Shares in Isle of Man-based Strix (KETL:165p), a global leader in the manufacture and design of kettle safety controls, have been simmering in recent months and have achieved my 165p target price.
I initiated coverage ahead of last summer’s IPO (‘Tap into a hot IPO', 7 Aug 2017), albeit the shares popped 30 per cent above the 100p share price on listing. I last advised buying at 133p (‘Profit from corporate activity’, 26 Mar 2018), so after taking into account 2.9p a share of dividends paid for the five months of the 2017 financial year – equivalent to an annual payout of 7p a share – the holding has still returned 29 per cent in less than 12 months.
One reason why investors have been warming to the investment case is the company’s dominant market position. Globally, around 182m sets of safety kettle controls were produced in 2017 of which Strix controlled a 38 per cent share of the market by volume, and 50 per cent share by value. It has an unblemished safety record – the company has never had a single product recalled due to a fault with its controls – and takes an active role by engaging with regulators to improve regulation levels and enforcement of patent infringement to protect a portfolio of over 150 patents. It defends these vigorously, and successfully, having won court cases in China and the Netherlands in the first half of 2018.
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. Furthermore, Strix has relationships with over 400 brands and retailers around the world including multi-nationals Siemens, Philips, Walmart, Supor, and Tesco. The fact that two-thirds of the company’s top 30 clients have traded with Strix for more than a decade highlights the valuable long-term standing the company has in the industry and value chain, which underpins its market-leading position and acts as a strong barrier to entry for rivals.
Highly cash generative
I have been effervescing about the highly cash-generative nature of the business, too: net operating cash flow was £33.8m in 2017 – well ahead of Strix’s operating profit of £29.1m, the latter is stated after non-cash depreciation and amortisation charges of £6m, in line with capital expenditure and capitalised development costs. The company also has the benefit of an Isle of Man tax base, which means the corporation tax charge is minimal, thus enabling the board to earmark around £13m of this year’s forecast annual free cash flow of £23m for dividend payments, and still have enough cash left over to pay down borrowings of £46m. In fact, net debt could be slashed by almost a third to £31m by the December year-end. The point is that as borrowings are paid down more of the ownership of the enterprise shifts from debt holders to equity shareholders.
To highlight how this works in practice, consider the following. Currently, Strix has a market value of £313m and an enterprise value of £359m after factoring in net debt of £46m. Its enterprise value equates to 11.6 times this year’s forecast operating profit of £30.8m, or less than 10 times likely cash profit of £36.7m. The difference between the operating profit and cash profit estimates is the aforementioned £6m non-cash depreciation and amortisation charges. However, if net debt is slashed to £31m by the year-end and the enterprise value remains the same at £359m, then we can expect the £15m debt repayment to be reflected in a £15m increase in the company’s market value to £328m.
Based on an issued share capital of 190m shares, this year’s forecast debt repayment boosts equity shareholders' interests in the enterprise by 8p a share alone. Add to that the 7p a share forecast dividend, which is covered more than two times by reported EPS of 14.5p, and it’s reasonable to expect at least a 9 per cent annual return on your investment as a minimum. Furthermore, because debt is being repaid so quickly – analysts’ financial models suggest net debt could be reduced to £5.5m by the end of 2020 – then interest payments are being cut, too, which boosts the retained profits of shareholders and supports expectations that EPS will rise to 16.1p in 2019. So, in effect, we have a situation whereby recycling cash in this way creates shareholder value, a key reason why the shares have done so well.
Sales of Aqua Optima gush higher
Strix’s cash flow is also being used for investment in new products, and successfully so as the company 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 that sterilises 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 more than 2m filters have been sold. The machines are used for around 18 months, and require between four and six replacement filters, thus providing a lucrative secondary income stream. Last year, the company doubled its share of the UK market to 12 per cent, buoyed by some major incremental contracts with Tesco and Boots. There is potential to replicate this growth overseas, too.
Importantly, with the company reporting a healthy start to the 2018 financial year, and the shares still only trading on 11 times EPS forecasts, falling to 10 times 2019 expectations of house broker Zeus Capital, then there is every reason to expect investors to continue to warm to the investment case. A prospective dividend yield of 4.2 per cent for 2018, rising to 4.7 per cent in 2018 is also attractive.
So, ahead of the release of first-half results in late September, I continue to rate Strix’s shares in a positive light, so much so that I have upgraded my target price from 165p to 200p. I have done so to reflect the anticipated £40m pay down of debt by 2020 – a sum worth 21p a share – which transfers more of the ownership of the enterprise from debt holders to equity shareholders, and to take into account the hefty retained profits in the business. Buy.
■ Simon Thompson's new book Successful Stock Picking Strategies can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source and is priced at £16.95 plus £2.95 postage and packaging. Full details of the content is available on YPDBooks website.
Simon's second book Stock Picking for Profit has been reprinted and is available to purchase online at www.ypdbooks.com for £16.95, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. Simon has published an article outlining the content: 'Secrets to successful stock picking'
