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Self-help initiatives revitalise distributors

Radical restructuring has left distributors in good shape as end markets begin to show signs of recovery
April 10, 2015

Self-help strategies have been at the centre of the distributor story in recent years, as this diverse set of companies moves to arrest a slump in profits and re-energise sales amid subdued trading conditions. Low organic growth and strong balance sheets mean acquisitions have taken precedence, with many industry participants opting to purchase new businesses to boost market share and gain exposure to the world's growth markets.

Looking ahead, it seems that adherence to an acquisitive strategy has left many sector constituents better prepared to contend with what analysts at Peel Hunt predict could be "another volatile year." It can also provide a quick route to specialisation - another potential advantage in a wide-ranging sector. According to a note published by Peel Hunt at the beginning of 2015, the continuation of sluggish global economic growth means companies focused on value-add services in niche markets should once again come out on top. Above all, margins are perceived as the key determinant in separating those companies that dominate markets from those at their mercy. This is borne out by recent share price movements within the sector, which have been largely predicated on the resilience of marginal rates of profitability. Electrocomponents (ECM) and Premier Farnell (PFL) stand out as the year's biggest strugglers in this regard.

 

No margin for error

Electrocomponents, a distributor of electronics and maintenance products, has blamed a strong pound and an unfavourable change in its sales mix towards lower-margin regions and products (like semiconductors) for a 1.3 percentage point dip in gross margins in the four months ot 31 January. One of Electrocomponents' four strategic initiatives is to make three-quarters of products available right across the globe. This strategic focus helped deliver underlying sales growth of 5 per cent, yet sprouting demand in regions like North America also weighed on profits.

Management has since taken action to turn this around, while noting that sales momentum remains strong as a growing number of transactions are made online. It's been a similar period of transition for electronic products and maintenance distributor Premier Farnell. Like Electrocomponents, its margins have come under pressure as less profitable product lines have taken a larger proportion of overall sales, as management splashed the cash to modernise the group's customer proposition. Nevertheless, the implementation of cost-cutting measures is expected to generate about £12m of savings in the next two years. And daily sales are now at their highest level in four years as restructuring measures start to filter through.

Both Electrocomponents and Premier Farnell will also be encouraged by all-important purchasing managers index indicators (PMI). A low oil price, weaker currency and the ECB's bond-buying programme lifted Europe's PMI to a three-year high in March, raising hopes of a reversal in the continent's economic fortunes.

 

Acquisitive growth

That's also good news for European distributor of maintenance, repair and overhaul products Brammer (BRAM), whose self-help measures helped secure 14 contracts worth more than €60m (£44m) a year and increase revenues by 11 per cent in 2014. Acquisitions, too, played a big role in this top-line growth, while profits were boosted by focusing on key customer accounts, closing a distribution centre in Coventry, and installing industrial tool vending machines. Those efforts should leave the group in better shape as it battles tough European markets. However, chief executive Ian Fraser has ruled out further acquisitions for the year ahead in a bid to reduce the group's swelling net debt.

Essentra (ESNT), on the other hand, has no plans to stop buying exciting, undervalued businesses, despite already splashing out on 13 new ones since 2011. When Colin Day took the reins four years ago, he earmarked acquisitions as a pivotal strategy in transforming the struggling cigarette filter maker into a niche speciality components supplier, targeting markets that are underpinned by strong structural drivers. That approach, coupled with aggressive cost-cutting measures, has so far resulted in huge sales and profit growth, together with a commensurate rise in the group's market value. We believe the shares will continue to outperform, as the benefits of Mr Day's transformation of Essentra's business model become ever more apparent.

Acquisitive growth has also been central to Acal (ACL) and Diploma's (DPLM) outperformance. When Nick Jefferies took over as chief executive of Acal in 2008, he sought to transform the group from a general electronics supplier into a specialised electronics designer and manufacturer. Moving into niche areas proved to be a masterstroke, with sales up considerably in recent months.

Diploma, too, has had a decent run of late, even if negative currency effects and softer European industrial markets have at times proved troublesome for the supplier of specialised technical products and services. In a bullish March trading statement, Diploma's management confirmed that revenues continue to grow, although this was mainly due to a 9 per cent contribution from recent acquisitions.

Given Diploma's reputation as a consistent performer with an envious track record for delivering value from M&A, it should come as no surprise to see that shares have rallied in the previous year. Such consistency, however, often comes at a premium, hence why shares trade on a higher rating than peers.

 

 

Construction plays

Prospects are similarly buoyant for the handful of industrial suppliers serving a reinvigorated UK construction market. Home improvement retailer Travis Perkins (TPK), kitchen supplier Howden Joinery (HWDN), and insulation and roofing materials group SIG (SHI) all recently posted impressive growth as the UK residential housing market springs back into life, following a brief hiatus.

Significant investments have been made by the companies to ensure they're well-placed to maximise returns from long-term growth in the UK housing market. Travis Perkins, for example, is just 12 months into a five-year plan to grow market share by expanding its network, while Howden continues to add depots and ramp up investment in manufacturing and logistics.

Likewise, SIG is in much better shape since the recession, having drastically cut costs and disposed of three of its underperforming assets. Such measures drove increased profits and enabled the group to weather weak trading conditions on the continent.

Company Name / Ticker

Price (p)

Market cap (£)

NTM forward PE (x)

Five-year historic PE average (x)

Dividend Yield (%)

Year change (%)

Acal (ACL)

260

164m

15.6

33.1

3.6

10.6

Brammer (BRAM)

400

518m

18.5

21.9

2.7

-18.4

Diploma (DPLM)

802

906m

20.6

19.6

2.1

11.2

Electrocomponents (ECM)

242

1.1bn

18.8

15.8

4.9

-16.4

Essentra (ESNT)

994

2.6bn

19.6

24.2

1.8

12.5

Howden Joinery (HWDN)

444

2.9bn

17.6

13.8

1.9

19.0

Premier Farnell (PFL)

185

679m

12.5

14.0

5.6

-22.9

SIG (SHI)

203

1.2bn

15.6

43.5

2.2

-1.1

Travis Perkins (TPK)

1,951

4.8bn

14.9

13.3

1.9

6.2

IC View: Self-help measures and shrewd acquisitions leave distributor stocks well poised to profit once economic conditions improve. The initiatives should also help during a year of continued economic uncertainty. However, recent PMI data does suggest that a turnaround in industrial productivity could be on the cards for continental Europe. That makes some of these names look extremely undervalued and ripe for picking - specifically those tapped into construction markets and others with niche product ranges that bear more defensive, as opposed to cyclical, characteristics. Of course, the widening gap between the top and bottom of the ratings table is a reflection of consistency, though it should also be noted that those lingering in the depths have spent wisely in recent years to improve their prospects. Depressed share prices, meanwhile, have also brought dividend yields in some camps to mouthwatering highs.

Favourites:

A combination of factors designed to improve long-term performance of Premier Farnell actually took their toll on profits and shares in 2014. The high-yielding electronics distributor undertook strategic initiatives to enhance its customer proposition, cut costs, and weed out unprofitable revenue lines - but remedial measures can take time. Now - with sales up and these costly initiatives complete - Premier Farnell looks much healthier and poised for a dramatic turnaround, spurred by an improving outlook for semiconductor sales and a strengthening European economy. Travis Perkins, too, stands out as a must-buy. Shares trade at a discount to peers, yet its self-help drivers should maximise returns from a construction market in bull mode.

Outsiders: From the host of solid names that make up the sector, Electrocomponents is the one most likely to take a fall. Digitising its services and branching into new markets has certainly spurred sales growth, yet this drive has also been detrimental to profits. Uncertainty, meanwhile, has also been fuelled by the recent departure of veteran chief executive Ian Mason, who has been replaced by the former executive vice president of Future Electronics, Lindsley Ruth. Though certainly not a bad company, it's hard to justify buying shares when they trade at a 50 per cent premium to those of Premier Farnell.