The company offers an unrivalled range of original equipment manufacturer (OEM) and own-brand products to over 3,600 distributors and resellers. It's a sizeable operation as Flowtech's catalogue contains 52,000 individual product lines and is distributed to 85,000 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, providing a 'best in industry' service offering. This core UK distribution business accounted for two thirds of the company’s revenues of £44.8m in 2015 and is highly profitable too, generating margins north of 20 per cent before central overheads.
That’s not to say the company has been immune to the material deterioration across the UK industrial sector seen in the second half of last year. In that six month period, revenues in Flowtech’s core UK division fell by 6.9 per cent, representing a steep decline on the 2.7 per cent positive growth in the first half. However, the company has been recycling its strong cashflow into earnings accretive bolt-on acquisitions, announcing a further two deals last summer: Northern Ireland-based Nelson Hydraulics, a distributor of hydraulic equipment, components and hose assemblies; and North Wales-based Albroco, a distributor of hydraulic and electro-mechanical components to the mobile, on- and off-highway and construction markets. As a result contributions from these acquisitions more than offset the profit impact the company would otherwise have faced and helped Flowtech lift its full-year adjusted pre-tax profits from £6m to £6.7m on revenues up 18 per cent to £44.8m.
Furthermore, since the December year-end, Flowtech has made two more acquisitions for a combined initial cash consideration of £3m. The purchase of certain assets of the UK division of Indequip in February adds a complementary product range to the company’s existing pneumatics ranges and brings with it new customers too. I understand that there should be “significant savings expected from the integration of the employees and operations into the Skelmersdale site”. And in mid-March, Flowtech acquired Hydravalve (UK), a specialist distributor of valves and associated equipment to the process industry based in Willenhall in the West Midlands. This business adds significantly to its procurement position in valves.
De-risking analyst forecasts
Importantly, these deals de-risk analysts’ 2016 pre-tax profit estimates which suggest that Flowtech’s adjusted pre-tax profits and EPS will increase by a fifth to £8.1m and 15.1p, respectively, based on a £10m increase in annual revenues to £54.7m. The majority of the rise in turnover reflects a full 12-months contribution from Nelson Hydraulics and Albroco, both of which are trading in line with guidance given at the time of their acquisitions last summer. Analyst Andy Hanson at house broker Zeus Capital believes that the Power Motions Control unit which these acquisitions formed are capable of reporting revenues of £16m and operating profit of £1.7m in 2016.
He also believes that Flowtech’s UK division should be able to put in a flat performance on last year on an underlying basis. Moreover, with margins enhanced by increased buying power, and after factoring in upside from bolt-on deals, then current year operating profit of this core UK business is expected to rise by 10 per cent to £7.9m based on revenues of £31.4m, up from £29.4m in 2015. That doesn’t seem an unreasonable prediction unless trading conditions in the UK industrial market worsen further.
I would also flag up that embedded in those 2016 company forecasts is a flat operating profit of £400,000 performance from Flowtech’s small Benelux business, and a maiden contribution of the same order from the Indequip and Hydravalve acquisitions which will form a new ‘process’ division. Central costs are expected to rise by 5 per cent to £2m. I feel these are reasonable predictions as is the expectation that Flowtech’s board will continue to target further small earnings accretive acquisitions, one of the primary reasons the company listed its shares on Aim in the summer of 2014. The board certainly have the flexibility to do so as proforma net debt is currently around £12m by my reckoning, representing a fifth of shareholders funds or a modest 1.3 times cash profit forecasts of £9m for 2016.
The prospect of 20 per cent earnings growth this year aside, which frankly is being underrated in a modest forward earnings multiple of 9, shareholders can also expect a continuation of the progressive dividend policy. The well covered dividend was raised by 5 per cent to 5.25p a share, including a final payout of 3.5p a share payable on 24 June, and both analyst David Buxton at finnCap and Mr Hanson at Zeus predict a similar rise to 5.5p a share this year. On this basis, the prospective dividend yield is almost 4 per cent.
Target price
Admittedly, investors have been warming to the investment case as they differentiate between the more positive prospects for the niche distributors such as Trifast (TRI) and Flowtech and those of general distributors such as Brammer and Premier Farnell. Indeed, shares in Flowtech have risen by 25 per cent since I recommended buying at 109p a couple months ago ahead of yesterday’s full-year results ('Undervalued and ripe for a re-rating', 4 Feb 2016). They have also performed well since I advised buying at the time of the Aim-listing when the price was 118p ('A fluid performance', 2 June 2014).
But even after the recent re-rating the company’s equity is still only priced around book value of 135p a share, and on a hefty 22 per cent discount to Brammer and Premier Farnell forward earnings multiples of 11.6. That’s harsh to say the least and I feel that a return to last September’s highs around 157p is more than warranted.
Please note that I have published three columns today, and five so far this week, all of which are available on my IC home page...
