One of the perennial conundrums facing investors is when to take profits on a winning shareholding. My policy is to always run profits until the rationale behind the original investment thesis no longer holds. However, I am cognisant of the fact that risk management plays an important part in running any portfolio and if you find yourself sitting on huge gains on any single holding then top-slicing to diversify risk is a sensible strategy. That way you can benefit from further upside on the balance of a winning holding, while at the same time crystallising gains to protect erosion of paper gains in the event that investor sentiment turns.
This is exactly what I suggested with shares in Trifast (TRI:193p), a small-cap manufacturer and distributor of industrial fastenings, with operations across 31 locations across the UK, Europe, Asia and North America, after the price hit my 275p long-term target at the end of April 2018 (‘Five small-caps with Character’, 30 April 2018). A year earlier I had recommended doing exactly the same thing when the share price was 223p ('Hitting target prices', 2 May 2017), having first advised buying, at 51.9p, in my 2013 Bargain Shares portfolio. True, I may have been slightly premature taking some cash off the table in May 2017, but it has proved a sensible decision in hindsight given that Trifast’s share price has fallen back below the levels of both sales.
Or put it another way, if you had purchased £10,000-worth of Trifast shares in February 2013, by selling half your holdings on both occasions as I recommended, you will have cashed in stock worth £22,100 in May 2017 (to crystallise a 342 per cent total return on half your shareholding after taking into account dividends paid) and banked a further £13,650 of sales in April 2018 (to crystallise a 446 per cent total return on a quarter of your original holding). This would still have left you with a quarter of your original shareholding to play any further potential upside, and with a decent profit on it too as it was worth £13,650 in April 2018, or more than five times the £2,500 original investment.
My rationale for maintaining a financial interest in Trifast was based on three factors: the possibility of the board making further earnings-accretive bolt-on acquisitions to boost earnings per share (EPS); the scope for margin upside from the capital investment made in its manufacturing facilities in Singapore; and an order pipeline that offers potential for outperformance against consensus forecasts.
I also noted that Trifast had announced the £8.5m acquisition of East Grinstead-based Precision Technology Supplies (PTS), a distributor of stainless steel industrial fastenings and precision turned parts, primarily to the electronics, medical instruments, petrochemical, defence and robotics sectors. PTS delivers high-quality products and services, selling into 80 countries directly through its distributor network, and an e-commerce platform that offers over 43,000 products for sale. The business had generated strong sales growth over the three years prior to the acquisition and delivered annual pre-tax profits of £720,000 on revenue of £5.1m in its previous financial year.
Analysts believed that PTS would be able to grow at a mid-to-high single-digit growth rate in the foreseeable future, and Trifast’s directors stated that the acquisition would be earnings accretive in the financial year to March 2019. Both predictions have proved on the money as Trifast’s trading update for the 10 months to end January 2019 has revealed that PTS bedded down well and is delivering strong year-on-year growth. Moreover, Trifast is on course to deliver 2019 EPS forecasts in the 14p to 14.2p range that analysts had predicted when I top-sliced the holding for the second time in April 2018.
However, despite these positives, the share price has fallen by a third since then, a reflection of global economic uncertainty, the ongoing Brexit saga, and perceived concern about the automotive sector, which accounts for a third of Trifast’s businesses.
I say perceived concerns because over 90 per cent of the company’s automotive supply remains outside of the combustion engine and power train, and is mainly focused on seating, console, dashboard and lighting systems. True, the UK auto market has been softer, but 70 per cent of group sales are overseas and Trifast continues to build market share with existing and new OEM customers. It is also benefiting from growth from new vehicle technology (including electric vehicles) and seeing demand pull as multi-national customers enter new territories.
Nonetheless, the de-rating means that Trifast’s shares now trade on a price/earnings (PE) ratio of 13.5 for the financial year ending 31 March 2019 and offer a prospective dividend yield of 2.1 per cent. That’s not an expensive rating for a company that makes a mid-teens pre-tax return on capital employed, nor one that has consistently generated free cash flow to fund both a progressive dividend policy and make shrewd bolt-on acquisitions that have diversified revenue streams, and expanded the geographic reach into new territories. The acquisitions of VIC, an Italian maker and distributor of fastening systems predominantly for the white goods industry, and Kuhlmann, a distributor of customised industrial fasteners focused mainly on the German market, have proved their worth several times over. I would also flag up that Trifast has boosted its higher-margin in-house manufacturing capability, a segment that now accounts for 35 per cent of total sales.
True, investors are likely to remain cautious in the near term, but if the economic risk factors currently subduing Trifast’s valuation unwind – and for the record, I still maintain the thesis I outlined earlier this year that global equity markets are set for a V-shaped bounce from their fourth quarter lows ('Profit from unwinding of recessionary risk', 21 January 2019) – then the shares are likely to rerate.
So, ahead of a pre-close trading update in mid-April 2019, I would maintain your interest in Trifast if you have been following my advice on this company. Run profits.
Engineering fluid gains
This is an opportune time to revisit Aim-traded Skelmersdale-based Flowtech Fluidpower (FLO:125p), the UK's leading specialist supplier of technical fluid power products.
Flowtech’s main distribution business offers more than 100,000 individual product lines to more than 80,000 industrial maintenance, repair and overhaul end users in the UK and Benelux through a network of around 5,000 distributors and resellers. It also has a power motions controls (PMC) division that designs, assembles and supplies engineering components and hydraulic systems.
I first advised buying the shares at 118p ('A fluid performance', 2 June 2014), since when the board has paid out dividends of 23.5p a share. The share price subsequently peaked early last summer at 195p, just shy of my 205p target price, so had been performing well until that is the company issued a modest profit warning when it released interim results last autumn ('Investors overreact to Flowtech’s warning', 19 September 2018). I believed investors massively overreacted to the warning, and still do.
That’s because at the time joint house broker Zeus Capital only reined in its 2018 adjusted pre-tax profit estimate by £700,000 to £10.7m on forecast annual revenues of £108m, up from £78m in 2017, hardly a major downgrade. Moreover, the main reason for the downgrade was due to higher operating costs from acquisitions made last year, and costs incurred to streamline the cost base.
Bearing this in mind, the bolt-on acquisitions made by Flowtech in March 2018 have delivered results in line with guidance, vindicating the decision of the board to raise £11m at 170p a share in a placing to fund them. The businesses acquired were Beaumanor Engineering, a Leicester-based fluid power equipment distributor and a competitor to the Flowtech's Flowtechnology business; and Derek Lane, a specialist fluid power engineering business that has crossover with Flowtech’s PMC division.
Strategically, they have widened Flowtech’s customer base, provided opportunities for cost savings in its catalogue business, and added a second logistics centre in Leicester to improve supply chain management and stock purchasing. There are cross-selling opportunities for Flowtech’s own-branded products, and scope to enhance margins, too.
Furthermore, Flowtech has just announced that it will deliver full-year pre-tax profits of £10.6m-£10.8m, up from £8.7m in 2017. True, the vast majority of the profit increase has come from acquisitions, but organic revenues still rose 6 per cent, the same growth rate as in 2017, so there is underlying growth being generated, too. On this basis, analysts expect 2018 EPS of 14.9p to support a hike in the dividend per share from 5.8p to 6.1p.
Importantly, the company posted strong sales growth in the final quarter of 2018, and the directors report that market conditions across Europe remain positive, albeit the same economic uncertainty that has impacted the rating on Trifast is making investors cautious on Flowtech ahead of Brexit, so much so that the shares are rated on a miserly PE ratio of 8 and offer a prospective dividend yield of 4.9 per cent for the 2018 financial year. That rating suggests the company has gone ex-growth, which it hasn’t, and points towards a dramatic drop-off in trading activity this year. The modest rating also ignores the fact that the business is actually making decent progress and the focus in 2019 will be on driving organic growth and achieving cost synergies.
Ahead of the release of the annual results and the first-quarter trading update for 2019 on Tuesday, 16 April 2019, I rate Flowtech’s shares a lowly rated buy.
Finally, I will be publishing an update tomorrow on Colchester-based Titon (TON:130p), a small-cap designer and maker of domestic ventilation systems, and door and window hardware, once I have had the opportunity to discuss the company’s trading update with chairman Keith Ritchie.
■ Simon Thompson's new book Successful Stock Picking Strategies and his second book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.
