30. Ergomed
Biotech company valuations came crashing down to earth as the threat from Covid-19 receded and interest rates rose. Naturally, this was not a welcome development for retail investors – but it undoubtedly created M&A opportunities. Pharmaceutical services group Ergomed (ERGO) will soon become the latest London-listed life sciences group to be taken private when its £700mn sale to private equity group Permira is completed.
Permira’s 1,350p-a-share offer represented a premium of over 28 per cent to the company’s share price on the last business day before the bid was announced, albeit Ergomed was previously trading at that level at the end of last year. Shares have since pulled back fractionally to 1,326p at the time of writing, but the deal was passed with the support of 83 per cent of shareholders at a court meeting earlier this month. Hold. JJ
29. Advanced Medical Solutions
Trading conditions have been volatile this year for wound care group Advanced Medical Solutions (AMS), but that only became clear to investors at the start of last month, when a profit warning sent shares tumbling by 30 per cent. Its issues are twofold: first, destocking by US distributors has hit demand for its LiquiBand skin adhesive. Meanwhile, it has also seen shrinking royalty income from one of its patent licensing agreements.
A re-rating is more or less contingent upon an improving outlook for LiquiBand, its flagship product range. In the meantime, there is concern about the group’s shrinking level of cash, given it decided to build up its own stocks in the first half. If demand remains weak, this could present yet another problem for the company.
Things aren’t all bleak, however. AMS signed a new commercialisation agreement for one of its LiquiBand products last month, which it says marks its entry into “a new $200mn (£164mn) addressable market”. But the risks are apparent enough. Hold. JJ
28. GB Group
Making a big technology acquisition at the height of the low interest rate era was unlikely to end well for identity verification business GB Group (GBG). A £122mn non-cash impairment charge meant it swung from a £23mn profit in FY2022 to a £112mn loss in the 12 months to 31 March this year.
The impairment was in relation to its North American Identity business, to which it had recently added two acquisitions: Acuant and Cloudcheck. The pandemic saw an increase in demand for the identification services provided by the likes of GB Group, but this has not proved permanent.
On top of this, organic constant currency growth has been underwhelming, falling from a rate of 3.7 per cent in the year to March to an annual rate of 1.8 per cent in the six months to September. Meanwhile the expensive acquisitions have left it with net debt of £105mn. There is a good underlying business here, but the jury is still out on the poorly timed acquisitions.
There is a case that GB operates in a structural growth market which justifies its relatively high valuation; broker Numis currently has it trading on a 2024 price/earnings ratio of 18. This is too much for us given the debt pile. Sell. AS
27. Renew
A focus on maintenance contracts for road, rail and utilities schemes provides a steady stream of work for Renew Holdings (RNWH), and mean it can plan and invest safely in the knowledge that the job it is carrying out won’t suddenly be pulled by an unpredictable client. The vast bulk of revenues for its current financial year, which began on October 1, are already covered by its order book and its healthy levels of cash generated have funded a well-executed buy-and-build strategy. Its financial performance is impressive – adjusted operating margin grew from 1.6 per cent in 2010 to 6.9 per cent last year.
This has underpinned a 22.4 per cent compound annual growth in earnings per share over the past 12 years, according to Berenberg analysts.
Renew’s shares are more highly rated than peers such as Kier (KIE) and Morgan Sindall (MGNS), but deservedly so. And at less than 12 times forecast earnings, they’re hardly likely to break the bank. Buy. MF
26. Marlowe
Marlowe (MRL) is one of those companies that has benefitted from ever greater strictures linked to regulatory compliance. The group provides business-critical services and software with seven business categories covered within its dual divisions: governance, risk & compliance (GRC) and testing, inspection & certification.
Midway through this year, it emerged that Marlowe was exploring the sale of this latter division, a provider of safety and compliance services in fire, water hygiene and air quality. An August press update from the group indicated that any potential strategic action has not yet been taken off the table. A sale of the unit could yield a valuation of up to £650mn.
As perhaps befits a group that benefits regulatory complexity, Marlowe itself is a machine with many moving parts. It could be argued that its negative share price performance over the past 12 months was due in part to uncertainties linked to the divergence between adjusted and reported earnings, a differential which reflects the acquisitive nature of the group.
Marlowe has completed another five acquisitions (for a total enterprise value of £35mn) since its March year-end. With 93 per cent of non-current assets deemed intangible, amortisation charges and fair value adjustments are par for the course, especially when you’re pursuing a buy-and-build strategy. Strip out non-core charges in FY2023, and group cash profits were 52 per cent to the good at £82.7mn.
Restructuring costs have also been to the fore as Marlowe develops a one-stop compliance service platform. The group aims to broaden its GRC capabilities into the “highly complementary” ISO certification market, thereby affording potential cross-selling opportunities.
It can be difficult to arrive at meaningful discounted cash flow valuations for companies perpetually engaged in M&A activities. But forecasts point to a marked step-up in group cash flow generation, so the enterprise/cash profit multiple could narrow appreciably through to 2026, suggesting that the company may be undervalued on that basis. The danger exists, of course, that integration costs could weigh on returns. The current consensus is that Marlowe’s return on equity (net income divided by shareholder equity) will increase by two percentage points to 11.8 per cent by FY2026.
Returns aside, while it is understandable that some investors shy away from highly acquisitive companies, it’s worth considering that Marlowe’s insiders certainly have ‘skin in the game’ with combined holdings equivalent to 18.4 per cent of the issued share capital – a positive point given due diligence demands – and director compensation is strongly aligned with shareholder interests. Buy. MR
25. Volex
If you want to understand how Volex (VLX) reinvented itself, the cable manufacturer’s operating margin is a great place to start. It was a paltry 1.9 per cent in 2014 but had increased to 7.5 per cent by 2023. Its scale has helped to achieve this, having grown its revenue by increasing its range of customers and acquiring businesses.
The company now operates in several markets – electric vehicles (EV), grid cabling, complex industrial technology, and the medical industry – in theory giving it a degree of resistance if a recession hits next year. Its exposure to the more resilient US market should also help, though consumer electricals do still account for a third of overall sales. In any case, analysts forecast revenue and earnings to grow further in the year ahead, aided by the EV transition.
Yet, the market is more concerned about the near-term risks. The shares trade at under nine times forecast annual earnings for 2024, which looks cheap given the variety of uses and evident demand for Volex’s products. Buy. ML
24. Young & Co’s Brewery
Young & Co’s Brewery’s (YNGA) premium estate is serving it well. A relatively affluent customer base has kept spending, which helped the company become the first among its listed peers to see profits outstrip pre-pandemic levels.
Investing more than competitors, in acquisitions and the existing estate, is also a key part of the story. Capital spending is backed up by a strong balance sheet, helped by a mostly freehold estate. Net debt is significantly lower than at competitors such as Marston’s (MARS) and Mitchells & Butlers (MAB). Leverage sits under 2 times cash profits, a very manageable situation which supports the acquisition pipeline.
In the first 13 weeks of this financial year, revenue was up by over 8 per cent. Analyst consensus is for steady revenue and profit growth in the years ahead. A rating of 15 times forward consensus earnings is undemanding given the growth profile, performance against peers, and balance sheet and investment strengths. Buy. CA
23. Learning Technologies Group
Corporate training business Learning Technologies Group (LTG) sold itself as a recession resistant company. Its theory, that companies couldn’t cut corporate training budgets because of regulatory requirements, has proved incorrect.
LTG has blamed its flat organic revenue in the six months to the end of June on a slowdown in transactional work. The company defines “transactional” as anything that isn’t a long-term contract. The implication is that where customers could cut, they did cut. Thankfully software-as-a-service and long-term contracts accounted for 72 per cent of revenue, so there is some robustness there.
A concern is net debt of £108mn, resulting from a large deal for consultancy GP Strategies – which now makes up two-thirds of revenues – at the end of 2021. Management is cutting GP’s costs to boost margins, but interest costs are rising which will offset these savings.
This is all reflected in the share price, which is down 45 per cent year to date and leaves it trading on a free cash flow yield of 8 per cent. This is tempting, but we would like to see some growth return, rather than just blaming the “challenging macroeconomic” backdrop. Hold. AS
22. Judges Scientific
Some claim that buy-and-build strategies have become synonymous with the private equity industry, but it could be argued that M&A growth is more readily attained through specialised channels. Judges Scientific (JDG) provides a case in point via its focus on companies engaged in the design and production of scientific instruments, yet it places as much emphasis on growing its subsidiaries organically, a process aided by the fact that the group has longer time horizons than the private equity industry. The steady increase in financing costs could lead to an increase in distressed assets – and lower M&A multiples – but Judges says this would not influence its dealmaking rationale.
The group recently delivered a one-third increase in adjusted interim profits, together with a 40 per cent hike in operating cash flow, while trading profit increased by 12 per cent on an organic basis. It also closed out the period with an improved order book and a forward rating that was slightly below its five-year average, albeit the stock is still priced for growth. Hold. MR
21. Next 15
Next 15 (NFG) is a tech-focused marketing firm with a big client base in North America. For a couple of years, this was a winning combination: the value of its shares rose five-fold between March 2020 and March 2022. Since then, however, US tech sector woes and general economic gloom have weighed heavily on its valuation, which is now at a 10-year low.
Its latest results reflect the difficult backdrop. Next 15 reported delays in client spend in the first half of its financial year, and its adjusted operating profit (after lease interest) fell by 7 per cent to £57mn.
The company is still targeting sales and profit growth for the full year, however, and its divisions look poised for long-term success. The group – usually laser-focused on expansion – has also announced its first share buyback scheme, suggesting that management is similarly convinced that the group is undervalued. Buy. JS
