Order intake increased 13 per cent to £42.3m at a book-to-bill ratio north of 100 per cent, a significant improvement on the prior year when the ratio was below 90 per cent. The year-end order book of £7m equates to around two months of analysts' revenue estimate of £44.5m for the current financial year, adding support to the positive trading update accompanying the results. The internal target is to raise the book-to-bill ratio to 110 per cent and for the order backlog to be extended to between two and a half and three and a half months. With the company confirming that the positive momentum has continued through the first quarter of the new fiscal year, these targets don't seem unrealistic.
Moreover, it is clear that the margin improvement I predicted when I initiated coverage ('Tooled up for a strong recovery', 14 Apr 2014) is coming through strongly. In fact, operating margins more than doubled from 3.6 per cent in the first half of the trading period to 7.7 per cent in the second half. On this basis, the flat margin forecast of 5.6 per cent from broking house finnCap for the current year to March 2015 looks too conservative once you factor in the growth potential for 600 Group's laser-marking business.
Laser sharp performance
Operating under the Electrox brand, this business designs, develops and manufactures equipment for the permanent marking of a wide variety of materials using lasers from its operations at Letchworth Garden City.
In the second half, the laser unit increased revenues by almost 20 per cent to deliver an 8 per cent rise in full-year revenues to £7.6m, or the equivalent of 18 per cent of 600 Group's revenues of £41.7m. The growth was primarily driven by a step up in marketing activity, well received new product launches, greater presence at key trade shows, and recruitment of additional sales staff. Importantly, given the operating gearing of the business, a higher proportion of these incremental revenues dropped down to the bottom line. In fact, operating profit almost doubled to £421,000 reflecting a hike in margins from 3 per cent to 5.6 per cent.
It's worth noting that the laser unit's second-half margin of 7.2 per cent, up from 4.2 per cent in the first half, adds substance to finnCap's prediction that the margin can soar to 8.8 per cent in the current financial year. If achieved, and assuming a 10 per cent increase in revenues to £8m, the division is on course to produce operating profits of £700,000. Finance director Neil Carrick believes there are "further operational gearing opportunities in the business" as available production capacity is filled. There is also scope for market share gains since Electrox only has a 3.5 per cent share of a global market. Analyst David Buxton at finnCap believes the unit could generate revenues of £9m and operating profits of £900,000 in fiscal 2016, implying a margin of 10 per cent.
Prospects for the metal-cutting machine tools business are improving, too. According to industry forecasts from Gardner Research, market conditions are expected to improve in machine tool consumption, led by North America (9 per cent growth forecast this year) and Europe (13 per cent). The North American market is important as the region accounts for more than half of 600 Group's total sales. But so is continental Europe (15.6 per cent of revenues) and the domestic market (20 per cent). The resurgent UK economy is clearly a positive here. A slight negative is the surge in sterling as this led finnCap to rein in revenue forecasts for 2015. But there is no profit impact as there is an offsetting gain on components imported at more favourable prices.
Growth not priced in
The bottom line is that you can expect another year of decent growth and a realistic chance of an earnings beat. Mr Buxton is looking for pre-tax profits of £2.1m and EPS of 2.1p in the 12 months to March 2015 after factoring in revenue growth of around 7 per cent. On this basis, adjusted EPS rises from 1.9p to 2.1p which means the shares are trading on 10.5 times forward earnings, a significant discount to the UK industrial peer group average of 16.8 times. Even if you look a further year out, the shares are still trading on a 25 per cent discount to the peer group average of 13 times earnings estimates.
The valuation becomes even more compelling once you consider 600 Group's cash flow generation. Operating cash flow is set to ramp up by 35 per cent to £2.7m in the current financial year, rising to £3.1m the year after based on analyst estimates. The net effect of this will be to slash net debt from £5.3m to £2.5m by March 2016. Gearing is already modest at 23 per cent of net assets of £22.5m and the company has £4m of available funds, including untapped bank facilities, the majority of which are committed to May 2017. Net debt is less than two times underlying cash profits, so the company's finances are clearly in good shape.
The fact that the board are proposing to reorganise the company's capital and create distributable reserves strongly suggests that a chunk of this cash flow is set to be returned to shareholders through dividends. It's also fair to assume that selective acquisitions could be on the cards, especially for the laser-marking unit which has scope to make small bolt-on deals to consolidate its position in what is a fragmented industry.
In the circumstances, I continue to rate 600 Group shares a medium-term buy on a bid-offer spread of 21p to 21.75p. My year-end target price is 30p.
■ 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'
