A key indicator of a company’s ability to create shareholder value is how its return on investment (ROI) compares with its cost of capital. The trick is to identify companies that are growing organically, and cover the blended cost of debt and equity to deliver an excess return.
A good example is Northbridge Industrial Services (NBI:176p). Having sold off its non-core Tasman tools drilling operations, the group is focused on Burton upon Trent-based Crestchic, a fast-growing business that manufactures, sells and rents load banks and transformers to domestic and international customers for the commissioning, testing and maintenance of independent, off-grid power sources.
The accelerating transition from fossil-based energy sources towards cleaner renewable energy (12 per cent of sales) is leading to a proliferation of smaller energy generators whose sites require commissioning and connection into distribution networks. This is driving higher demand for testing both the primary and backup generators to ensure the resilience of supply. Northbridge is a major beneficiary.
The group is also expanding its geographic penetration and range of products and services supplied to the rapidly growing data centres market (30 per cent of sales). Crestchic’s rental revenue surged a third in 2021, and it plans to invest £4mn in its hire fleet this year.
Crestchic buoyant demand drives upgrades
- Annual revenue up 20 per cent to £29.5mn
- Underlying pre-tax profit surges eightfold to £3.3mn (10 per cent beat)
- Analysts at Equity Development upgrade 2022 and 2023 EPS estimate by 12 and 11 per cent to 12.4p and 13.8p, up from 9.3p in 2021
- Annual dividend of 1p a share expected to double in 2022
- Cash from disposal of Tasman Drilling to be recycled into new hire rental fleet and factory expansion
Such is demand for Crestchic’s load banks that the group started the year with a record order book of £8mn and is scaling up manufacturing capacity by 60 per cent. The 25,000 sq ft expansion of its Burton-on-Trent facility completes in June and means that current lead times of 22 weeks could be halved by the year-end.
The benefit of longer than average lead times is that management can factor in higher input costs in the prices charged to customers in a tight market. The inflationary backdrop is working in the group’s favour, too, given that Crestchic has a £6mn hire fleet that cost £30mn (and is insured for £40mn). Disposals of hire fleet equipment is regularly at double book value, or more.
So, with revenue from higher margin hire rentals surging to account for £15.5mn of annual revenue of £29.5mn, gross margin improved from 44.9 to 47.2 per cent which, on a relatively fixed cost base, resulted in underlying operating profit soaring from £1.8mn to £3.8mn. That equates to an 18 per cent ROI, well above Northbridge’s 12.5 per cent cost of capital. It doesn’t take a genius to work out the returns to be made by recycling £4.5mn disposal proceeds from Tasman into additional hire fleet capacity and the £2.2mn manufacturing facility expansion.
During our results call, chairman Peter Harris also highlighted the group’s expansion plans. For instance, Crestchic has signed a lease on a new rental depot in Texas and has a supply agreement in place with a US manufacturer, Mosebach, for the purchase of a fleet of smaller load banks targeted specifically at data centre testing. Importantly, demand for the sale of equipment into the USA remains robust, thus offering additional growth opportunities as manufacturing supply constraints from the UK ease with the factory expansion.
The shares are up 40 per cent since I initiated coverage ('Alpha Report: A high-growth play on the battery storage boom’, 7 September 2021), and have outperformed the FTSE Aim All-Share index by 18 per cent since my last article (‘High-growth play on decarbonisation, battery storage and data centres’, 1 0ctober 2021). I expect the outperformance to continue, so much so that I am lifting my target from 200p to 220p which equates to a 2023 price/earnings (PE) ratio of 16. Buy.
Spike in whey price weighs on Supreme
- Annual revenue in excess of £130mn and cash profit of £21mn in line with analyst estimates
- General cost pressures and commodity price inflation within sports nutrition and wellness lead to analyst earnings downgrades for 2022/23 financial year
The pre-close trading update from Supreme (SUP:159p), a distributor and manufacturer that sells a range of products to discount retailers and supermarkets (B&M, Home Bargains and Poundland are all customers), has not been well received.
As expected profits hit forecasts for the 12 months to 31 March 2022, but news that general cost pressures combined with commodity price inflation within the group’s sports nutrition and wellness unit (12 per cent of estimated revenue) is impacting profitability sent the share price down 16 per cent. It’s a massive overreaction.
Supreme’s vaping brand, 88vape, the market leader in the UK with a 30 per cent market share, delivered 10 per cent sales growth in the latest financial year to account for a third of group revenue and an estimated 53 per cent of gross profit (Equity Development forecasts). The performance was buoyed by new listings in Sainsbury’s and Morrisons, as well as ongoing organic growth across other discount retailers. The directors are guiding investors to expect the double-digit growth for this category to continue.
The group’s batteries and lighting divisions showed their defensive qualities, delivering single-digit revenue growth and on better gross margins, too, a reflection of wider breath of distribution and enhanced buying power. Supreme sells globally-recognised brands such as Duracell, Energizer and Panasonic, and supplies lighting products exclusively under the Energizer, Eveready and JCB licences across 45 countries. Combined these two segments account for a third of group gross profit.
They are hardly discretionary spend either. If anything, the cost of living crisis should drive more customers to discount retailers to save on their retail purchases. The same is true of 88vape, which retails for 100p a bottle, or a third of the average price for competing products.
Admittedly, the 46 per cent spike in the cost of whey protein concentrate in the 12 months to end January 2022, and general cost inflation (transport and wages) led analysts at Equity Development to rein back their cash profit estimates from £24mn to £22mn on 4 per cent higher revenue of £136.5mn for the 12 months to 31 March 2023. However, adjusted pre-tax profit and earnings per share (EPS) will still both increase 8 per cent to £19.3mn and 13.5p, respectively, thus underpinning forecasts of a 7.3p a share pay-out.
On this basis, the shares are rated on a forward PE ratio of 12 and offer a prospective dividend yield of 4.6 per cent. The £8.4mn cost of the dividend is covered more than two times by £17.9mn (15.5p a share) of estimated free cash flow, with surplus cash set to wipe out net debt completely.
I first suggested buying the shares around 200p (Alpha Research: ‘Tap into a discount cash generator’, 27 May 2021) and reiterated that advice last summer ('Backing a retail cash generator', 21 July 2021). The share price got within pennies of my 250p target at the start of this year. The de-rating since then is overdone given that activities accounting for 88 per cent of group revenue continue to perform well. Recovery buy.
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