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OPINION

Powering on up

Powering on up
September 17, 2014
Powering on up
IC TIP: Buy at 130p

To recap, the company offers an unrivalled range of original equipment manufacturer (OEM) and own-brand products to approximately 3,000 distributors and resellers. It's a sizeable operation as Flowtech's catalogue contains 47,000 individual product lines and is distributed to over 90,000 industrial maintenance, repair and overhaul end users from facilities in the UK and Benelux. Recognised as the definitive source for fluid power products, over 80 per cent of products are stocked and can be delivered next day by national courier service FedEx, providing a 'best in industry' service offering. The domestic market accounts for almost 90 per cent of sales.

The highly cash generative business is very profitable too: in the latest six month trading period Flowtech reported operating profit of £3.3m on turnover of £17.2m, a mid-single digit increase on the respective figures in 2013. And shareholders who backed the flotation on the Alternative Investment Market in May are being rewarded with a maiden half year dividend of 1.67p a share. Expect a total dividend of 5p for the full-year covered more than two times over by forecast post-tax EPS of 11.5p, up from 8.2p in 2013, according to analysts at Edison Investment Research. On this basis, the shares offer a decent prospective yield just shy of 4 per cent and the forward PE ratio is less than 12. The full-year payout would cost Flowtech around £2m, or a third of current year pre-tax profit forecasts of £6m, up from profits of £4.5m reported in 2013.

Strong growth prospects

There are prospects of decent growth next year too underpinned by last month’s acquisition of Knowsley-based Primary Fluid Holdings. Primary Fluid specialises in designing and making hydraulic systems and purifiers, which accounts for about two thirds of its turnover, and also distributes hydraulic components which represents 30 per cent of revenue. It also has a small service and repair business too.

Last year, the business reported revenue of £11.2m and profit before tax of £1.1m. It looks a cracking deal as Flowtech satisfied the consideration by making an initial net cash outlay of £2.95m to the vendors who also received shares in the company worth £3.5m and are due a final deferred payment of £1.6m in August 2015. Factoring in the earnings of Primary Fluid into next year’s forecasts, Edison believe Flowtech can generate pre-tax profits of £7.3m and EPS of 13.4p in 2015, based on a 32 per cent increase in turnover to £45.4m. Prior to the acquisition, Edison was predicting profits of £6.3m and EPS of 12.5p.

On this basis, Flowtech shares are currently trading on a modest 10 times next year’s earnings estimate, a 30 per cent discount to the average PE ratio for Flowtech’s peer group. It’s worth noting that the company’s pro-forma net debt of £9.1m equates to only 17 per cent of equity shareholder funds of £55m post the Primary Fluid acquisition, so the balance sheet is not overly geared. Flowtech’s market capitalisation is also bang inline with book value of the company, albeit intangible assets do account for £42.5m of net assets.

In my view, the modest valuation looks overly harsh considering the scope for the company to use its paper to make more selective bolt-on acquisitions and potential for organic sales growth through product development and overseas expansion. I still feel that a share price closer to 165p, or 12 times 2015 earnings estimates is a fairer valuation for the equity. Other investors seem to be thinking the same way as the shares have risen 14 per cent since I initiated coverage when the price was 118p (‘Powered up for a fluid performance’, 2 June 2014). I subsequently updated the investment case six weeks ago when the price was 127p (‘A fluid acquisition’, 6 August 2014).

In the circumstances, I am happy to reiterate my positive advice and maintain a target price of 165p. Trading on a bid-offer spread of 129.5p to 130p, and offering 27 per cent upside to my target price, the shares rate a buy.

Please note that Cenkos Securities (CNKS: 250p) has reported half year results today. I will update my view shortly. I have also published another two columns today, both of which are available on my IC homepage...

■ 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'