To give you some idea of how strong the underlying business has been performing, seven 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. However, following a further 10 per cent upgrade post this morning's announcement, analysts Paul Hill and Hannah Crowe at research company Equity Development now expect pre-tax profits to more than treble to £1.75m in the 12-month period and adjusted EPS to rise from 1.2p to 3.4p. Following a thumping quadrupling of the half-year dividend to 0.36p a share in March, they predict a final payment of 1.04p, up from 0.32p last year, to make a total of 1.4p. On this basis, the shares trade on 22 times prospective earnings and offer a decent 1.9 per cent forward dividend yield.
Importantly, there is little reason to expect the earnings growth to grind to a halt at this point given that Tristel is now generating robust top-line growth. In fact, Equity Development predicts that revenues will surge from £10.6m last financial year to £13.35m in the 12 months to end-June 2014. This growth is being generated across all the markets Tristel addresses: human healthcare, animal healthcare and contamination control, with three distinctively branded product ranges: Tristel, Anistel and Crystel. Moreover, chief executive Paul Swinney points out that margins are improving too, which is accentuating the increase in profits.
To put the current growth rate into some perspective, only seven months ago analyst Keith Redpath at finnCap predicted an £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 £13.4m of revenues in the 12-month period. The additional £300,000 of revenues in the latest upgrade have fed through to a similar-sized profit upgrade to reflect the higher margins.
For the financial year to end-June 2015, Mr Redpath has upgraded his revenue forecast from £14.3m to £15m, lifted his pre-tax profit estimate from £1.8m to £2.3m and now expects EPS to rise by over 30 per cent to 4.2p in the 12-month period. On this basis, expect a dividend of 2p a share. Analysts at Equity Development have similar estimates and are pencilling in EPS of 4.41p. This means that even after a 17 per cent share price surge this morning, shares in Tristel are only trading on 17 times earnings estimates and offer a prospective yield of 2.7 per cent.
Cash-generative and operationally-geared
These bumper earnings upgrades also highlight 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.
It's also worth pointing out that Tristel is highly cash-generative. Net funds increased from £1.5m at the end of December to £2.2m at the end of April 2014, and analysts at Equity Development expect net cash to rise by a further 50 per cent to £3.5m by this time next year. Given the company is forecast to make annual cash profits of £2.7m in the year to June 2014, rising to £3.3m in fiscal 2015, the £800,000 cost of next year's dividend of 2p a share is well covered by both free cash flow and cash profits.
Moreover, based on 40m shares in issue, Tristel now has a market capitalisation of £30.8m, so the cash pile alone now equates to 5.5p of the current share price. Adjust for cash and the shares are trading on 16 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 for the coming year. 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 at the end of 2012, 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. Tristel's patented chlorine dioxide chemistry is now seen as the 'gold standard' in the UK for sterilising small medical instruments. The company is also in the process of replicating this domestic success overseas by targeting China, Germany and Australia as key markets.
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.
New target price
So, with the company growing revenues at a heady pace and pre-tax profit margins set to hit the board's long-term target of 15 per cent as early as the next financial year, it's hardly surprising that investors are waking up to the real likelihood of Tristel delivering robust profit growth for years to come.
But even after a re-rating this year, on valuation grounds - the cash-adjusted forward PE ratio is only 16 for the financial year to the end of June 2015 - there is still value in the shares. And with six directors controlling 30 per cent of the share capital, the insiders have a vested interest in the company's fortunes, too.
In the circumstances, I am upgrading my fair value estimate to 90p, up from my previous target of 75p to 80p. I have come to this conclusion based on Tristel delivering pre-tax profits of £2.3m on revenues of £15m for the financial year to June 2015 and a cash pile at the period-end of £3.5m (worth almost 9p a share), as analysts at Equity Development predict. Based on 40m shares in issue, this would give the company a market value of £36m if my new target price is achieved. Deduct the cash pile from the market capitalisation and the enterprise value would be £32.5m, or 10 times cash profit estimates. That seems a very realistic valuation to me.
It also means that the cash-adjusted PE ratio would only be 18 as the near 20 per cent-plus uplift in the share price to my 90p target price would be entirely driven by earnings growth. In turn, that opens up the real possibility for an even higher price target if enough investors are willing to pay a higher multiple for a share of Tristel's earnings.
Needless to say, I continue to rate the shares a medium-term value buy on a bid-offer spread of 75p to 77p.
■ 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'
