- Adjusted pre-tax profit up 45 per cent to $14.7mn
- Gross margin rises from 32.2 to 36.3 per cent
- Free cash flow of $17.4mn beats expectations
- Net cash more than doubles to $27.9mn
Analysts pushed through material upgrades at the time of Nexteq’s (NXQ:155p) pre-close trading update, but the technology group still beat the upgraded expectations by 5 per cent.
Operating in the gaming, medical, broadcast and industrial markets, the group’s specialised computer platforms are best known for powering machines in the global casino gaming and slot machine market. Although gaming sector revenue declined by 6 per cent to $69.2mn (accounting for 60 per cent of group revenue of $114mn), mainly due to lower monitor sales after customer Azure Group filed for bankruptcy, this was more than mitigated by a higher gross margin.
Importantly, new business development gathered pace as manufacturers reignited their product development. For instance, the group’s two largest customers, Everi and Ainsworth Game Technology, launched several new gaming cabinets and new ‘hold and spin’ games at last autumn’s Global Gaming Expo in Las Vegas. Nexteq is well placed to capitalise with its refreshed product suite, which now harnesses Intel processors that offer superior graphics processing performance and longer supply lifetimes for its gaming customers.
The group’s much-improved margin performance also reflects the diversification of Nexteq’s revenue. Following the acquisition of Densitron in 2015, around 10 per cent of sales are now derived from the broadcast sector, 10 per cent from medical and 20 per cent from other industries. In the media sector, Densitron supplies HMI hardware and control systems that blend touch screens with a range of tactile object and feedback technologies to broadcasters including Channel 4, BBC and Canadian Broadcasting Corporation.
Broadcast revenue increased 12 per cent to $8.4mn in 2023, the fourth consecutive year of double-digit growth, and at a record gross margin, too. Nexteq’s management believes the new margin level is sustainable, a reflection of the value proposition offered to its customers.
Bumper free cash flow generation and low rating
Nexteq’s earnings beat was not the only thing that caught the eye; cash flow generation was mightily impressive, too.
That’s because the group operates a capital-light model that generates high levels of free cash flow (FCF), which funds investment in the business and supports a progressive dividend policy. Reflecting an easing of supply chain constraints that forced Nexteq to hold higher levels of inventory, as well as the bumper profit contribution, the group generated annual FCF of $17.4mn, or 74 per cent higher than house broker Cavendish had forecast prior to January’s pre-close trading update.
In turn, closing net cash increased by $15mn to $27.9mn (32.8p) and is forecast to hit $36.2mn (42.5p) by the 2024 financial year-end, even after the board raised the payout per share by 10 per cent to 3.3p. Cavendish anticipates another hike in the dividend to 3.6p a share this year, the forecast payout covered more than three times by an estimated FCF of 12.9p.
Although analysts expect flat earnings per share of 18.1¢ (14.1p) in 2024, the business is creating value for shareholders as the cash build highlights. Investors are starting to recognise this as Nexteq’s share price is now 25 per cent higher than the 120p suggested entry point in my 2024 Bargain Shares Portfolio. However, shares in the £100mn market capitalisation company are still only trading on a cash-adjusted price/earnings (PE) ratio of 8.3, which falls to 7.6 and 6.8 at the end of 2024 and 2025, respectively, assuming Nexteq hits Cavendish’s forecasts. There is also the possibility that the group will outperform market expectations, as was the case last year. Buy.
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