The company I have identified offering such tantalising prospects is Tristel (TSTL: 60p), a maker of infection prevention, contamination control and hygiene products. To give you some idea of how strong the underlying business has been performing, six months ago brokers predicted that Tristel’s pre-tax profits would grow by 80 per cent to £900,000 in the current financial year to the end of June 2014.
But after a raft of upgrades, the last of which followed yet another earnings beat in a trading update last week, analyst Paul Hill and Hannah Crowe at research company Equity Development now expect pre-tax profits to more than treble to £1.59m in the 12-month period and adjusted EPS to rise from 1.2p to 3.1p. Following a thumping quadrupling of the half-year dividend to 0.36p a share in March, they predict a final payment of 0.84p, up from 0.32p last year, to make a total of 1.2p. On this basis, the shares trade on 19 times prospective earnings and offer a decent 2 per cent forward dividend yield.
Importantly, there is little reason to expect the earnings growth to grind to a stop at this point given that Tristel is now generating robust top-line growth. To put the current growth rate into some perspective, only six months ago analyst Keith Redpath at finnCap predicted a £800,000 rise in full-year revenues from £10.6m to £11.4m for fiscal 2014. But Mr Redpath now expects Tristel to have generated £13.1m of revenues in the 12-month period. And as you can see from the profit upgrades, the incremental £1.7m of revenues is expected to produce an additional £600,000 of pre-tax profits. This highlights the operational gearing of the company, whereby a higher proportion of increasing revenues fall straight down to the bottom line. That’s because Tristel’s fixed-cost base is already covered, which means the profits earned from incremental sales are greater.
Cash generative and operationally geared
This operational gearing helps to explain why Equity Development predicts a 13 per cent increase in pre-tax profits to £1.78m in the financial year to the end of June 2015 on revenues up 9 per cent to £14.5m. On that basis, expect underlying EPS of 3.5p and a further 16 per cent hike in the dividend to 1.4p a share. It could be even more because that forecast payout is covered 2.5 times by post-tax earnings. Moreover, with Tristel’s balance sheet strengthening further – net funds have increased from £1.5m at the end of December to £2.2m at the end of April 2014 – the £560,000 cost of that dividend is easily covered by free cash flow. Broker finnCap expects free cash flow of £2.7m in the year to June 2014, which is slightly above forecast annual cash profits of £2.5m due to positive working capital movements.
Based on 40m shares in issue, Tristel has a market capitalisation of £24m, so the cash pile alone now equates to 5.5p of the current share price. And it is set to grow further as finnCap predicts that Tristel will have £900,000 of surplus cash in the financial year to the end of June 2015 after paying out dividends, taxation and capital expenditure. Adjust for cash and the shares are trading on 15 times forward earnings for fiscal 2015, hardly a racy rating for a company in an earnings upgrade cycle and with a real chance of exceeding even the latest upgraded estimates. The impressive financials aside, the business case is based on robust industry demand for Tristel’s products.
Fighting superbug and contamination
Following a reorganisation of the company 18 months ago, Tristel has refocused from being almost exclusively dependent on declining legacy products used in endoscopy departments in UK hospitals, to a more diversified business targeting a number of key growth markets and geographies. As part of the restructuring programme, the company reduced its cost base and achieved positive cash flow in all its overseas operations.
The key to this transformation is Tristel’s chlorine dioxide technology that differentiates the company from rivals. Over 1.7m decontamination procedures were carried out globally last year in 27 countries using the Tristel Wipes System on the small flexible endoscopes and ultrasound probes that are used in a range of hospital departments including gynaecology, urology, ear, nose & throat, cardiology and IVF. It’s a fast-growing market as sales in Tristel’s human healthcare business increased by 86 per cent in the UK and by 40 per cent overseas in the six months to the end of December 2013, driven by demand for Tristel Wipes.
The company also supplies liquids, wipes, foams, sprays and gels for disinfecting surfaces, which are are used by hospital nursing staff and housekeeping teams to clean ward floors, operating theatre walls, bed mattresses, commodes and patient trolleys. The human healthcare business accounted for 57 per cent of the company’s first-half revenues of £6.4m.
The contribution from this segment is set to grow further because Tristel’s patented chlorine dioxide chemistry is now seen as the ‘gold standard’ in the UK for sterilising small medical instruments. For example, in January last year University Hospitals Coventry and Warwickshire NHS Trust was nearing its limit for cases of Clostridium difficile (C.diff) infections. The Trust's infection prevention and control team responded with a campaign focused on hand washing, prompt isolation of infected patients, antibiotic prescribing and effective environmental cleaning. Tristel's Jet trigger spray gel was deployed for areas close to patients and Tristel’s Fuse liquid disinfectant was used on larger surface areas. Both products are rapidly effective against bacteria, fungi, viruses, mycobacteria and, crucially, spores.
As a result of the campaign, every ward in the Trust has been C.diff free for a period of at least 100 days, 95 per cent of all wards have been C.diff free for 200 days and 14 wards have achieved a year clear. In fact, the Trust has received the accolade of National Hospital Team of the Year from the UK Infection Prevention Society. This can only be positive for Tristel in winning further contracts with other NHS Trusts and not only in fighting C.diff. That’s because the company’s technology also combats the Norovirus and the multi-drug resistant bacteria, all of which have been grabbing the headlines and forcing the management of NHS Trusts into action. For example, the company has just been included in the NHS Scotland framework agreement for surface disinfectant products.
Tristel is also in the process of replicating this domestic success overseas by targeting China, Germany and Australia as key markets. A potential game-changer, according to analyst Paul Hill at Equity Development, is America, the world's biggest healthcare market. Mr Hill says: “Tristel is receiving emails almost daily from hospitals in North America keen to trial its products. Although at this early stage, no contribution from the region has been included in our profit forecasts, we recognise the substantial upside available in the event access is secured.” And so does Tristel’s chief executive, Paul Swinney, who notes that although "it may take time to win FDA approval, the US is right at the top of our wish-list as we explore new territories".
Interstingly, Tristel has just announced that its Wipes System has been recommended in an article published in the peer-viewed Journal "Russian Otorhinolaryngology", titled 'Modern and Traditional Methods for High Level Disinfection of Endoscopes used in ENT practice'. The Journal was published to coincide with the III St. Petersburg International Forum of Russian Otorhinolaryngologists, held in St. Petersburg at which Tristel was an exhibitor.
Having first registered its Wipes System in Russia two years ago, this could prove to be a tipping point towards widespread acceptance of the innovative approach to decontaminating ENT endoscopes in the country. Tristel already has a well-established branch operation in Moscow so is well positioned to build its presence in what is clearly a substantial market place.
Product innovation
Another attraction of Tristel’s business model is that 72 per cent of revenues are now derived from products with intellectual property (IP) protection. This is important as it creates a high barrier to entry. In fact, the company’s main commercially important patents are effective until 2028-29. Furthermore, so effective is Tristel's technology that the NHS recommends using chlorine dioxide-based disinfectants for the dual function of cleaning and disinfecting.
Reflecting the commitment to product innovation, Tristel received 37 new patent grants last year. It looks money well spent because investment in new chlorine dioxide products extends their life cycle and widens their use in applications. For example, Tristel Trace is a new version of the company’s Wipes System, providing barcoding and electronic traceability which add to the product's appeal and extend its IP protection. Tristel Revolver is a new delivery system for chlorine dioxide which is expected to revolutionise the use of disinfectants in aseptic units.
Target price
So, with the company growing revenues at quite a pace and pre-tax profit margins of 11.5 per cent making headway towards the board’s long-term target of 15 per cent, investors are now waking up to the real likelihood of Tristel delivering robust profit growth for quite some time to come.
But even after a re-rating this year, on valuation grounds – the cash-adjusted forward PE ratio for the financial year to the end of June 2015 is only 15 – there is still value in the shares. And with six directors controlling 30 per cent of the share capital, then the insiders have a vested interest in the company’s fortunes, too.
I also have a feeling that finnCap’s full-year pre-tax profit estimate of £1.5m could be on the low side. Paul Hill and Hannah Crowe at Equity Development have pencilled in pre-tax profits of £1.59m. In other words, it would not surprise me to see Tristel releasing yet another upbeat trading statement in mid-July and one that would lead to earnings upgrades from at least one broker for the fourth time this year. More likely, both brokers may have to hike their estimates. Indeed, Mr Redpath at finnCap notes that “given the recent history of upgrades, the risk to our estimates is firmly on the upside”.
In the circumstances, I feel that fair value for the shares is somewhere in the range 75p to 80p. I have come to this conclusion based on Tristel delivering pre-tax profits of £2.5m on revenues of £16.7m for the financial year to June 2016 and its cash pile at the period end of £4.5m (worth 11p a share), as analysts predict. Based on 40m shares in issue, this would give the company a market value of between £30m and £32m if my target price range is achieved. Deduct the cash pile from the market capitalisation and the enterprise value would be £25.5m at the lower end of my price range, or seven times cash profit estimates for fiscal 2016. That seems a realistic valuation to me, albeit it assumes that the company can hit the 15 per cent pre-tax profit margin in two years' time.
It also means that the cash-adjusted PE ratio would only be 14 as the 25 per cent-plus uplift in the share price would be entirely driven by earnings growth in the next two financial years. In turn, that opens up the possibility for an even higher price target if enough investors are willing to pay a higher multiple for a share of its earnings.
Needless to say, I rate Tristel's shares a medium-term value buy on a bid-offer spread of 58p to 60p.
Please note that I am still working my way through a list of companies on my watchlist including: Eros (EROS), Inland (INL), API (API), Charlemagne Capital (CCAP), Oakley Capital Investments (OCL), Thalassa (THAL), Camkids (CAMK), Taylor Wimpey (TW.), Barratt Developments (BDEV) and Bovis Homes (BVS).
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