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Power up your portfolio with Electrocomponents

The industrial and electronics products specialist has increased its market share during the pandemic - now for the margin improvement
June 3, 2021
  • Electrocomponents is expanding beyond distribution into higher margin value-added services
  • The fragmented global market should throw up more opportunities for earnings boosting acquisitions
IC TIP: Buy at 1015p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points

Competes in fragmented markets

Profit margins improving

Fund manager pick

Analyst upgrades

Bear points

Cyclical exposure

Recent cost pressures

Founded in 1937 as a business selling spare parts for radios, Electrocomponents (ECM) has become one of the world’s leading distributors of industrial and electronic products. Working with more than 2,500 suppliers, the group stocks over 650,000 items, acting as a ‘one-stop shop’ for designers, builders and maintainers of industrial equipment and operations. Its 1.2m-plus customers come from a wide variety of sectors – running the gamut from healthcare to mining – and it provides them with everything from calibration instruments to personal protective equipment (PPE).

Electrocomponents estimates that its global market is worth around £400bn and typically grows faster than GDP. It is aiming to grow at more than twice the rate of its market, both by attracting new customers and selling more to existing clients. There is certainly room for growth in the fragmented global landscape as the top 50 players only account for around 30 per cent of the market. Electrocomponents’ market share is less than 1 per cent, and even in the UK, its most mature market, its share is under 5 per cent.

Despite there being many players in the market, Electrocomponents does claim advantages over its rivals who are largely offline, smaller and with a regional or niche focus. With 12 distribution centres across the world, the group is one of only a few companies with global scale, selling into 80 countries. It also has a broader product range than major competitors.

Online sales channels in the global distribution market are relatively immature and Electrocomponents is looking to be a “digital disruptor”. It invests around 4 per cent of revenue to bolster its digital and technology offering each year, and 63 per cent of total sales now come from digital channels, up from just 18 per cent in 2005.  

On the ascent

Electrocomponents is a popular choice among funds, being the number two holding of the Threadneedle UK Equity Income Fund (GB00B8169Q14). Manager Richard Colwell says the investment case is “underpinned by the firm’s highly competent management, strong cash conversion and consistent market-share gains.”

The arrival of chief executive Lindsley Ruth in 2015 was key to revitalising the group’s fortunes after the 2008-09 financial crisis and, under his leadership, the share price has risen from around 230p to over £10. Ruth has overseen Electrocomponents’ shift up the value chain, beyond pure product distribution into services. The group now operates across the product lifecycle from design and procurement through to inventory management and maintenance. For example, its RS Monition business helps customers monitor the condition of their equipment and early detection of problems allows them to reduce machine downtime, increase the lifespan of their assets and save on maintenance costs.

The push into services has increased customer ‘stickiness’, as tailored solutions mean that Electrocomponents is more integrated into its customers’ supply chains, making it more difficult for them to switch to another provider. These value-added services have also helped improve profit margins, with the adjusted operating margin climbing from 6.7 per cent in 2015 to 11.3 per cent in 2020.

That said, the margin did dip to 9.4 per cent in the year to 31 March, on the back of elevated freight costs due to the pandemic and Brexit-related expenses. It was also squeezed by higher inventory provisions amid a fall in the selling price of PPE purchased at the beginning of the pandemic.

Despite the Covid-related disruption, the group is still targeting a mid-teens adjusted operating profit margin in the medium-term, and broker Jefferies forecasts that the margin will hit 13.8 per cent in 2025.

Margin momentum should be aided by growth from Electrocomponents’ own higher margin brand, RS PRO, which outperformed the rest of the group last year. RS PRO sales rose by a tenth on a like-for-like basis, benefitting from new product launches and investment in marketing. There is further room to grow, particularly in the Americas, where RS PRO revenue accounts for under 1 per cent of the region’s total compared with 19 per cent in its largest market, ‘Europe, the Middle East and Africa (EMEA), and 13 per cent in Asia Pacific.

Growing its own brand is a key objective of Electrocomponents’ ‘Destination 2025’ programme, which also aims to expand the group's value-added service offering and improve the efficiency of its operations. Management has spent £40m on expanding and automating the US distribution centre, doubling its capacity, and is also investing £60m to double the capacity of the German distribution centre. Once the project in Germany is completed in the autumn, Electrocomponents says it will help overcome some of the logistical and procedural challenges relating to Brexit, as products can be stocked in Europe rather than being shipped from the UK. James de Uphaugh, manager of the Edinburgh Investment Trust (EDIN) where Electrocomponents is also a top 10 holding, adds that “heavy supply chain investment will create a highly efficient and more sustainable business that will accommodate the management’s ambitious growth plans.”

In order to accelerate ‘Destination 2025’, management also unveiled the ‘RISE’ programme in November, through which it will cut  £25m of costs by the end of March 2023 – although this will cost £16m to implement. The group hasn’t publicly disclosed its 2025 targets beyond the mid-teen margin ambition, but Jefferies believes Electrocomponents could reach £3.0bn to 3.5bn of revenue and £450m to £520m of adjusted operating profit.

That would be up from £2.0bn of revenue in 2020-21, in a year that chief executive Ruth says “stress-tested the business materially”. But even with the challenges of the pandemic, revenue still rose by 2.5 per cent as the group widened its customer base and increased its market share across all key markets.

While like-for-like revenue dipped by 7 per cent in the first half of the year, it jumped by a tenth in the second half, reflecting a recovery in demand and weaker prior-year comparatives. That momentum carried over into the first seven weeks of the current financial year, although Electrocomponents has warned of potential supply chain shortages, Brexit frictions and ongoing pandemic-related costs.

Still, while Ruth says the group “remains mindful of external pressures”, it is confident it can continue to take market share. Analysts are similarly bullish, viewing the cost inflation as a short-term hurdle that should abate alongside the pandemic, while the market share gains should persist beyond this crisis. City analysts nudged up their forecasts again once again following the group’s full-year results last month.

Acquisitions could prompt further upgrades

The group was sitting on £122m of net debt at the end of March, down 36 per cent from a year earlier and equivalent to just 0.5 times adjusted cash profits (Ebitda). The fall in net debt was aided by more than doubling free cash flow to £133m, on the back of lower capital expenditure and a focus on preserving cash during the pandemic. While these benefits will likely reverse moving forward, Electrocomponents still has a good long-term track record of free cash-flow generation.

The balance sheet therefore has sufficient firepower to capitalise on the group’s fragmented markets and support further acquisitions. The past year will have placed greater strain on smaller competitors, and Electrocomponents said in December that the number of “active” opportunities in its M&A pipeline was three to four times higher than two years ago.

The group made three purchases in year to 31 March, the largest of which was US-based supply management services provider Synovos for £110m in January. Synovos helps customers save money when sourcing inventory, complementing the group’s existing procurement services business IESA. Electrocomponents can offer Synovos’ value-added solutions to its existing US customers and can cross-sell its own brand RSO Pro products to Synovos’ clients.

The group has also been expanding its footprint in the safety products sector, where demand for PPE is expected to continue growing beyond the pandemic. It acquired Needlers for £40m in December, which is a leading supplier of PPE, safety and hygiene products to the food manufacturing industry in the UK. It also purchased John Liscombe in March for £11m, which already supplies industrial safety and PPE products to a number of Electrocomponents’ existing customers.

The Synovos and Needlers acquisitions were funded through a £180m placing of 21.8m new shares, but Jefferies thinks it unlikely that management will continue to rely on dilutive placings, unless it is making a large purchase. The broker reckons that Electrocomponents’ balance sheet can “comfortably support” net debt of up to 2 times Ebitda, funding more than £500m of deals  

Analysts at Peel Hunt believe that in the long-term acquisitions “could help smooth out some of the more cyclical element of ECM’s organic growth.” Indeed, with more than 50 per cent of its revenue coming from manufacturing customers, Electrocomponents is vulnerable to an economic downturn. But this is partially mitigated by the diversity of its end markets, as well as rising adoption of technology as part of the so-called ‘fourth industrial revolution’ bringing the ‘Internet of Things’.

Room for improvement, but worth the price tag?

Electrocomponents does not yet look as high quality a company as fellow distributors Diploma (DPLM) and XP Power (XPP), with lower margins and return on capital employed (see table). But the attraction is in the potential of its ongoing recovery story, together with momentum from acquisitions and the global economic bounce back.

Electrocomponents versus fellow UK-listed distributors
CompanyMarket Cap (£bn)Share price (p)% change in price vs 1 year agoGross profit margin LTM (%)Adjusted operating profit margin LTM (%)Return on capital employed (ROCE) LTM (%)FCF yield LTM (%)Dividend yield NTM (%)Price-to-earnings ratio NTM
Bunzl (BNZL)7.702,28520.124.56.5517.57.22.416.4
Diploma (DPLM)3.592,88657.636.418.419.12.41.433.2
discoverIE (DSCV)0.6775047.233.27.5310.54.61.427.2
Electrocomponents (ECM)4.6599055.243.09.8416.22.61.723.9
XP Power (XPP)0.985,00055.846.919.621.63.31.825.8
Source: FactSet

So, while the shares are highly rated, trading at 24 times consensus earnings for 2021-22 with an enterprise value to adjusted operating profit ratio of 18, the long-term growth story means this could nonetheless be a very acceptable entry point.

ELECTROCOMPONENTS (ECM)   
ORD PRICE:1,015pMARKET VALUE:£4.77bn  
TOUCH:1,014-1,015p12-MONTH HIGH:1,110pLOW:622p
FORWARD DIVIDEND YIELD:2.1%FORWARD PE RATIO:20  
NET ASSET VALUE:191p*NET DEBT:14%**  
Year to 31 MarTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p) 
20191.8821536.714.8 
20201.9521537.65.9 
20212.0018231.225.4 
2022†2.3126743.017.3 
2023†2.5032151.720.9 
% change+8+20+20+21 
*Includes intangible assets of £469m or 100p per share
**Includes lease liabilities of £61.5m
† Jefferies forecasts, adjusted profit and EPS

Last IC View: Hold 771p, 10 Nov 2020