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Research: TMT
At the recent Capital Markets Day, discoverIE management confirmed the company’s strategy to grow the business through a combination of organic growth, and acquisition of design and manufacturing businesses. The integration process is designed to retain the entrepreneurial spirit of acquired businesses while taking advantage of the group balance sheet and central functions, to drive good organic growth post acquisition. Management aims to provide investors with a progressive dividend and a return of 15-20% pa.
discoverIE Group |
Outlining the growth opportunity |
Capital Markets Day |
Electronic & electrical equipment |
19 March 2018 |
Share price performance
Business description
Next events
Analysts
discoverIEdiscoverIE Group is a research client of Edison Investment Research Limited |
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At the recent Capital Markets Day, discoverIE management confirmed the company’s strategy to grow the business through a combination of organic growth, and acquisition of design and manufacturing businesses. The integration process is designed to retain the entrepreneurial spirit of acquired businesses while taking advantage of the group balance sheet and central functions, to drive good organic growth post acquisition. Management aims to provide investors with a progressive dividend and a return of 15-20% pa.
Year end |
Revenue (£m) |
PBT* |
EPS* |
DPS |
P/E |
Yield |
03/16 |
287.7 |
15.2 |
17.8 |
8.1 |
23.1 |
2.0 |
03/17 |
338.2 |
17.8 |
19.9 |
8.5 |
20.1 |
2.1 |
03/18e |
391.0 |
21.6 |
21.6 |
9.0 |
19.1 |
2.2 |
03/19e |
427.6 |
25.0 |
24.6 |
9.5 |
16.4 |
2.3 |
Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.
Consolidating a fragmented market
After making 11 acquisitions in the design and manufacturing space over seven years, management continues to find multiple acquisition opportunities in the fragmented custom electronics market. Management has strict criteria for targets and a well-defined integration process to maximise growth and operating efficiency, and the acquired business should generate an EBIT return on investment of at least 15% within two years of being acquired. Cross-selling is a key tool to drive organic revenue growth, and divisional heads were keen to emphasise the attractiveness of being part of a larger group with access to a wider customer base. Sales incentives have been structured to encourage this.
Shifting the profile to higher-margin D&M business
Organic growth from existing businesses, combined with the acquisition of D&M businesses, is gradually shifting the proportion of D&M revenues as a percentage of the total: from 3% in FY11 to our 56% estimate for FY18 (and 59% including Santon on a pro forma basis). D&M operating margin, before central costs, was 11.5% in FY17, versus 3.2% for Custom Supply. This mix shift has grown the underlying group operating margin from 2.8% in FY11 to 6.2% in FY18e. With the target of moving the proportion up to 75% of revenues in the medium term and 85% in the longer term, this provides a pathway to push the operating margin above 10% for the group.
Valuation: Still trading at a discount
The stock is trading on an FY19e P/E of 16.4x, at a c 14% discount to the peer group average. Continued growth in the proportion of revenue generated from design and manufacturing should support operating margin expansion, and should help to reduce the valuation discount. The stock is also supported by a dividend yield of more than 2%.
Design and manufacturing: Lifting the lid
At the recent Capital Markets Day, analysts had the opportunity to meet management from each of the 12 D&M businesses and see a variety of products from across those businesses.
D&M product criteria
D&M group commercial director, Paul Neville, outlined the characteristics of the products that the D&M business seeks to supply:
■
Vital niche products in growing markets. Target growth markets include renewable energy, transportation, medical, and industrial connectivity.
■
Customised products priced on value rather than on a “cost-plus” basis.
■
Customers require local engineers and language.
■
Products demand high performance and reliability and are optimised for each application.
■
Product is a small proportion of overall equipment cost, but is essential to the end-device.
The businesses fit broadly into two categories:
1.
Magnetics & power: Flux, Myrra, Noratel, Plitron and RSG
2.
Components: Contour, Foss, Hectronic, MTC, Santon, Stortech and Variohm.
D&M growth path
The D&M division has grown from revenues of £6m in 2011 (all UK-based) to revenues of £176m in FY17, spread across the UK (14%), Europe (58%), North America (9%) and Asia/ROW (19%). This is from a combination of organic growth and 10 acquisitions (with one additional acquisition during FY18). Post-acquisition, on average businesses have shown organic revenue growth of 5% pa and organic EBIT growth of 7% pa.
Product demos highlight the benefits of being part of discoverIE
Meeting the business heads, it was apparent they appreciated being part of the larger discoverIE group, citing benefits such as the strong balance sheet (which gives comfort to customers), access to resources to help with international expansion, and importantly, the benefits of introductions to potential customers by other group companies (and vice versa). The range of products being demonstrated highlighted the large number of applications that discoverIE products go into. Some business heads commented on the ability of their businesses to supply small and medium sized volumes of customised products to customers, which differentiates them from volume manufacturers using cheaper Asian facilities, who are not interested in such small production runs. Others highlighted the reliability of their products, which has allowed them to retain customers for many years. Talking to the different heads, it became apparent that the wide geographical spread of manufacturing facilities serve various purposes:
■
the company can take advantage of lower labour costs – for example, magnetics produced at the Flux Thai facility;
■
meet domestic demand - the soon to be opened Bangalore facility services the domestic Indian market; or
■
meet regulatory requirements relating to the location of manufacturing - for example, US transport organisations buying technology for use in trains require at least 60% of the solution to be manufactured in the US. Noratel US is able to meet this requirement with its facility in California.
Approach to M&A
Jeremy Morcom, group head of Corporate Development, outlined the criteria used for selecting acquisition targets and the process undertaken to integrate businesses once acquired.
Well-defined criteria for acquisition targets
■
Active in target growth markets.
■
Already performing well – no problem companies that need fixing.
■
Products that fit into the D&M product criteria listed above and that the group already understands.
■
Strong value proposition, ie products require some element of customisation such that the product is not priced as a commodity.
■
OEM customer base.
■
Business has long-term growth potential.
■
Management is ambitious.
The business should be capable of generating an EBIT return on investment1 of at least 15% within two years of acquisition. Of the 10 acquisitions made up until the end of FY17, six companies have beaten that target and four have yet to hit it. On average, the return is 16%. The company expects the average to increase in FY18.
Calculated as annualized operating profit divided by initial consideration, acquisition costs, earnouts (if paid) and integration costs.
Future acquisitions could be bolt-ons that complement existing acquisitions or standalone deals. Target size (by enterprise value) is £10-80m, but a larger deal would be considered. Geographically, the company is keen to increase its presence in North America.
With net debt/EBITDA forecast at 1.7x at the end of FY18 and the company targeting gearing below 2x, it has some headroom to use debt. We expect that any larger deals would be part-equity funded.
Integration approach – retain entrepreneurial spirit
The company’s approach to integration begins even before a deal is closed. It will develop a three-year business plan with the target, which is agreed with the target pre-acquisition. Typically, deals are structured with an earnout element to align incentives.
The acquired company typically retains its brand and identity. As discoverIE is keen to retain an entrepreneurial spirit within the group, it acquires companies with ambitious management teams and allows them a certain amount of autonomy. The newly acquired business will have access to the larger resources of the discoverIE group. This includes purchasing efficiencies, manufacturing, finance and back office functions, and international sales and marketing resources. Cross-selling is encouraged – incentives are offered to both parties to a cross-selling transaction to encourage growth in this area. This usually takes a few years to become evident at the revenue level, as the design process for many products is in the region of one to three years.
Exhibit 1: Financial summary
£m |
2013 |
2014 |
2015 |
2016 |
2017 |
2018e |
2019e |
||
Year end 31 March |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
||
PROFIT & LOSS |
|||||||||
Revenue |
|
|
177.4 |
211.6 |
271.1 |
287.7 |
338.2 |
391.0 |
427.6 |
Cost of Sales |
(123.0) |
(148.6) |
(186.7) |
(195.1) |
(227.2) |
(264.9) |
(289.1) |
||
Gross Profit |
54.4 |
63.0 |
84.4 |
92.6 |
111.0 |
126.1 |
138.6 |
||
EBITDA |
|
|
7.4 |
9.1 |
16.6 |
19.8 |
24.3 |
29.0 |
34.4 |
Operating Profit (before am, SBP and except.) |
6.1 |
7.7 |
14.0 |
17.0 |
20.6 |
24.8 |
29.2 |
||
Operating Profit (before am. and except.) |
|
5.5 |
7.1 |
13.4 |
16.3 |
20.0 |
24.2 |
28.4 |
|
Amortisation of acquired intangibles |
(0.7) |
(1.0) |
(2.1) |
(2.8) |
(3.9) |
(4.9) |
(7.4) |
||
Exceptionals |
(3.4) |
(0.9) |
(5.2) |
(2.1) |
(8.4) |
(3.9) |
(3.2) |
||
Share-based payments |
(0.6) |
(0.6) |
(0.6) |
(0.7) |
(0.6) |
(0.6) |
(0.8) |
||
Operating Profit |
1.4 |
5.2 |
6.1 |
11.4 |
7.7 |
15.4 |
17.7 |
||
Net Interest |
(0.5) |
(0.8) |
(1.6) |
(1.8) |
(2.8) |
(3.1) |
(4.2) |
||
Profit Before Tax (norm) |
|
|
5.6 |
6.9 |
12.4 |
15.2 |
17.8 |
21.6 |
25.0 |
Profit Before Tax (FRS 3) |
|
|
0.7 |
4.2 |
4.3 |
9.4 |
4.8 |
12.1 |
13.3 |
Tax |
1.4 |
(0.5) |
(1.4) |
(2.2) |
(1.3) |
(3.5) |
(3.5) |
||
Profit After Tax (norm) |
4.6 |
6.0 |
10.0 |
11.8 |
13.6 |
16.2 |
18.7 |
||
Profit After Tax (FRS 3) |
2.1 |
3.7 |
2.9 |
7.2 |
3.5 |
8.6 |
9.9 |
||
Average Number of Shares Outstanding (m) |
39.2 |
43.1 |
57.6 |
63.3 |
65.4 |
70.7 |
70.9 |
||
EPS - normalised & diluted (p) |
|
|
11.3 |
13.1 |
16.4 |
17.8 |
19.9 |
21.6 |
24.6 |
EPS - IFRS basic (p) |
|
|
(4.8) |
3.0 |
5.0 |
11.4 |
5.3 |
12.1 |
13.9 |
EPS - IFRS diluted (p) |
|
|
(4.7) |
2.8 |
4.8 |
10.9 |
5.1 |
11.4 |
13.0 |
Dividend per share (p) |
6.2 |
6.8 |
7.6 |
8.1 |
8.5 |
9.0 |
9.5 |
||
Gross Margin (%) |
30.7 |
29.8 |
31.1 |
32.2 |
32.8 |
32.2 |
32.4 |
||
EBITDA Margin (%) |
4.2 |
4.3 |
6.1 |
6.9 |
7.2 |
7.4 |
8.0 |
||
Operating Margin (before am, SBP and except.) (%) |
3.4 |
3.6 |
5.2 |
5.9 |
6.1 |
6.3 |
6.8 |
||
BALANCE SHEET |
|||||||||
Fixed Assets |
|
|
30.9 |
33.1 |
88.6 |
108.4 |
122.2 |
147.9 |
141.5 |
Intangible Assets |
24.2 |
25.5 |
69.9 |
88.2 |
100.7 |
126.6 |
118.8 |
||
Tangible Assets |
3.1 |
3.5 |
13.8 |
14.7 |
16.0 |
15.8 |
17.3 |
||
Deferred tax assets |
3.6 |
4.1 |
4.9 |
5.5 |
5.5 |
5.5 |
5.5 |
||
Current Assets |
|
|
81.8 |
92.7 |
127.3 |
128.3 |
149.6 |
164.6 |
170.7 |
Stocks |
19.3 |
19.4 |
39.8 |
42.9 |
50.1 |
57.8 |
63.3 |
||
Debtors |
44.7 |
48.3 |
60.2 |
65.5 |
77.3 |
86.8 |
94.9 |
||
Cash |
17.8 |
18.1 |
26.7 |
19.9 |
22.2 |
20.0 |
12.6 |
||
Current Liabilities |
|
|
(50.9) |
(58.3) |
(62.1) |
(61.7) |
(78.4) |
(95.2) |
(101.6) |
Creditors |
(46.6) |
(51.5) |
(61.9) |
(60.9) |
(77.1) |
(89.9) |
(96.3) |
||
Short term borrowings |
(4.3) |
(6.8) |
(0.2) |
(0.8) |
(1.3) |
(5.3) |
(5.3) |
||
Long Term Liabilities |
|
|
(10.3) |
(19.0) |
(61.1) |
(73.1) |
(69.6) |
(93.3) |
(86.5) |
Long term borrowings |
(1.7) |
(9.5) |
(45.5) |
(57.2) |
(50.9) |
(70.9) |
(65.9) |
||
Other long term liabilities |
(8.6) |
(9.5) |
(15.6) |
(15.9) |
(18.7) |
(22.4) |
(20.6) |
||
Net Assets |
|
|
51.5 |
48.5 |
92.7 |
101.9 |
123.8 |
124.1 |
124.2 |
CASH FLOW |
|||||||||
Operating Cash Flow |
|
|
5.7 |
6.1 |
6.6 |
14.6 |
20.3 |
19.2 |
27.1 |
Net Interest |
(0.6) |
(0.8) |
(1.6) |
(1.8) |
(2.8) |
(3.1) |
(4.2) |
||
Tax |
(1.4) |
(0.9) |
(3.3) |
(4.3) |
(3.0) |
(5.4) |
(6.3) |
||
Capex |
(1.3) |
(1.4) |
(2.5) |
(2.3) |
(3.4) |
(3.7) |
(6.2) |
||
Acquisitions/disposals |
(0.5) |
(9.2) |
(37.3) |
(19.8) |
(11.8) |
(27.0) |
(6.4) |
||
Financing |
5.7 |
0.1 |
52.7 |
0.0 |
13.6 |
0.0 |
0.0 |
||
Dividends |
(2.3) |
(2.7) |
(3.6) |
(4.9) |
(5.2) |
(6.2) |
(6.5) |
||
Net Cash Flow |
5.3 |
(8.8) |
11.0 |
(18.5) |
7.7 |
(26.2) |
(2.4) |
||
Opening net cash/(debt) |
|
|
6.3 |
11.8 |
1.8 |
(19.0) |
(38.1) |
(30.0) |
(56.2) |
HP finance leases initiated |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
||
Other |
0.2 |
(1.2) |
(31.8) |
(0.6) |
0.4 |
0.0 |
0.0 |
||
Closing net cash/(debt) |
|
|
11.8 |
1.8 |
(19.0) |
(38.1) |
(30.0) |
(56.2) |
(58.6) |
Source: discoverIE, Edison Investment Research
|
|
Research: TMT
EMIS Group’s recent restructuring enabled it to report FY17 adjusted profits in line with forecasts, despite revenues below our expectations. The company’s immediate focus is on strengthening its core business, both in the wake of the recent customer support issue, but also to ensure it can maintain its market-leading position in the UK primary care market. Lower revenue growth and increased costs to support near-term projects reduce our earnings forecasts for FY18 and FY19. Management is working on detailed plans for growth, which it expects to share later this year.
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