I have spent a considerable amount of time researching and analysing tomorrow’s Aim flotation of Strix (KETL:100p), a global leader in the manufacture and design of kettle safety controls.
The shares list on London’s junior market at 100p each at 8am on Tuesday 8 August after the company’s broker and nominated adviser, Zeus Capital, placed £190m of shares with institutions to buy out private equity owners AAC Capital, which has owned the business for the past 12 years. They may be cashing in their chips, but I believe this could be one of the IPO winners of the year and not just because the shares are being listed on an attractive single-digit earnings multiple and offer a 7 per cent prospective dividend yield.
The Isle of Man-based company has been around in its current form since 1982, having been originally founded by Eric Taylor in 1951 to commercialise product opportunities for a revolutionary thermostat he invented to control heated flying suites worn by bomber crews at high altitude during the Second World War. His son John Taylor subsequently took over the reins and by the late 1980s Strix had become a world leader in the supply of safety controls for small domestic appliances, primarily kettles, which disconnect the power to the heating element when either the water has boiled, there is no water present, or when the kettle is lifted off its base. The company has been incredibly successful, having sold over 1.9bn sets of its safety kettle controls to date. As a result, a kettle using one of Strix’s safety controls is boiled more than 1bn times a day by consumers across more than 100 countries, accounting for over 10 per cent of the world’s population.
A market heating up nicely
Globally, around 174m sets of safety kettle controls were produced last year of which Strix had a 38 per cent share by volume, and 50 per cent share by value. It produces over 400m components each year mainly from a production facility in Guangzhou, China, where it employs 800 of the company’s 900 staff. Strix earns a decent margin on these sales, too, making a gross profit margin of around 40 per cent last year and delivering an operating margin of 30 per cent.
In the regulated markets of western Europe, US, Japan, Turkey and Australia, it’s a dominant player with a market share of over 61 per cent. But it has been seizing the opportunity in less regulated markets (16 per cent market share), where either high safety or intellectual protection standards are not in place, by developing new, lower-cost products designed to increase market penetration. Strix has also been targeting a major growth opportunity in China, the single largest market globally, and one that has grown at a compound annual growth (CAGR) of 12 per cent over the last four years, and is expected to deliver CAGR of 8 per cent over the next four years, according to industry experts. Analysts at the company’s house broker, Zeus Capital, believe that the global market for the company’s products is likely to grow at around 7.6 per cent annually in the coming years, buoyed by structural growth as market penetration rates increase.
Bearing this in mind, Strix raised its share of the China market from 31 per cent to 51 per cent by volume last year alone. Interestingly, the directors note that Chinese brands and retailers are working to some of the highest safety standards in the world. This highlights the opportunity for Strix – which has never had a single product recalled due to fault with its controls – to continue to do well by selling its best-in-class safety controls not only at an attractive price, and one reflecting the huge economies of scale the business benefits from, but also leverage its precision engineering capabilities to capture share from low-cost producers operating in these markets. I would also flag up that Strix takes an active role by engaging with regulators to improve regulation levels and enforcement of patent infringement in order to protect a portfolio of over 150 patents. It defends these vigorously, and successfully, having won cases across the world, including in China.
In terms of the supply chain, its products are supplied to original equipment manufacturers (OEM) of which 90 per cent by volume are based in China. However, unlike other companies operating in this market, Strix has indirect customers in the form of appliance brands and retailers who work with the company to select the best OEM for a product in order to meet their quality specifications and price point. Moreover, Strix has relationships with over 400 brands and retailers around the world including multi-nationals Siemens, Philips, Walmart, Supor, and Tesco. The fact that almost two-thirds of the company’s top 30 clients have traded with Strix for more than a decade, and not a single one of its top 30 clients in the past five years have been lost apart from two which left the industry, highlights the valuable long-term relationships Strix has in the industry. It also highlights the high standing the company has in the value chain, which secures its leading market position and acts as a stiff barrier to entry for rivals.
New product developments
Operating from two facilities, one on the Isle of Man, and the other in Guangzhou, China, the company has been launching a range of new products in the past 18 months following extensive research and development. The aim is to capitalise on the opportunity to increase volumes in less regulated markets, and to enhance its product range by producing enhanced quality controls at a lower unit cost in order to take advantage of the product replacement cycle as kettles using older controls come to the end of their useful life.
Strix has also developed a range of Aqua Optima water filtration products, including water filter jugs, which are sold online and through UK high street retailers. Revenue here primarily relates to the Tommee Tippee baby formula appliance which sterilises baby formula powder, and prepares a bottle of the correct volume and temperature in under two minutes.
Since launch in 2013, over 600,000 of these appliances and over 2m filters have been sold, equating to a 25 per cent slice of the UK market. The machines are used for around 18 months each, and require between four and six replacement filters during this time, thus providing a lucrative secondary income stream for the company. The directors of Strix believe that there is “substantial potential” to replicate this growth internationally and are currently working with the brand owner in this regard.
It’s not just Strix’s solid market position, and potential to exploit opportunities in China and less regulated markets that appeals. The company’s financials look solid, too, and support a valuation well above the listing price.
That’s because, in the past decade, not once has this business made annual cash profit below £30m, suggesting that after factoring in pro-forma net debt of £54.7m on listing, and a market capitalisation of £190m at the 100p listing price, Strix’s enterprise valuation of £244.7m equates to a very reasonable 7.3 times cash profits of £33.3m earned in 2016, and just seven times house broker Zeus Capital’s cash profit forecasts of £35.1m for this year.
This year’s estimates are based on Strix delivering revenue of £92.6m, up from £88.7m in 2016, to produce a £2m rise in operating profit to £28.8m and pre-tax profit of £26.6m. Please note that the £6.3m difference between the cash profit forecast and the operating profit estimate reflects a non-cash depreciation and amortisation charge. The tax treatment of the company’s earnings is worth flagging up, too, given the company’s Isle of Man corporation tax exempt domicile.
Based on 190m shares in issue on listing, and using a 3 per cent tax charge on all its earnings, the company should deliver post-tax profit of £25.8m this year, implying the shares are being floated on just 7.4 times this year’s post-tax earnings estimates using the company’s actual tax charge, or 8.8 times using a normalised UK tax charge of 19 per cent.
I would also highlight the robust cash generation of the business: net operating cash flow was around £34m last year, well ahead of Strix’s operating profit of £26.7m, which is stated after non-cash depreciation and amortisation charges, albeit one-off gains and positive working capital changes did flatter the cash-flow performance. That said, if Strix can deliver £96m of revenue in 2018 as analysts at Zeus predict, then this points towards cash profit rising to £36.7m to deliver operating profit of £30.8m after depreciation and amortisation charges, and supports forecasts of a net operating cash inflow north of £33m.
That’s worth noting because the company’s directors have committed to declaring a 7p a share dividend for the 2018 financial year, which has a cash cost of £13.3m. So, not only does the likely net operating cash inflow cover that cash payout a healthy 2.5 times over, but it also covers the forecast annual interest charge of £1.7m on £60m of gross borrowings, and leaves the company with ample cash flow to invest around £7m in capital expenditure, pay a modest £1m corporation tax charge, and be able to reduce debt, too. The company has arranged a new five-year £70m debt facility with Royal Bank of Scotland and HSBC under which interest is payable at 2.2 per cent above Libor.
Please note that the company has pro-forma negative net assets of £41.5m, so effectively the aforementioned debt facility is funding its working capital position. That’s not a problem given Strix’s awesome cash generation, and high-quality customer base who pay their bills, but clearly if there is any deterioration in trading then the business does not have the benefit of a strong balance sheet to fall back on. Nonetheless, as long as the cash flow continues to roll in then there are very real prospects of hefty dividend payments to shareholders: analysts at Zeus Capital are predicting a payout of 7p in 2018, rising to 7.7p in 2019.
For the 2017 financial year, the board’s guidance points towards a total dividend of 2.9p being declared based on the 100p a share listing price, a payout that reflects the fact the shares will be listed for less than five months this year.
Experienced management team
I am also reassured to see the directors have been with the company for some time, led by Mark Bartlett, who has valuable experience in the engineering sector and joined Strix 11 years ago; chairman Gary Lamb was the former finance director of Strix until 2007 and is currently the chief executive of Manx Telecom (MNX:176p), another company I have maintained a favourable view on since its Aim IPO in 2014; and finance director for the past six years, Raudres Wong, has over 20 years of international experience in corporate finance and has worked for a raft of multinationals.
It’s equally important that both the engineering director and commercial directors have both been with the company for over 25 years, the sales director has been on board for a decade, and the director heading up the Aqua Optima business joined Strix in 2004. In other words, this is a business with a valuable and stable management team.
Mr Lamb, Mr Bartlett and Ms Wong have modest shareholdings, controlling just 0.58 per cent of the equity between them, although the fact that Mr Bartlett and Ms Wong have 5.7m shares under option at nil cost under an EPS-based awards scheme maturing in December 2019, and a further 4.5m shares will be granted to senior employees shortly after admission of the shares on Aim, means that there is a hefty incentive for senior management to deliver.
Clearly, some smart institutional investors are attracted by the investment case as 105.5m of the 190m shares in issue, or around 55.5 per cent, were picked up by some high-profile fund managers including Woodford Investment Management, Schroders, Artemis, BlackRock and Miton. I understand that the balance of the 83m shares placed by Zeus Capital have all been with UK regulated institutions, so there are at least 26 institutions that have backed the placing, thus giving a wide shareholder base and one that should help liquidity in the shares in the aftermarket.
|Strix's major shareholders|
|Shareholder||Shares held (m)||Percentage of share capital (%)|
|Woodford Investment Management||17.5||9.2|
|Schroder Investment Management||14.2||7.5|
|Artemis Investment Management||10.0||5.3|
|River and Mercantile Asset Management||10.0||5.3|
|Premier Fund Managers||9.5||5.0|
|Miton Asset Management||8.5||4.5|
|Old Mutual Global Investors (UK)||6.8||3.6|
|J O Hambro Capital Management||5.9||3.1|
That’s not to say this is a one way bet as no investment is without risk and in the case of Strix there are several to consider.
The most obvious risk is that the company’s top 10 customers account for two-thirds of annual revenue, with its largest customer accounting for almost a fifth of the total. The loss of any one of these customers would have a material impact, although the fact that Strix has retained all of its top 30 customers for the past six years, apart from two that left the industry, would indicate very good client relationships.
Input cost pressures are worth bearing in mind, too. For example, the main commodities used in safety controls are silver, copper and plastic, so the company is exposed to adverse commodity price movements. These commodities are sourced globally, and preferably from China, in order to save on transport costs to its production facilities in Guangzhou. I would also flag up wage inflation in the country, which has been increasing at a rate of around 6 per cent, although increased automation of production to drive down headcount and unit costs are an offsetting factor.
Manufacturing risk is worth flagging up as the majority of Strix’s products are made in China and to order, so any disruption in the operations at the site would impact its ability to meet its customers demands.
It goes without saying that Strix has significant currency exposure. This is mainly to the US dollar (the currency in which most commodities are priced), the China renminbi, Hong Kong dollar, and to a lesser extent the euro. Its cost structure acts as a natural hedge to some extent, but there is still some currency risk as the directors point out that a 5 per cent decrease in revenue due to adverse currency moves impacts cash profits by around 1 per cent.
There is macroeconomic risk, too, as any global economic slowdown would undoubtedly impact volumes being sold to OEMs in faster-growing regions where Strix has a high market share.
I have already raised intellectual property issues and the risk of patent infringements, although to date the company has proved successful in defending its valuable intellectual property. There is no reason to believe it will not be able to continue to do so in the future, but this is still worth flagging up.