Each month Richard Beddardtrawls through annual corporate results for candidates for his Watchlist and the Share Sleuth portfolio of companies that satisfy key valuation metrics, such as earnings yield and return on capital, and profiles the most interesting businesses.
Abcam (ABC): Market leader
Abcam is a catalogue retailer with a difference. It supplies antibodies to research scientists who use them to investigate and, ultimately, cure disease.
Results for the year to June 2017 once again confirmed its status as a growth share. Strong revenue growth of 27 per cent compared with the previous year led to an increase in adjusted profit of 17 per cent. While this is not as high as it used to be, shareholders are unlikely to have a problem with a return on capital of 18 per cent.
Abcam’s profitability stems from its market leadership. The firm earned £160 million from primary antibodies that allow scientists to locate and identify proteins. That gives it about 24 per cent of a market estimated by the company to be worth $906 million(£687 million). The antibody market is growing as researchers in Europe, the US and China bear down on diseases such as Alzheimer’s and cancer.
Abcam manufactures about 40 per cent of its antibodies itself, a growing capability that adds to its traditional strengths as a retailer. The company has a reputation for sophisticated online marketing and for providing a wide range of products, comprehensive data and high levels of customer service compared with its rivals.
These attributes have drawn comparisons with the most famous of all online retailers, Amazon– although that company serves a very different market. Abcam’s data sheets, for example, are populated by feedback from the scientists who use the antibodies described.
The company is perhaps also aping Amazon inbroadening its product range. It provides kits containing all the ingredients a research scientist needs to perform tests. It’s also partnering with medical diagnostics companies to provide antibodies for blood testing machines, a strategy it has dubbed ‘Abcam inside’.
Government science budgets are under pressure. However, Abacam’s profitability and growth seem assured, given its leading position in the research antibody market and its potential to provide life scientists with more of their needs.
That may explain why Abcam shares are highly rated. A share price of £10.25 values the enterprise at well over £2 billion or about 40 times adjusted profit. Abcam’s earnings yield is little more than 2 per cent.
Harvey Nash (HVN): Disruption risk
It has been a busy six months for recruitment consultancy Harvey Nash. In results for the half-year to July 2017, the company reported that it had moved its listing from the main market of the London Stock Exchange to Aim, the alternative market, where lighter regulation will allow it to acquire other companies more easily.
An acquisition initiative is the centrepiece of the company’s new strategy, which involves focusing closely on the recruitment of staff in the technology sector, its core business. As if to show intent, Harvey Nash has recently acquired two recruitment firms – PAT Management, a Swedish consultancy, in July, and Crimson, a UK IT consultancy, in September.
Recruiters have a deserved boom and bust reputation. Demand for staffing depends on the state of the economy, a cycle that has been exaggerated in the IT sector by manias and crashes. But Harvey Nash has been profitable through past cycles, and if the cost of past acquisitions is taken into account, its return on capital has been acceptable.
The shares may be something of a bargain because Harvey Nash’s share price of 90p values the enterprise at just over £60 million, seven times adjusted profit in the year to January 2017. The earnings yield is 13 per cent.
The high returns on offer to investors currently depend on profit being sustained or improved, though. In the short term, Harvey Nash says its acquisitions will increase profits.
But their necessity stems from the fact that the company has struggled to grow profits since it recovered from the dotcom crash, and like all recruiters, it faces challenges. Recruiters are contending with new competition from software providers and social media sites such as LinkedIn. Moreover,the job market is being disrupted:by technology,as more jobs are automated; by cheaper foreign labour,as jobs are off shored;and by the expansionof the ‘gig economy’, or freelancing as we used to call it.
Harvey Nash believes it will prosper through the changes ahead, because IT is one sector of the job market that should still grow as companies recruit technicians and software developers to work on machines and algorithms.
These are activities the company also profits directly from. Its smallest division operates centres in Vietnam that undertake software development and IT as well as human resourceswork,for companies that don’t want to do it themselves.
Ricardo (RCDO): Change of gear
In a mixed financial year ending in June 2017, engineering and environmental consultancy Ricardo achieved a very modest increase in revenue and profit t compared with the previous year. Return on capital was almost bang on its long-term average of 14.5 per cent.
Government commitments to phase out diesel and petrol cars have forced car manufacturers to reconsider their strategies, resulting in a shift in emphasis towards hybrid and electric vehicles. The disruption interrupted Ricardo’s automotive consulting work, but the company’s capabilities extend to the new technologies, and now that its customers have refined their research and development plans, Ricardo says orders have returned to a more normal pattern. Around 17 per cent of new orders in the year – a record year for the group as a whole – were related to the electrification of vehicles.
For many years now, Ricardo has diversified, both geographically and in terms of its spheres of operation. It has a large environmental consulting business, which is helping governments, institutions and companies research air quality and climate change, and develop policy. Ricardo’s environmental business and rail consultancy both had better years than its automotive consultancy business.
Ricardo says it thrives on change, principally the enduring imperative to make vehicles more efficient, less polluting and safer. Change requires new technologies, strategies, management and certification, all of which Ricardo’s scientists, technicians and consultants can provide. Indeed, the projects itis working on – from testing the safety of driverless vehicles in China to helping develop lighter, cheaper and safer lithium-sulphur batteries – are like snapshots from the future.
Ricardo also earns about 20 per cent of revenue designing and manufacturing high-performance engines and drive trains for super-car manufacturers such as Bugatti and McLaren. It will supply the transmission for a new hyper-car, presumably even more impressive than a super-car–the Aston Martin Valkyrie.
A share price of 800p values the firm at about £550 million or 16 times adjusted profit. The earnings yield is 6 per cent. But while the shares are no bargain, Ricardo has been profitable through thick and thin. Weakness in the share price may be an opportunity to buy shares in a good business at a reasonable price.
Solid State (SOLI): Robust returns
Solid State is another business investing in lithium-sulphur battery technology. It manufactures rugged computers, communications systems, battery packs and antennae generally used in harsh industrial and military environments. The combination of technical expertise and regulatory clearance required to handle dangerous materials and sensitive information means it is often one of just a small number of companies with sufficient capabilities to supply demanding customers.
The year to March 2017 was a year of consolidation for Solid State. It combined its existing battery division with Creasefield, a battery producer acquired in the previous financial year. Creasefield gives Solid State new battery chemistries to develop, and fresh customers outside the oil and gas market that it has supplied for many years.
Solid State closed its electronic monitoring business unit, set up as part of a consortium to develop electronic tags for the Ministry of Justice. The MOJ terminated the contract two years ago when it chose to use an off -the-shelf solution instead of the bespoke system being developed by the consortium. Solid State has decided not to commercialise the technology it developed.
Revenue and profit increased by 9 per cent compared with the previous year, and the company has cash to spend from a settlement with the MOJ over the termination of the electronic monitoring contract. Solid State is overdue an acquisition. The company targets one a year, but it hasn’t made one since the Crease field purchase in May 2016.
A share price of 490p values the enterprise at just over £50 million or 20 times adjusted profit. The earnings yield is 5 per cent. It’s probably a fair price for a business that has earned good returns on capital for more than a decade, and shown it can create value by acquiring other firms and making them more efficient. Solid State’s immediate prospects are good. Two months into the financial year, the value of the company’s order book was at a new high, 16 per cent higher than at the same time in the previous year.
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