A lowly rated below-the-radar UK chip company

Chip designer and maker CML Microsystems (CML:455p) continues to materially outperform growth in the semiconductor market (around 3 to 4 per cent last year), delivering 22 per cent organic revenue growth in the latest 12-month period.

This highlights the resilience of the group’s end markets, where the focus is weighted towards industrial and critical communications application areas in contrast to the memory, personal computer and consumer markets, which tend to exhibit more volatility. Specifically, CML provides integrated circuits to distributors and system integrators (Cobra, Hytera, Icom, Kenwood, Orbcomm and Sepura are among its clients).

The eye-catching improvement in profitability also vindicates the board’s decision to divest its solid-state storage division in 2021 and increase the focus on the global communications markets, with a key objective being expansion into end applications requiring microwave and millimetre wave (mmWave) products.

The global communications market is vast, encompassing a myriad of end-application areas ranging from mobile networks to precise positioning systems to short-range remote control devices. Within this landscape, CML is actively participating in sub-markets that play to its strengths and have sustainable growth potential. Its key markets include mission-critical communications, wireless networks and satellite, Industrial Internet of Things and broadcast radio. The addressable market exceeds $1bn (£0.8bn).

The mission-critical communications sector is forecast to grow at a compound annual growth rate of 9 per cent over the next five years. Applications include those for public safety, government agencies, transportation, energy and utilities, and mining. Growth is being driven by the increased adoption from energy and utility sectors, rising investment by defence sectors and trends within the transportation industry where real-time data is being used to support dynamic decision-making.

Mission-critical communications have been a cornerstone of CML's global business for many years and the key driver behind last year’s outperformance. That said, revenue from customers producing similar products for industrial and commercial business users also grew well across the year.

A smart way to play 5G and satellite communications growth

CML also offers exposure to the rapid development of 5G and satellite-based communications as advancements propel the world towards a future where faster, cheaper, and more accessible internet connectivity becomes a reality for all. 5G's high-speed, low-latency capabilities, combined with satellite technology's wide coverage and reach, enable a bridging of the digital divide, connecting remote regions, enabling faster communication and empowering industries. To build this new reality, a vast 5G network of base stations, small cells and other mmWave infrastructure will be required.

Using expertise in advanced compound semiconductor integrated circuit design, CML has started producing high-performance Radio Frequency integrated circuits (RFICs) and Monolithic Microwave integrated circuits (MMICs) that are relatively simple to use but have the technical characteristics and commercial competitiveness required to be successful in mass-market applications. Products released last year in this area under CML's SµRF brand are now generating income and the directors believe that, over time, the flow of revenue will constitute a “very sizeable proportion of the group's total revenue”.

A smart acquisition

The strategic disposal of its storage division left CML with a bumper cash pile and an ungeared balance sheet that is enabling the directors to recycle cash flow to maintain high levels of research and development (R&D) in its cutting-edge technology, maintain a progressive dividend policy and seek out acquisitions.

Subject to US regulatory clearance, the previously announced $18mn (£14.1mn) complementary and earnings-enhancing acquisition of Silicon Valley-based semiconductor company Microwave Technology is expected to complete in the coming weeks. Founded in 1982, the company is a recognised leader in the design, manufacturing and marketing of GaAs and GaN-based MMICs, discrete devices, and Hybrid Amplifier Products for commercial wireless communication, defence, space, and medical MRI applications.

The acquisition expands CML’s product portfolio, strengthens its support resources and enhances the group’s R&D capabilities. In addition, there is a significant opportunity to increase market share by internationalising Microwave Technology’s products given that the majority of its focus and client concentration has been within the US to date.

Another year of bumper earnings growth

Excluding the contribution from the acquisition and factoring in CML’s strong order book and contract momentum, house broker Shore Capital believe the group should increase revenue by 12 per cent to £23.1mn in the 12 months to 31 March 2024. Underlying pre-tax profit (excluding property gains) is forecast to grow even more quickly, rising 22 per cent to £4.4mn, highlighting the operational gearing of the business in a positive sales cycle.

On this basis, expect underlying earnings per share (EPS) to increase at a similar rate to 27.3p and support another 20 per cent hike in the dividend per share to 13.2p. This implies the shares are rated on a prospective price/earnings (PE) ratio of 16.6 and offer a forward dividend yield of 2.9 per cent. On a cash-adjusted basis, the forward PE ratio is only 11.4, a bargain-basement rating that tempted me to include the shares, at 490p, in my 2023 Bargain Shares Portfolio.

There is hidden value in the balance sheet, too. That’s because CML has been granted planning permission for the redevelopment of 13 acres of surplus land at its 29-acre site located at Oval Park, Maldon. The 2023 results include a £2mn gain on the first land parcel to be sold, and the directors expect to conclude all disposals within the next 12 months. They are also selling off a £2mn investment property in Fareham.

Admittedly, the group’s top nine shareholders control 69 per cent of the 15.5mn shares in issue, so the shares are tightly held. However, they are well worth buying as they will either re-rate or attract predatory interest at a significant share price premium that more accurately reflects CML’s growth profile. Buy.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com. The books are priced at £16.95 each plus postage and packaging (P&P) of £3.95 [UK], or both books can be purchased for the promotional price of £25 plus P&P of £5.75.