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Plug into Ricardo's electric growth

The engineering group’s shares have suffered in recent times, but its prospects are tied to a number of compelling growth trends
September 20, 2018

Electric vehicles, renewable energy, managing pollution: what's not to like about a company positioning itself to take advantage of all these long-term trends? Well, in the case of engineering consultancy Ricardo (RCDO), the answer: is a profit warning in July; the large portion of revenue based on the testing of carbon-spewing internal combustion engines; and order disruption caused by Brexit, the diesel emissions scandal and tough new European regulations. However, we think the negatives are distracting investors from the longer-term opportunity for the company. What's more, a jump in order intake following a tough second half to its recently completed financial year suggests buyers may not have to wait too long to wait for the wider market to reassess the company's prospects and potentially re-rate its shares from depressed levels.

IC TIP: Buy at 824p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points

Orders growing
Supportive long-term industry trends
Cash performance improving
Cheap against history

Bear points

Automotive industry under pressure
Recent profits warning

Ricardo's work covers consulting and manufacturing products across a range of areas, including transport, security, energy, resource management and waste, all of which are undergoing profound change as they prepare for the future. The group’s largest geography, the UK, and its largest sector, automotive, have been challenging in recent times. Lower confidence in the UK economy following the Brexit referendum has led to slower domestic order intake. The UK accounted for 34 per cent of the group’s orders in the year to June 2018, down from 47 per cent in the previous year.

Separately,  Europe's introduction of the Worldwide Harmonised Light Vehicle Test Procedure, a tightened emissions standard for new cars built from September 2018 onwards, has impacted the automotive sector and exacerbated challenges created by the diesel scandal. 

All this has negatively impacted sentiment and contributed to July's profit warning, but reasons are emerging to feel more positive. As the UK has flagged, order intake has risen across the group’s other regions, with Asia accounting for the most significant increase, and now respresenting 27 per cent of the total, which is on par with mainland Europe. Meanwhile, automotive orders have continued to grow, ending the 12 months to mid-2018 up almost a quarter at £144m. Overall order intake rose 13 per cent to hit a record £413m, while the order book was 16 per cent ahead at £288m.

The company has historically been a big player in the development and testing of combustion engines, which is widely regarded as being in a state of long-term decline. However, it is evolving with the automotive industry. As electrification becomes a more prominent theme, Ricardo has shifted focus and associated orders intake accounted for 21 per cent of the total last year, compared with 17 per cent the year before.

Demand for this type of work is strong in Asia, but the company also saw growth among tech companies on the west coast of the US, many of whom are new to the car market. Underlining the shift away from combustion engine-focused parts of the market, Ricardo recently completed a restructuring, selling two of its engine testing facilities in Germany and Chicago.

Outside of automotive, strong growth in the rail industry has boosted the group. Order intake here accounted for a fifth of last year's total and was up 12 per cent in the year, thanks in part to a rail assurance project the group won in Taiwan, one of its largest ever. As with automotive, much of the growth in the rail sector is coming from Asia, as governments invest in improving transport both within and between cities. In the UK, an increased regulatory focus on innovation has created opportunities in the energy and environment business, as the UK’s water companies gear up for the coming five-year asset management period. That said, taking on staff in anticipation of an uptick in growth last year that didn't materialise weighed on performance.

Cash generation has been an area of concern for the company historically, but efforts to address it had encouraging results. Management has been focusing on working capital management and this helped Ricardo reduce net debt by £11.8m in the year to £26.1m.

RICARDO (RCDO)   
ORD PRICE:824pMARKET VALUE:£440m
TOUCH:816-824p12-MONTH HIGH:1,085pLOW: 740p
FORWARD DIVIDEND YIELD:2.9%FORWARD PE RATIO:12
NET ASSET VALUE:330*NET DEBT:15%
Year to 30 JunTurnover (£m)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
201633237.757.018.1
201735238.355.619.3
201838039.057.120.5
2019**39641.559.221.9
2020**42847.968.223.6
% change+8+15+15+8
Normal market size:500   
Matched bargain trading    
Beta:0.09   
*Includes intangible assets of £97.2m, or 182p a share ** Jefferies forecasts, adjusted PTP and EPS figures