance on best practices. Where appropriate, manufacturing is rationalised to make the most efficient use of the group’s network of manufacturing facilities.

Acquisition track record

The table below summarises the acquisitions the group has made since FY12.

Exhibit 9: Acquisition timeline

Company

Date

Product areas

Operations

Sales

Cost (£m)

Hectronic

Jun 11

Embedded computing

Sweden

Nordic region, US

1.2

MTC

Oct 11

Electro-magnetic shielding

Germany, South Korea

Europe and Asia

2.7

Myrra SAS

Apr 13

Transformers, coils, cores and inductors

France, Poland, China

Europe, Asia, North America, Africa

9.9

Noratel

Jul 14

Low-, medium- and high-power transformers and inductors

Nordic region, China, US, India, Poland, Sri Lanka

Europe, Asia, North America

73.5

Foss

Jan 15

Customised fibre-optic solutions

Norway, Slovakia

Norway, Eastern Europe

12

Flux

Nov 15

Customised magnetic components

Denmark, Thailand

Denmark

4

Contour

Jan 16

Custom cable assemblies and connectors

UK

UK

17.5

Plitron

Feb 16

Custom toroidal transformers

Canada

North America

1.8

Variohm

Jan 17

Electronic sensors, switches and motion measurement systems

UK, Germany

UK, France, Germany, US

13.3

Santon

Feb 18

DC and AC switches and switchgear

Netherlands, UK

Europe, Asia, US

23.7

Cursor Controls Group

Oct 18

Human-to-machine interface technology

UK, Belgium

UK, Europe, North America, Asia

19.0

Hobart

Apr 19

Customised transformers, inductors, magnetics

US, Mexico

North America

11.7

Positek

Apr 19

Sensors

UK

UK, Europe, North America, Asia Pacific

4.2

Sens-Tech

Oct 19

Specialist sensing and data acquisition modules for X-ray and optical detection applications

UK

US, Europe, Asia, UK

58.0

Phoenix

Oct 20

Magnetically actuated sensors, encoders and related products

US

US

8.5

Limitor

Feb 21

Custom thermal safety components including temperature & current sensors, limiters and thermal switches

Germany, Hungary

Europe, US, Asia

13.2

CPI

May 21

Custom, rugged sensors and switches

US

US

8.1

Beacon EmbeddedWorks

Sep 21

Custom system-on-module embedded computing boards & related software

US

US

58.8

Antenova

Sep 21

Antennas and RF modules

UK, Taiwan, US

Europe, US, Asia

18.2

CDT

Jul 22

Customised plastic enclosures for circuit boards and membrane keypads

UK

UK

5.0

Magnasphere

Jan 23

High performance magnetic sensors and switches for industrial electronics

US

US

19.1

Silvertel

Aug 23

Power-over-ethernet modules

UK

>70 countries

21.0

2J Antennas Group

Sep 23

High performance antennas for industrial connectivity

Slovakia, UK, US

50 countries

45.0

Total

472.5

Source: discoverIE

The company has taken a disciplined approach to M&A; based on initial consideration, it has paid an average of 8.6x trailing PBT and 1.5x trailing sales for businesses with average PBT margins of 18.6%. This compares to 14.1x, 1.5x and 10.9% for discoverIE, respectively.

For H124, the company analysed the current EBIT return on investment (ROI) of all 19 acquisitions that it has owned for more than two years. It measures ROI as annualised operating profit for H124 divided by acquisition cost (upfront consideration, acquisition expenses, earnout and integration costs). The average EBIT ROI was 19.2%, well above the group’s 15% target. Ten of the acquisitions were at or above the target ROI with the remaining nine positive, but below 15%. Most companies below this target were the more recent acquisitions, reflecting the time it takes to integrate businesses and exploit synergies.

Seeking accretive targets

The company is currently tracking more than 400 companies and has identified 250 potential targets. Of these, it is talking to 45 and in active deal discussions with 15 targets that combined make up more than £100m in deal value and could increase EBIT by more than 10%. The chart below shows the areas in which discoverIE already has some presence as well as areas that it is interested in but has yet to penetrate.

Exhibit 10: Target areas for acquisitions

Source: discoverIE

Despite the current higher interest rate environment, we expect discoverIE to continue to make accretive acquisitions to drive growth. As deals in the pipeline can take a while to come to fruition, the timing of deals is difficult to forecast and discoverIE wants to take advantage of good deals when they present themselves. Management noted that economic uncertainty is causing vendors to reduce their valuation expectations compared to a year ago and in some cases, is making them keener to sell.

At the end of H124, the company had a net debt position of £111.3m and gearing of 1.6x EBITDA. The company has a £240m revolving credit facility (RCF) due in June 2027. It also has access to an £80m accordion facility; the RCF can be used for acquisitions and working capital. The company targets a gearing range of 1.5–2.0x, suggesting c £40–50m headroom for further acquisitions based on our forecast for gearing of 1.4x by end FY24.

Carbon emissions reduction

In FY23, discoverIE set net zero carbon emission targets, including a 65% reduction in absolute emissions from the level in CY21 by the end of CY25. By the end of CY22, the company had reduced absolute emissions by 35% compared to CY21, helped by solar panel installation projects at manufacturing sites in Sri Lanka and Thailand, and the reduction now stands at 45%.

Well established ESG strategy

At the start of 2020, the board and group executive committee initiated a review of the company’s approach to ESG matters, with the aim of further improving discoverIE’s approach to sustainability. As a result, the company committed to spending £3m over the next five years to resource and deliver its ESG strategy.

Governance structure in place

The company has a non-executive director, Rosalind Kainyah, with in-depth ESG experience. She established and chairs the sustainability committee, which includes all board members, to help set the group’s overall strategy and ensure the board has access to the knowledge and skills required in this area. Below this, the group sustainability team drives initiatives throughout the group and liaises with operating companies to consider what is practical and feasible.

Each member of the group executive committee has a specific ESG responsibility and targets within their personal objectives relating to ESG, with a proportion of annual bonus dependent on achievement of those targets. The company has also rolled out ESG objectives to the management of individual operating businesses.

Three overarching aims

The company has set three primary aims for its ESG strategy:

make a positive impact on the environment;

keep staff safe and happy; and

ensure the reliability and sustainability of products.

As well as ongoing initiatives in each area (eg increasing diversity, development and training plans for staff, supplier audits, responsible sourcing policies, enhancing cyber security controls), measurable targets have been set to work towards achieving each aim. See Exhibit 11 for targets and progress to date. We note that the reduction in carbon emissions is a key strategic indicator for the group.

Exhibit 11: Specific ESG targets

Aim

How measured

Targets

Progress

Minimise negative impact on the environment

Carbon emissions – scope 1&2

65% reduction against CY21 emissions

End CY22 -35%, now 45%

ISO14001 accreditations

>80% of group’s operations (by revenue) to be covered by an ISO14001 accreditation by 2025

59% by end CY22 (61% end CY21)

Energy audits conducted at group sites

>80% of all group sites to have been subject to an energy audit within the last five years

63% by end CY22 (53% by end CY21)

Company cars

50% to be electric or hybrid by 2025

33% by end CY22 (26% end CY21, 19% end CY20)

Keep staff safe
and happy

Proportion of workforce covered by ISO45001 compliant occupational health & safety (H&S) system

>80% to be covered by 2025

48% by end CY22 (5% by end CY21)

No. of H&S representatives and trained H&S staff across the group

Maintain a ratio of at least 1:50 trained H&S staff to total employees

1:21 end CY22 (1:38 end CY21, 1:52 end CY20)

Staff turnover

Unplanned staff turnover ≤15% pa

10% in CY22 (13% in CY21)

Ensure the quality and reliability of products

Share of group products covered by an ISO9001 system

Ensure that at least 80% of all products are built in accordance with ISO9001 accredited processes

92% at end CY22 (87% CY21)

Source: discoverIE. Note: All historics adjusted to excluded discontinued operations and include acquisitions since 1 January 2020.

Net zero targets set; scope 3 analysis undertaken

In FY23, the company set net zero carbon emission targets (Science Based Targets initiative (SBTi)-aligned). Based on scope 1 and 2 carbon emissions, the company is aiming to reach net zero carbon emissions by 2030, and including scope 3 emissions, by 2040. Of the 7,745t carbon dioxide equivalent (CO2e) scope 1 and 2 emissions in CY21, 94% came from four emissions sources: purchased electricity (73%), natural gas (13%), company-owned vehicles (7%) and refrigerants (1%). To track progress, the company has set the following milestones:

electricity 80% from renewables by 2025 and 100% by 2030 (end CY22 58% from renewable or clean energy, up from 29% at end CY21);

90% of gas heating to be replaced with electric options by 2029;

all company vehicles to be fully electric by 2030;

all refrigerants removed by 2025;

energy intensity (kWh/£m revenue) reduced by 10% by 2030. In 2022, energy consumption was 4% lower despite acquisitions and high manufacturing volumes, resulting in energy intensity falling 18% y-o-y; and

invest in carbon removal projects to remove residual emissions from 2030 onwards.

In FY23, the company completed its first analysis of scope 3 emissions. CY22 emissions totalled c 70,000tCO2e, making up more than 90% of group emissions across all scopes. The largest source of scope 3 emissions was from purchased goods and services (c 75%) followed by freight (c 18%) and employee commuting (c 3%). In the next 12 months, the company intends to improve its knowledge of scope 3 emissions, start upgrading systems and processes to capture the data more efficiently, complete an equivalent exercise for CY23 scope 3 emissions and develop an SBTi-aligned plan to reduce scope 3 emissions.

In FY23, the company completed a detailed scenario analysis and quantified the potential financial impact of climate change per Task Force on Climate-Related Financial Disclosures (TCFD) requirements. Based on the 2DS (2oC warming or lower) and BAU (business as usual) TCFD scenarios, the net financial impact over the seven-year period to 2030 is immaterial and represents c 1–2% of group operating cash flows.

External reviews validate approach

In its 2023 assessment, MSCI upgraded discoverIE’s rating from ‘A’ to ‘AA’. The company is rated as a low-risk by Sustainalytics ESG risk rating service, with a Regional Top Rating (Europe) and ranking 72 out of 653 in its technology hardware group.

Financials

Review of H124 results

Exhibit 12: H124 results highlights

£m

H124

H123

H123 CER

Reported yoy

CER y-o-y

Organic yoy

Revenues

222.0

222.6

213.7

(0%)

4%

1%

Magnetics & controls

134.4

139.4

131.5*

(4%)

2%

2%

Sensing & connectivity

87.6

83.2

82.2

5%

7%

1%

Underlying operating profit

Magnetics & controls

19.9

18.0

17.1

11%

16%

Sensing & connectivity

15.2

13.6

13.4

12%

13%

Unallocated

(6.5)

(6.0)

(6.0)

8%

Total underlying operating profit

28.6

25.6

24.5

12%

17%

Total underlying operating margin

12.9%

11.5%

11.5%

1.4%

Magnetics & controls

14.8%

12.9%

13.0%

1.9%

Sensing & connectivity

17.4%

16.3%

16.3%

1.0%

Reported operating profit

19.5

16.9

15%

Underlying EPS (p) - diluted

19.2

17.8

8%

Reported EPS (p) - diluted

11.7

10.9

7%

Net debt

111.3

45.2

146%

Source: discoverIE

discoverIE reported flat H124 revenue on a reported basis, up 4% y-o-y CER and up 1% on an organic CER basis, with both divisions reporting organic growth. Underlying operating profit increased 12% y-o-y or 17% CER, with the margin increasing 1.4pp to 12.9%. Both divisions increased their underlying operating margin. Reported operating profit includes amortisation of acquired intangibles totalling £7.7m and acquisition-related costs of £1.4m. Net finance costs increased from £2.1m in H123 to £3.5m in H124 reflecting higher interest rates and higher debt to fund acquisitions. Overall, underlying EPS increased 8% y-o-y.

Making good progress versus KPIs

Exhibit 13 shows discoverIE’s KPIs and we discuss the performance below.

Exhibit 13: Key performance indicators

FY15

FY16

FY17

FY18

FY19

FY20

FY21

FY22

FY23

H124

Target

Sales growth: CER

36%

14%

6%

11%

14%

8%

0%

29%

15%

4%

Well ahead of GDP

Sales growth: continuing organic

9%

3%

(1%)

11%

10%

5%

(4%)

18%

10%

1%

Underlying EPS growth

31%

10%

13%

16%

22%

11%

(8%)

31%

20%

8%

>10%

Dividend growth

11%

6%

6%

6%

6%

N/A**

6%

6%

6%

6%

Progressive

ROCE*

12.0%

11.6%

13.0%

13.7%

15.4%

16.0%

14.5%

14.7%

15.9%

15.1%

>15%

Operating cash flow generation+

104%

100%

136%

85%

93%

106%

128%

80%

94%

91%

>85% of underlying operating profit

Free cash flow generation+

22%

64%

101%

58%

94%

104%

136%

77%

95%

85%

>85% of underlying profit after tax

Source: discoverIE. Note: *Calculated as underlying operating profit (acquisitions annualised) as a percentage of net assets excluding net debt, deferred consideration for discontinued operations and legacy defined pension asset/liability. **Only interim dividend paid to preserve cash. +Half-year performance based on trailing 12 months.

Sales growth: the business has shown strong organic growth since FY18, well ahead of GDP, apart from in COVID-affected FY21. The CAGR of organic revenue since FY18 is c 9%. Organic growth has slowed as the macroeconomic environment has weakened and companies have worked down excess inventory. The company still targets 10% organic growth through the cycle.

EPS growth: excluding FY21, the company has grown underlying EPS at or ahead of its target rate every year to FY23. H124 growth was affected by the effect of higher interest rates and higher net debt to fund acquisitions.

Dividend growth: aside from FY20 when the company did not pay a final dividend to preserve cash, discoverIE has grown the dividend every year. The FY24 interim dividend of 3.75p was 6% higher year-on-year and marginally ahead of our 3.7p forecast. The company targets dividend cover (based on underlying EPS) of at least 3x.

ROCE: the company met the target achieving ROCE of 15.1% in H124. This declined from the 15.9% achieved in FY23 due to the recent acquisitions of Silvertel and 2J Antennas. The company expects Silvertel to be accretive to ROCE this year and 2J Antennas next year.

Operating cash conversion: H124 operating cash conversion exceeded the target level and trailing 12-month operating cash flow of £49.8m was 36% ahead of the same period a year ago.

Free cash flow conversion: free cash flow conversion met the target level. Trailing 12-month free cash flow of £30.5m was 26% higher year-on-year. The company set this metric to help it work towards its target of self-funding acquisitions.

Gearing to reduce below 1.5x by end FY24

At the end of H124, the company had used £144m of its £240m RCF. The chart below shows discoverIE’s gearing levels since FY15, with gearing only higher than 1.5x on two occasions, after the acquisitions of Contour and Cursor Controls. The lower level of gearing in FY21–23 reflects the focus on cash preservation during COVID, which included a brief pause in acquisitions, as well as equity fund-raising in FY22 to partially fund the acquisitions of Beacon EmbeddedWorks and Antenova. Our forecasts, absent any further acquisitions, assume that gearing reaches 1.4x by the end of FY24 and declines to 1.3x by the end of FY25.

Exhibit 14: Net debt/EBITDA (x) FY15–FY25e

Source: discoverIE, Edison Investment Research

Outlook and changes to forecasts

As previously highlighted by the company, the order book has been normalising from its peak of £257m at the end of H123 (equating to around seven months of revenue visibility), declining to £223m at the end of FY23 and to £203m by the end of H124, providing more like five months’ forward visibility. Management believes that customer destocking is largely complete.

H124 orders of £193.9m were 18% lower y-o-y (down 16% CER). B:B for H124 was 0.87:1 versus 1.08:1 in H123, with Q224 orders 2% ahead of Q124. The company exited September on a B:B close to 1:1 and so far in H224, orders have been ahead of sales.

Design win activity is a leading indicator of future revenue growth. In H124, the company generated design wins with an estimated lifetime value of £190m, 23% higher year-on-year, with 89% from target markets.

Management anticipates delivering underlying earnings in line with its expectations for FY24. We leave our revenue, underlying operating profit and underlying EPS forecasts unchanged. We note that with an unchanged operating profit margin forecast of 12.5% for FY24, this implies a reduction in margin in H224 to 12.1%. While this may appear conservative, the company noted the negative effect of the strength of sterling on profitability. We have slightly increased our FY24 full year dividend from 12.0p to 12.1p. Based on the company’s expectation for gearing approaching 1.3x by year end, we have lowered our working capital forecasts and reduced our net debt forecasts by 2.5% in FY24 and 6.6% in FY25. We note that our conservative forecast results in gearing of 1.4x by end FY24.

Valuation

Exhibit 15 shows financial metrics for discoverIE’s peer group and Exhibit 16 shows the valuation metrics. For the peer group, we use companies active in the electronics market and acquisitive industrial companies. discoverIE’s stock has declined c 9% over the last year compared to a flat UK market. It initially declined 20% after the 2J Antennas acquisition was announced in mid-September but since interims were announced has nearly regained this ground. The stock trades in line with the average of its broader UK industrial technology peer group on an FY24e P/E basis but at a discount compared to peers with a similar decentralised operating model (such as Halma and Spirax). The focus on strategic growth markets supports sustained organic revenue growth through the cycle and we see potential for upside to earnings through operating margin expansion and accretive acquisitions.

Exhibit 15: Peer group financial metrics

Year end

Share price (p)

Market cap (£m)

Revenue growth (%)

EBITDA margin (%)

EBIT margin (%)

CY

NY

CY

NY

CY

NY

discoverIE

31-Mar

714

688

0.7

5.6

15.9

16.0

12.5

12.8

Diploma

30-Sep

3,428

4,597

10.9

5.4

22.0

21.9

18.8

18.9

Gooch & Housego

30-Sep

570

147

6.9

4.2

14.9

15.9

9.0

10.2

TT electronics

31-Dec

148

262

1.5

0.2

10.9

11.8

8.0

8.9

XP Power

31-Dec

1,196

283

5.8

2.7

18.5

19.1

12.3

13.1

Avon Protection

30-Sep

809

245

6.5

6.7

15.6

16.9

9.2

10.6

Halma

31-Mar

2,205

8,371

7.0

6.3

23.4

23.7

20.6

20.8

Spectris

31-Dec

3,504

3,565

10.7

4.4

20.9

21.2

16.9

17.5

Spirax-Sarco Engineering

31-Dec

9,478

6,992

5.6

4.9

24.7

25.4

19.3

20.4

Average

6.9

4.4

18.9

19.5

14.3

15.0

Source: Edison Investment Research, Refinitiv (as at 11 December)

Exhibit 16: Peer group valuation metrics

EV/sales (x)

EV/EBITDA (x)

EV/EBIT (x)

P/E (x)

Div yield (%)

CY

NY

CY

NY

CY

NY

CY

NY

CY

NY

discoverIE

1.4

1.3

9.0

8.4

10.9

10.2

20.1

19.2

1.7

1.8

Diploma

3.7

3.5

16.9

16.1

19.7

18.6

25.2

23.6

1.7

1.8

Gooch & Housego

1.1

1.1

7.6

6.8

12.5

10.6

14.8

12.3

2.3

2.4

TT electronics

0.6

0.6

5.9

5.4

8.0

7.2

8.1

7.3

4.5

4.8

XP Power

1.6

1.6

8.6

8.1

13.0

11.9

10.3

10.7

2.0

0.0

Avon Protection

1.5

1.4

9.7

8.4

16.5

13.4

20.8

16.0

2.9

3.1

Halma

4.5

4.3

19.4

18.0

22.0

20.5

27.4

25.4

1.1

1.1

Spectris

2.3

2.2

11.1

10.5

13.7

12.7

17.8

16.8

2.3

2.5

Spirax-Sarco Engineering

4.6

4.4

18.6

17.3

23.8

21.5

29.5

26.9

1.7

1.8

Average

2.5

2.4

12.2

11.3

16.2

14.6

19.3

17.4

2.3

2.2

Premium/(discount) to average

(43.2)

(43.5)

(26.7)

(25.9)

(32.3)

(30.2)

4.2

10.8

(26.4)

(19.9)

Source: Edison Investment Research, Refinitiv (as at 11 December)

Ability to weather economic uncertainty

As interest rates have risen to combat inflation, concerns about a potential recession have weighed on discoverIE’s share price, exacerbated by the higher level of debt post the acquisitions of Silvertel and 2J Antennas. The company has previously weathered downturns in demand, such as the downturn in FY17 due to a global adjustment in capex and in FY21 (the COVID pandemic). The company saw a 1% decline in organic revenue in FY17 but managed to expand its adjusted operating margin from 5.7% to 5.9%. Since then, the company has further diversified in terms of customer, technology, end market and geography, potentially adding more resilience to the group. The focus on strategic growth markets should also help during periods of economic weakness.

Potential for accretive acquisitions

We estimate that discoverIE is paying close to 7% for its debt (all floating rate) so any debt-funded acquisition will have a higher bar to clear to generate earnings accretion than was the case a couple of years ago. The company has a good track record for buying high-margin businesses on lower multiples than its own and is usually able to improve the businesses it buys, for example by focusing on design wins and target markets, optimising working capital or benefiting from group volume discounts and better sales reach. As an illustration of the potential for earnings accretion, if we assume that discoverIE spends £30m on a company with operating margins of 20% and pays 8x PBT, we estimate that this would increase our FY25 underlying operating margin by 0.27pp to 13.0% and increase our FY25 underlying diluted EPS forecast by 3.3%, while increasing end-FY24 gearing to 1.8x (compared to our current forecast of 1.4x). The same calculation on a 10x deal multiple would reduce EPS accretion to 1.8%. In the current uncertain macroeconomic environment, management noted that sellers’ price expectations have started to become more realistic.

Sensitivities

Our estimates and the discoverIE share price will be sensitive to the following factors:

Customer demand: Customer demand will be influenced by the economic environment in Europe and, increasingly, the United States and Asia-Pacific. It will also be sensitive to the gain or loss of major customers, although in H124 no customer made up more than 7% of sales.

Supply chain: discoverIE buys raw materials and components from suppliers around the world and will be affected by the availability of these supplies as well as the cost and availability of freight to transport them.

Currency: Translational – with c 90% of revenues in non-sterling currencies, discoverIE is exposed to the translation of euro, US dollar and Nordic-denominated subsidiary results into sterling, which decreased growth in sales by 4pp and underlying operating profit by 5pp in H124. Transactional – discoverIE sells mainly in euros, US dollars, sterling and Nordic currencies, and purchases mainly in US dollars and euros. discoverIE hedges with forward contracts to the extent that the exposure cannot be passed to the customer.

Pricing: discoverIE’s revenues and profitability are sensitive to the company’s ability to include within price quotes engineering time spent on designing customer solutions. The company aims to pass through supplier price increases and tariffs, with very few fixed-price contracts.

Acquisitions: The company is likely to make further acquisitions, which could add integration risk and will require funding.

Exhibit 17: Financial summary

£m

2020

2021

2022

2023

2024e

2025e

Year end 31 March

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

297.9

302.8

379.2

448.9

452.1

477.3

EBITDA

 

 

43.6

44.0

56.1

65.4

71.8

76.6

Normalised operating Profit (before am, SBP and except.)

31.6

31.9

44.8

54.3

58.8

63.3

Underlying operating Profit (before am. and except.)

29.8

30.8

41.4

51.8

56.4

60.9

Amortisation of acquired intangibles

(9.0)

(11.1)

(14.0)

(15.8)

(17.0)

(18.6)

Exceptionals

(4.3)

(2.6)

(6.5)

(1.4)

(1.9)

(1.0)

Share-based payments

(1.8)

(1.1)

(3.4)

(2.5)

(2.4)

(2.4)

Operating Profit

16.5

17.1

20.9

34.6

37.5

41.3

Net Interest

(4.3)

(3.6)

(3.8)

(5.5)

(9.2)

(11.0)

Profit Before Tax (norm)

 

 

27.3

28.3

41.0

48.8

49.6

52.2

Profit Before Tax (FRS 3)

 

 

12.2

13.5

17.1

29.1

28.3

30.2

Tax

(3.3)

(4.0)

(7.4)

(7.8)

(7.3)

(8.0)

Profit After Tax (norm)

21.8

21.6

30.8

36.1

36.8

38.5

Profit After Tax (FRS 3)

8.9

9.5

9.7

21.3

21.0

22.3

Discontinued operations

5.4

2.5

15.5

0.0

0.0

0.0

Net income (norm)

21.8

21.6

30.8

36.1

36.8

38.5

Net income (FRS 3)

14.3

12.0

25.2

21.3

21.0

22.3

Ave. Number of Shares Outstanding (m)

84.0

88.8

93.0

95.4

95.9

96.4

EPS - normalised & diluted (p)

 

 

25.1

23.4

32.1

36.7

37.4

38.9

EPS - underlying, diluted (p)

 

 

24.4

22.4

29.4

35.2

35.6

37.1

EPS - IFRS basic (p)

 

 

17.0

13.5

27.1

22.3

21.9

23.1

EPS - IFRS diluted (p)

 

 

16.5

13.0

26.3

21.7

21.3

22.5

Dividend per share (p)

2.97

10.15

10.80

11.45

12.10

12.50

EBITDA Margin (%)

14.6

14.5

14.8

14.6

15.9

16.0

Normalised operating margin (before am, SBP and except.) (%)

10.6

10.5

11.8

12.1

13.0

13.3

discoverIE underlying operating margin (%)

10.0

10.2

10.9

11.5

12.5

12.8

BALANCE SHEET

Fixed Assets

 

 

236.4

244.6

326.5

335.9

388.0

373.4

Intangible Assets

182.2

190.8

263.3

272.0

323.2

306.3

Tangible Assets

46.3

45.9

45.4

44.4

45.3

47.6

Deferred tax assets

7.9

7.9

17.8

19.5

19.5

19.5

Current Assets

 

 

197.4

183.6

266.2

249.8

197.7

213.1

Stocks

68.4

67.7

77.8

90.0

93.5

98.7

Debtors

90.1

84.9

78.0

74.6

80.5

85.0

Cash

36.8

29.2

108.8

83.9

22.4

28.1

Current Liabilities

 

 

(103.6)

(107.8)

(190.3)

(151.2)

(153.4)

(153.7)

Creditors

(94.0)

(102.2)

(114.2)

(107.3)

(109.5)

(109.8)

Lease liabilities

(5.3)

(4.8)

(4.7)

(4.0)

(4.0)

(4.0)

Short term borrowings

(4.3)

(0.8)

(71.4)

(39.9)

(39.9)

(39.9)

Long Term Liabilities

 

 

(129.7)

(112.0)

(112.0)

(130.9)

(120.4)

(109.6)

Long term borrowings

(93.8)

(75.6)

(67.6)

(86.7)

(81.7)

(76.7)

Lease liabilities

(14.7)

(16.7)

(16.4)

(14.8)

(14.8)

(14.8)

Other long term liabilities

(21.2)

(19.7)

(28.0)

(29.4)

(23.9)

(18.1)

Net Assets

 

 

200.5

208.4

290.4

303.6

311.9

323.2

CASH FLOW

Operating Cash Flow

 

 

48.0

56.8

42.5

52.1

60.6

64.2

Net Interest

(3.7)

(3.1)

(3.3)

(4.8)

(8.7)

(10.5)

Tax

(6.4)

(7.2)

(7.1)

(9.0)

(12.8)

(13.7)

Capex

(6.3)

(3.9)

(6.2)

(5.6)

(8.5)

(9.2)

Acquisitions/disposals

(73.6)

(20.5)

(46.8)

(25.1)

(68.5)

(2.0)

Financing

53.9

(6.6)

47.2

(7.5)

(6.0)

(6.1)

Dividends

(8.1)

(2.8)

(9.4)

(10.5)

(11.2)

(11.9)

Net Cash Flow

3.8

12.7

16.9

(10.4)

(55.1)

10.7

Opening net cash/(debt)

 

 

(63.3)

(61.3)

(47.2)

(30.2)

(42.7)

(99.2)

HP finance leases initiated

0.0

0.0

0.0

0.0

0.0

0.0

Other

(1.8)

1.4

0.1

(2.1)

(1.4)

(0.0)

Closing net cash/(debt)

 

 

(61.3)

(47.2)

(30.2)

(42.7)

(99.2)

(88.5)

Source: discoverIE, Edison Investment Research

Contact details

Revenue by geography

2 Chancellor Court, Occam Road,
Surrey Research Park, Guildford
GU2 7AH
+44 (0)1483 544500
www.discoverieplc.co.uk

Contact details

2 Chancellor Court, Occam Road,
Surrey Research Park, Guildford
GU2 7AH
+44 (0)1483 544500
www.discoverieplc.co.uk

Revenue by geography

Management team

CEO: Nick Jefferies

CFO: Simon Gibbins

Nick joined discoverIE as group chief executive in January 2009. He has held senior positions for over 15 years with leading international distributors of electronic components and computer products, such as Electrocomponents and Arrow Electronics. He originally trained as an electronics design engineer with Racal Defence (now part of Thales).

Simon was appointed as group finance director in July 2010. A chartered accountant, he was previously global head of finance and deputy CFO at Shire. Before joining Shire in 2000, he spent six years with ICI in various senior finance roles, both in the UK and overseas. His earlier career was spent with Coopers & Lybrand in London.

Chairman: Bruce Thompson

Bruce joined discoverIE as a non-executive director in 2018 and was appointed non-executive chairman from 1 November 2022. From 1996–2018 he was the CEO of Diploma. He is also non-executive director of Avon Protection.

Management team

CEO: Nick Jefferies

Nick joined discoverIE as group chief executive in January 2009. He has held senior positions for over 15 years with leading international distributors of electronic components and computer products, such as Electrocomponents and Arrow Electronics. He originally trained as an electronics design engineer with Racal Defence (now part of Thales).

CFO: Simon Gibbins

Simon was appointed as group finance director in July 2010. A chartered accountant, he was previously global head of finance and deputy CFO at Shire. Before joining Shire in 2000, he spent six years with ICI in various senior finance roles, both in the UK and overseas. His earlier career was spent with Coopers & Lybrand in London.

Chairman: Bruce Thompson

Bruce joined discoverIE as a non-executive director in 2018 and was appointed non-executive chairman from 1 November 2022. From 1996–2018 he was the CEO of Diploma. He is also non-executive director of Avon Protection.

Principal shareholders

(%)

abrdn

8.9

Impax Asset Management

5.8

Kempen Capital Management NV

5.7

BlackRock

5.2

Montanaro Group

4.1

Charles Stanley

3.0


General disclaimer and copyright

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Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

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Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

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

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

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.

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

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.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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OSE Immunotherapeutics — Timely FR104/VEL-101 update with Phase II plans

OSE Immunotherapeutics (OSE) has shared a positive update on the FIRsT clinical trial assessing FR104/VEL-101 (an anti-CD28 monoclonal antibody) as a maintenance therapy for kidney transplant patients. Long-term maintenance therapy in kidney transplant patients remains an ongoing medical need that has seen little progression in the last 20 years. Although OSE is in the early stages of clinical development, we believe there could be a significant opportunity. Encouragingly, the results show no safety concerns with FR104/VEL-101 treatment (seven patients for 12 months post-transplantation, and one ongoing at four months) and no cases of acute rejection, both of which are key objectives for this Phase I/II trial. While the FIRsT study involves a relatively small group size (eight evaluable patients), we believe the update is encouraging, and note that Veloxis Pharmaceuticals (OSE’s partner for this programme) is already preparing for a subsequent Phase II trial involving a larger patient population. We expect full results from the FIRsT study after all patients have completed the 12-month treatment protocol, most likely in H224.

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