Interactive Investor

Follow the money to cash-rich Dewhurst

19th January 2018 17:19

Richard Beddard from interactive investor

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I'm pretty nonchalant about profit growth. If return on capital is high and a company is managed equitably, I take a leap of faith and assume growth will follow almost as surely as night follows day. That may be about to change (not night following day, my attitude).

I'm pretty sure this policy works in aggregate. Highly profitable companies earn lots of money, which they can generally invest at high rates of return earning lots more money. The cycle repeats itself and the profits compound.

Yet Dewhurst, which has earned an average return on capital of 19% since 2011, has only grown revenue and adjusted after-tax profit at a compound annual growth rate of about 4%.

The year 2011 isn't a particularly flattering date to choose. By extending the measurement period back so it encompasses the Credit Crunch, Dewhurst's growth rate actually improves to 5%. That's because it was particularly profitable immediately before and during the financial crisis when, as a manufacturer of components for lifts, primarily, it may have benefited from the tail end of a construction and refurbishment boom. While the economy was in the doldrums in 2009 and 2010, projects agreed in happier times were still being completed.

With 19% more money to invest each year, shouldn't Dewhurst be growing faster?

Not necessarily. Growth doesn't just depend on how profitable a company is. It depends on how much of that money it chooses to invest to make more profit, its reinvestment rate.

We can estimate the reinvestment rate by comparing how much extra a company invests over a period to how much it earned during that period. Dewhurst used less than £5 million more operating capital at the end of September 2017 than it did in 2011, a period in which it earned nearly £32 million. By this crude measure, Dewhurst reinvested only 15% of its profit.

So what's it doing with the rest of the money? There are only really four options, it can invest in other companies, pay off debt of one kind or another, return money to shareholders or stockpile it. Dewhurst's doing all four.

I haven't included acquisitions in my calculations. Dewhurst has made some modest acquisitions, which we can add to the capital invested to give a total reinvestment rate of 25%.

Dewhurst's also paid dividends. I don't track dividends, but according to SharePad, Dewhurst's has paid a little over 20% of profit as dividends on average, which means investment and dividends probably account for around 45% of the cumulative profit.

Some of the remaining profit has been paid into the company's pension scheme at a rate of about £1.4 million a year (£9.5 million in total). It's a defined benefit pension scheme, which means Dewhurst must invest enough money to provide a predetermined level of pension to staff when they retire.

According to the actuaries, it hasn't, the obligations of the scheme were worth £11 million more than its assets at the end of this year. It's actually put more into the pension fund to plug the deficit, about 30% of the cumulative profit, than it has invested, which with investment and dividends accounts for about 75% of cumulative profit.

Dewhurst hasn't used the remaining 25% or so. It's languishing as cash in its bank accounts. Between 2011 and 2017, Dewhurst added more than £13 million to its cash balance which at the end of September stood at over £18 million (it has no debt). That £13 million increase in cash is 40% of the £32 million cumulative profit in the period, however the cash figure is overstated (one of the reasons my very rough and ready figures add up to 115%!) It includes, for example, cash from the sale of Dewhurst's former HQ in 2012, which is excluded from the cumulative profit figure.

One question leads to another: If Dewhurst is so profitable cash is oozing out of the accounts, why hasn't it invested more?

One possibility is it can't find enough opportunities to invest at a high return on capital. Though it mostly supplies the lift industry, let's deal with two smaller lines of business, transport, and keypads first. Transport is mostly TMP, a manufacturer of bollards and road signage acquired in 2006. It has not grown convincingly since the first few years after acquisition and it has contracted since austerity put the mockers on local authority spending.

Dewhurst is also a supplier of keypads to a single company. It won't say who, but I believe it's NCR. Barring a couple of blips due to customer stockpiling, revenue from keypads has been fairly stable. However, Dewhurst says the increasing use of cash alternatives means its principal market, ATMs, may contract in future.

As the chart shows, most of the growth has and probably will come from lift components. The sharp rise in revenue in 2017 was, unfortunately, not due to strong demand for new products, it was due to the weak pound, which increased the value of Dewhurst's overseas revenue. The acquisition of a small Australian company that designs and manufacturers lift interiors also boosted revenue.

Dewhurst faces challenges in the lift market as well. It's reputation is founded on pushbuttons, which it sells loose, but pushbuttons are being replaced in some lift car operating panels by LCD displays. Dewhurst has responded by broadening its range, making whole operating panels, hall lanterns (that light up to tell you a lift has arrived), and monitoring systems that report faults, for example.

It's also acquired companies that manufacture, supply and fit lift interiors, services often bought in tandem with the fixtures. This seems to be a more successful strategy in Australia than in the USA, where Dewhurst's loss-making ERM subsidiary is exiting the lift interiors business.

My impression is Dewhurst has to work hard to find opportunities to grow, because pushbuttons, like keypads, are old tech. and though they're still used in lifts, it must diversify into less familiar markets or whither slowly.

Dewhurst might also be hoarding cash to service the pension fund. But as the cash balance soars above even the pension deficit, the compulsion to accumulate more and more cash must surely dissipate.

This write up of Dewhurst presents a more negative picture of Dewhurst than my previous articles. It describes a company hamstrung by changes in its markets, and its pension scheme. Arguably management has done well to keep it growing.

I'd rather Dewhurst grew faster, but I think it's a reasonable investment even if it doesn't. The earnings yield, a measure of what you might get if Dewhurst were to return all its profit to shareholders, is 9% of what you'd pay to own the business at the current share price.

But Dewhurst's investing or returning less than half the money its earning. Once the pension scheme is fully funded, or perhaps sooner, it has the potential to do more. The question is, will it find opportunities to invest and grow? Will it squander the money? Or will it return it to shareholders.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard

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