Having prompted analysts to upgrade their earnings estimates four times since last summer, technology group Elektron Technology (EKT:42p) has issued yet another robust trading update ahead of the release of results for the 12 months to the end January 2019.
The transformation in Elektron’s fortunes from a loss-making technology group two years ago to one enjoying strong earnings momentum lies in the board’s "shrink to grow" five-year streamlining programme, which completed last April. It resulted in the closure or disposal of 12 businesses and reduced the number of sites in the UK and overseas from 12 to four. Low-margin business has been rationalised and annual revenues have been reduced from £63m in the 2011-12 financial year to £33.7m in the financial year just ended.
The strategy has simplified and optimised the structure of Elektron’s business activities, and enabled management to concentrate on scaling up the group’s core businesses: Bulgin, and Checkit. The focus has been on driving organic sales growth while maintaining class-leading margins and an eye-catching return on capital employed (ROCE) for a manufacturing business.
Key to this transformation is the turnaround of Bulgin, a world-class designer and maker of hermetically-sealed (air and watertight), fail-safe circular connectors used to supply electricity and other vital equipment, often in harsh environments. Bulgin may be a designer and manufacturer of environmentally sealed waterproof connectors and electronic components, but its value to customers and end users is far greater. Indeed, analyst Paul Hill at Equity Development estimates that the division made an operating profit of £9m on sales of £30.1m in the 12 months to the end January 2019, implying an operating margin of 30 per cent. A gross margin of around 50 per cent highlights the pricing power and the value Elektron’s management has created around this business.
Bulgin earns such a high gross margin by providing technological expertise to improve the performance and energy efficiency of electronic and electrical equipment used in automotive, consumer electronics, automation, computer/peripherals, industrial, marine, telecom, oil/gas and lighting applications. Products include waterproof circular connector range (power, signal and data), mains connectors, battery holders, indicators, and vandal-resistant LEDs and switches.
I expect the positive trend to continue for some time yet as Elektron’s directors have revealed that their company is on course for a record sales performance in the first quarter of the new financial year. They also note that Bulgin, which has low-cost manufacturing facilities in Tunisia, is “well placed to capitalise on the current 25 per cent tariff for Chinese electronic consumer goods imported to the United States, Bulgin’s largest market”. Moreover, Bulgin’s eye-catching progress has not gone unnoticed as the company received an “unsolicited offer for Bulgin at a substantial premium to the company’s market capitalisation of £83m”. Talks have ended, but it certainly highlights the value created in this business. It also brings into sharp focus the value in Elektron as the group’s net cash position has doubled year on year to £10.1m, a sum worth 5.4p a share.
Checkit is fast growing too
The investment case becomes even more compelling when you consider that Elektron has a proprietary work management ‘software as a service’ (Saas) product, Checkit, that has been designed to replace paper-based systems with a centralised, interactive cloud-based way of managing the multitude of tasks that staff have to carry out on a daily basis. Its interactive checklists actively prompt staff to perform tasks when and where they are required to. Completed tasks are then time stamped and sent to the cloud to provide an audit trail of work carried out and issues that have arisen.
The addressable market is estimated to be worth around £272m in the UK alone, with hotels, pubs and restaurants (36.8 per cent share), retail, travel and leisure (22.4 per cent), and food service (14 per cent) the key sectors, according to Mr Hill at Equity Development. Furthermore, the global addressable market could be worth £3.5bn, of which North America accounts for over a third. Checkit’s contracted recurring revenues doubled to £1.2m in the 2018-19 financial year, a trend that is set to continue in the years ahead and which will narrow sharply the £4.5m estimated operating loss made for this business unit.
Elektron Eye Technology up for disposal
I also note that the directors are looking to sell Elektron Eye Technology (EET), a profitable business that has developed portable analysers that measure macular pigment optical density and are used to detect age-related macular degeneration. These analysers provide results as fast as 90 seconds per eye, and are the only commercially viable device of their type on the market. It’s not the only product EET has as a third of divisional sales are derived from its range of Henson glaucoma screening and management analysers that enable eye care professionals to detect and monitor glaucoma progression. Boots, Specsavers and Vision Express are all customers in the UK where EET has a market share of about 50 per cent. The plan is to try and replicate domestic success overseas, albeit EET is up against German rival Carl Zeiss and Switzerland-based Haag-Streit in a global market worth £35m.
Sum-of-the-parts valuations
The best way to value Elektron is on a sum-of-the-parts basis. I feel that Bulgin should be valued on 13 times its post-tax earnings for the financial year to the end January 2019, implying a value of £95m based on a normalised tax charge, or 51p per Elektron share. To that you can add Elektron’s closing cash pile of 5.4p a share. EET could easily be worth £3m in a trade sale, or 15 times cash profit estimates for the 2019-20 financial year. That adds a further 1.6p a share to the sum-of-the-parts valuation.
Admittedly, valuing Checkit is more difficult as it is a blue-sky opportunity. However, if it achieves the £3m of cash profits analysts forecast in the 2021-22 financial year, then a multiple of 7.5 times forecast profits would imply a value of £22.5m, which equates to 12p per Elektron share. On this basis, I value Elektron’s shares at 70p, or 66 per cent above the current share price.
Importantly, there is a catalyst for a rerating as Elektron will report a bumper set of annual results in early May that should reveal an 80 per cent rise in its pre-tax profit to £4.7m, and a near 90 per cent hike in earnings per share (EPS) to 2p. Analysts are predicting a 25 per cent hike in EPS to 2.5p in the current financial year to January 2020 and a rise in the cash pile (before factoring in proceeds from the disposal of EET) to £14.8m, or 8p a share. On this basis, the cash-adjusted forward PE ratio is 13.5, hardly exacting for a company that is growing organically and is benefiting from a raft of higher-margin value added contracts.
I highlighted Elektron’s shares, at 44p, in my November Alpha Report, and continue to rate them a buy ahead of the forthcoming annual results. Buy.
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