It's a business that has been around for some time, having been founded in 1983, and currently employs 160 staff in the UK, Holland and China. Importantly, it's cash generative and very profitable: last year Flowtech reported operating profit of £4.3m on underlying turnover of £33m. Revenues are well underpinned, too, as the company is not overly exposed to any one customer. In fact, Flowtech's top 10 customers only account for 16 per cent of sales and the top 100 contribute almost half.
A growing business
Equally important, there is a growth angle, too. According to The British Fluid Power Association (BFPA), demand for hydraulic and pneumatic fluid power products in the UK was around £940m in 2012, with hydraulics accounting for £721m and pneumatics £219m. The BFPA forecasts that the market will increase at an annual rate of 3.37 per cent between 2014 and 2016.
Furthermore, there is scope for market share gains as orders placed with Flowtech currently represent a relatively small percentage of the company's customers' total spend in the sector, so the ongoing focus on high-quality customer service should help attract more business from existing customers. The company monitors customer service using three key metrics: error rates, meeting delivery schedules, and stock availability. Flowtech scores highly on all counts as the error rate has been a miniscule 0.2 per cent over the past few years, and in the second half of 2013 the stock availability has been running at just below 99 per cent, a marked increase from an average of 95 per cent over the previous two years. Flowtech's online platform should also help boost sales. Internet orders now account for 60 per cent of total sales, making it easy for customers to order products for next day guaranteed delivery.
There is also obvious potential to grow the business in northern Europe, to capitalise on the recent savings realised from consolidating the Dutch operation into a single facility and rebranding as Flowtechnology Benelux. The 17,500 sq ft warehouse in Deventer, Holland, now mirrors the UK operation, but with a smaller 25,000-line product range and supplying some 900 customers. Analysts at Edison Research note that Flowtech's market share in the Benelux countries is half that in the UK, which offers scope for market share gains there in the next few years.
It's worth noting that there is potential for expansion into other European countries where the market is generally fragmented. This offers an opportunity for Flowtech to capitalise on its existing relationships with global OEMs and its substantial supply base of products. Eastern Europe is an obvious target market given there is already a significant manufacturing presence in the region to distribute into.
Moreover, having introduced its UK systems into the Benelux operation, and streamlined the business, Flowtech has experience of operating in overseas markets which mitigates risk for any future expansion into new territories. The company’s Chinese operation largely comprises a procurement office in Shanghai and a 22,000 sq ft facility in Guangzhou through which most of the generic and own-brand products sourced in south-east Asia are handled.
True, Flowtech’s suppliers and customers are competitors since they could purchase products directly from manufacturers at lower prices if they are willing to accept longer lead times. However, by offering volume discounts to large customers at lower prices, and a prompt service across substantial product lines, the company is actually viewed as an important part of the supplier base, in particular for urgently required items. In this regard, product availability is more important than price. I also understand there is no other company similar to Flowtech operating as 'the key stockist of last resort', which helps explain why its gross margins are almost 42 per cent on branded OEM products, rising to 47 per cent on own-brand products. Flowtech’s board is in the process of expanding the product range to introduce additional higher-margin own-brand products and to introduce a number of new products which will further enhance margins.
It’s also well worth flagging up that now Flowtech has been removed from the shackles of its former private equity owners, it could easily use its paper to acquire existing distributors to accelerate the move into new markets.
Sound financials
Adjusting for the proceeds of the £40m raised at 100p a share at last week’s listing, Flowtech has pro-forma shareholders' funds of £49.4m and net borrowings of £7.1m to give a modest net debt-to-equity ratio of 14 per cent. Current assets of close to £20m, half of which is stock and £7.6m are trade receivables, are being largely funded by gross borrowings of £9.4m and trade payables of £4.5m, so the working capital position looks sound enough with currents assets exceeding current liabilities by almost £12m.
True, goodwill on the balance sheet is eye-catching, accounting for £42.5m or 86 per cent of shareholders' funds. However, in the absence of high borrowings, and with cash generated from operating activities around £3.3m, I am comfortable with this level of intangible assets.
Importantly, there is an earnings growth story to appeal to investors. Factoring in the new capital structure post the listing, analysts at Edison Research predict underlying pre-tax profits will rise from £4.5m in 2013 to £5.7m this year on a 3 per cent rise in revenues to drive EPS up from 8.2p to 10.8p. The respective estimates for 2015 are pre-tax profits of £6.3m and EPS of 11.7p, based on a 4 per cent increase in turnover. On that basis, the shares are trading on 11 times this year’s earnings estimates, falling to 10 times 2015 forecasts.
To put that rating into some perspective, the average PE ratio for Flowtech’s peer group is 15.9 for fiscal 2014 and 14.2 for 2015, according to analysts at Edison. For the current financial year, the forward earnings multiples for industrial distributors range from as low as 13 for HellermannTyton (HTY: 110p) to almost 19 for Brammer (BRAM: 487p). This means that Flowtech shares are priced 17 per cent below the lowest rated company in its universe and 42 per cent below the highest rated even though Flowtech has a similar earnings growth profile for the following two years.
If that’s not compelling enough, the board has stated it plans to pay a 5p a share dividend for fiscal 2014, so the prospective yield is 4.2 per cent with the shares trading on a bid-offer spread of 116p to 118p. Covered two times over by post-tax profits, the dividend looks secure and the board should have ample scope to adopt a progressive policy in the future.
Management team in place to drive growth
Sector watchers will have noted that Flowtech’s board of directors has just been beefed up by the appointment of Malcolm Diamond as a non-executive. He is currently executive chairman of global industrial fastenings group Trifast (TRI: 115p) where he has worked for 32 years. Trifast is a company I rate highly, having included the shares in my 2013 Bargain Shares Portfolio, since when they have more than doubled on the back of a robust operational performance. Mr Diamond’s appointment is clearly a positive for the much smaller Flowtech.
The company’s managing director, finance director and chief executive have been in place for at least four years and all have significant experience in the industrial sector, including boss Sean Finnon, who was appointed at the end of 2009 by the previous private equity owners. The average age of the five directors is 56, which in my view is another positive.
Target price
Post the listing, shares in Flowtech have traded in the range 110p to 122p, so investors participating in the placing are already in profit. However, I feel on a 12-month basis that a wider investor audience will be attracted to the merits of the company and will take advantage of the relatively inexpensive share price rating. I also feel that the shares should be trading around the aforementioned sector average earnings multiples, implying a target price of around 165p, or 40 per cent higher than the current price. Needless to say, I rate Flowtech's shares a buy at 118p.
■ Simon Thompson’s new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
