Share Watch: financial risk threatens this high performing company

Each month Richard Beddard trawls 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.

Motorpoint (MOTR) High performance, low margins

Independent motor dealer Motorpoint performed very well in the year to March 2018. Revenue increased 21 per cent and profit increased 34 per cent compared to the previous year, when it experienced a mini-slump after the Brexit referendum. Even that year, Motorpoint, which had only just floated on the stock market, was an impressive performer. Return on capital in the year to March 2017 was 13 per cent. In 2018 it was 18 per cent.

Motorpoint is a very profitable business, probably because of its unique position in the market. With 12 sites and revenue of nearly £1 billion, the UK’s largest car supermarket only sells nearly new cars, almost always still covered by the manufacturer’s warranty.

Size gives it purchasing power over the large fleets from which it buys cars, and the age of the cars is one of a number of factors that give car buyers confidence they’re not buying a lemon. Like some other car supermarkets, Motorpoint checks the cars, services them, and provides a vehicle history check. It sells the cars at a fixed price, which means a haggle and often hassle-free experience.

The company plans to open at least one new site a year, with a medium-term target of 20 or so. Other things being equal, growth seems likely for at least a decade as it expands and recently opened sites mature.

We shouldn’t get too carried away, though. Car supermarkets are low-margin businesses. Motorpoint’s high levels of profitability would probably not be sustained in a prolonged recession. Nearly-new cars are expensive and high levels of sales in recent years have been dependent on financing through sophisticated loans known as personal contract purchase (PCP). 2017’s mini-slump, when management reduced prices to clear surplus stock, was a taste of what could happen. In the first half of that year, profit fell 32 per cent.

A share price of 235p values the enterprise at about £340 million, or about 17 times adjusted profit. The earnings yield is about 6 per cent.

Solid State (SOLI) Power trio’s solid charge

In the year to March 2018, Solid State failed to turn 16 per cent revenue growth into more profit, and profit declined slightly compared to the previous year. In short, the company sold more of its less profitable products.

While Solid State Supplies, a distributor of electronic components and the smaller half of the business, grew strongly, profit margins are lower than at its slightly bigger sibling Steatite – a manufacturer – which grew less rapidly. Within Steatite, sales of portable battery packs supplied by the power division – among Solid State’s least profitable products – increased dramatically, while sales of more profitable rugged computers fell, and sales of military and meteorological antennae did not live up to expectations. An antenna sales drive in the US foundered, due to the US government’s hardening attitude to trade.

Even so, revenue grew fastest at Steatite’s communications division, which supplies radios as well as antennae, but it had limited impact because communications is the smallest of Solid State’s businesses.

Despite poor profit growth, Solid State is still performing well. The company earned a return on capital of 18 per cent, very close to its long-term average, and it has no borrowings.

Over the last 12 years, Solid State has grown revenue and profit at a compound annual growth rate of 12 per cent; while profit growth appears to have stalled, the company is doing all the right things to get it going again, principally by focusing on its most profitable products and operating more efficiently. Solid State Supplies is earning revenue from a new service that sources obsolete electronic components, tests them and stores them for customers. Steatite has rationalised its manufacturing divisions, closing down a surplus sales office and refocusing management on high-margin products.

After the year-end, the company announced a contract to supply portable battery packs for robots designed to work autonomously in warehouses – potentially opening the door to supplying other robotics applications.

Solid State is largely a product of acquisitions. The company aims to make one acquisition a year, but it has not made one since May 2016 when it bought an ailing battery manufacturer. As the company grows, it needs to make bigger acquisitions if they are to have the same impact, and because there are fewer occuring it may be having more trouble finding targets at the right price. It is right to be picky, and at the current share price a slower-growing Solid State still looks cheap.

At 280p, the share price values the enterprise at £27 million or about 10 times adjusted profit. The earnings yield is 10 per cent. The business is working hard to make itself better, but it is already quite good.

Trifast (TRI) Profits in nuts and bolts

Fastener distributor and manufacturer Trifast says its products ‘hold the world together’. In fact, the nuts, bolts, screws, washers and rivets it makes hold together a small proportion of the world’s vehicle dashboards, household appliances and telecommunications equipment. These components may be modest in size and value, but they can be critical in terms of reliability, weight and easy assembly.

In the year to March 2018, Trifast lifted revenue 6 per cent and adjusted profit 8 per cent. The company strikes a confident tone in its annual report, declaring this the optimum time to invest the equivalent of a year’s profit in a new software system that will integrate its operations on diff erent continents. It brushes off the threat of tariff s and trade barriers due to Brexit as an opportunity to improve the efficiency of its supply chain, routing more products through Trifast’s European manufacturing and distribution businesses if necessary.

Trifast’s strategy has been to target large manufacturers with exacting requirements in terms of both fastener specification and global supply – requirements that smaller local businesses often cannot meet.

To better serve these customers it has increased its product range and global footprint through acquisitions. Earlier this year it acquired PTS, located a few miles up the road from its Sussex headquarters. PTS distributes stainless steel fasteners in the UK. Three other acquisitions earlier this decade were in Malaysia, Italy and Germany.

Trifast has also adopted a policy of continuous improvement, evangelised by senior management since the company lost its way during the financial crisis. A new board, recruited in 2009 and 2010 from long-serving employees, put the emphasis on staff, fostering innovation, training and a sales-led culture that, along with a sustained period of growth in manufacturing generally, has delivered high levels of profitability. For the last four years, return on capital has exceeded 15 per cent, higher than pre-crisis levels, suggesting perhaps that Trifast has not just recovered but is a better business.

A share price of 225p values the enterprise at £310 million, or about 16 times adjusted profit. The earnings yield is 6 per cent. But while continued improvement has probably made Trifast more resilient, it still serves capricious markets that will inflict infrequent and temporary pain on the business and its shareholders.

Vp (VP.) Revenue up, debt up

Due in part to the acquisition of Brandon Hire in November 2017, Vp increased revenue by 22 per cent and profit by 20 per cent in the year to March 2018 compared to the previous financial year.

Vp is a group of specialist equipment rental fi rms. Brandon Hire joins Hire Station, Vp’s tool hire chain, perhaps doubling it in size. It’s Vp’s biggest business by revenue. The acquisition also reverses the international direction taken the previous year when Vp acquired TR, an Australian fi rm that specialises in renting electronic testing and measurement, communications and audio visual equipment. Thanks to struggling Airpac Bukom, a supplier of equipment to mainly overseas-based oil and liquefied natural gas companies, Vp only earned 10 per cent of revenue and a sliver of profi t from its two international businesses.

Nevertheless it earned a 10 per cent return on capital in the year to March 2018, very close to its long-term average and 1 per cent lower than the previous year. Though the level of profitability is unremarkable, its consistency is noteworthy. Despite serving cyclical construction, infrastructure and energy markets, return on capital did not drop more than 1 per cent or so below 10 per cent even in the years following the financial crisis. This has encouraged the company to borrow, allowing it to grow faster and earn higher returns for shareholders.

The firm’s reliance on external funding, bank borrowings and operating leases has been as consistent as its profitability, but that may have changed in 2018 when the acquisition of Brandon Hire required it to borrow even more. Now 85 per cent of the money required to equip and operate its depots is financed by banks and landlords; typically Vp has kept this ratio at about 70 per cent. Management may take the view it can sustain a higher level of debt, or it may have sufficient confidence to have calculated it can use profit to reduce borrowing to more normal levels before any major downturn strikes.

A share price of £11.20 values the enterprise just shy of £860 million or 19 times adjusted profit. The earnings yield is 5 per cent.

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