Shares in Volex (LSE:VLX), which makes critical power and data transmission products, remain currently weak despite yesterday’s update in respect of the first-half-year to 1 October declaring continued “strong financial momentum”.
Besides a modest equity valuation, I find Volex a potentially interesting telltale on the macro situation versus XP Power (LSE:XPP) in power-converted solutions. On 2 October, it had to warn of lower demand as customers deferred orders, hence a 10% fall in the order book.
Yet Volex remains optimistic about near-term sales opportunities and, so far at least, affirms market expectations for its year to April 2024, where $58 million (£48 million) net profit implies sterling equivalent earnings per share (EPS) of 25.7p, hence a forward price/earnings (PE) near 11 times with the stock currently at 280p. Quite whether a 14% advance in the April 2025 year materialises as expected remains to be seen, but it would imply a PE more like 9.5 times. So, either the market is correct to anticipate that Volex will succumb in due course, or the stock is mispriced.
It is down from 310p earlier this month before news of a hacking attack on its IT systems and data, which was not expected to have a material financial impact but was hardly helpful for a company pitching itself for dependable technology.
A chart context significantly influenced by macro change
This essentially takes the stock back to a sideways trend line from last May to August, if not levels since March 2022. Volex had a terrific run from around 150p in summer 2020, close to 500p in September 2021, as the financial summary table shows, with earnings re-rating (assisted by acquisitions) and the stock benefiting from speculation generally during Covid lockdowns.
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Its subsequent de-rating has been largely affected by the wider shift in expectations for interest rates – from ultra-low, as part of the response to Covid, to higher to tame subsequent inflation. This meant a shift in sentiment from “risk-on” to “risk-off” among small-caps, not necessarily reflective of their underlying financial condition. I would still respect how the market is (perhaps justifiably) pricing for a softer economic scenario going into 2024, even if broker earnings’ forecasts remain optimistic.
Resilient so far, but not wholly immune to change
Volex bills itself as “a robust and highly diversified business” sustaining its margins partly due to vertical integration (owning different stages of production), serving markets with “strong structural growth characteristics”.
The table shows the operating margin has grown progressively from 2.7% to 7.4% over the past six financial years, if shy of what you might expect of a genuine growth stock. Much still rests on its revenue remaining firm.
XP Power has some exposure to semiconductors, liable to be cyclical, whereas Volex makes power cables and bespoke electrical kit for an array of products such as electric vehicles, medical scanners, ventilators and laptops. Some £275 million power cords are sold each year, ranging from basic connections for irons and fridges, to complex cables enabling data centres to boost output while using less energy.
Yes, it is involved in “essential products in growth areas”, but if aggregate economic demand is reducing I would not be surprised to see this creep into updates and guidance. Serving electrical vehicles has been a boon, with the last annual results to 2 April citing 33% organic growth in this respect. However, reports now cite consumers stalling to buy, hence a glut of inventory, which may in due course temper assembly.
Those results also cited consumer electrical easing 3% due to lower input cost pass-through despite slightly higher volumes; while medical rose 16% amid continued strong demand.
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Principal customers are a bit elusive – on the record – however a 9 August announcement cited Tesla Inc (NASDAQ:TSLA) as a licensed partner for a North American charging system, Volex being a manufacturer of the coupler. Amazon.com Inc (NASDAQ:AMZN), Apple Inc (NASDAQ:AAPL) and Siemens AG (XETRA:SIE) are also thought to be involved; Volex’s global manufacturing offering them quality at a low price, and also cutting reliance on China.
A thoroughly improved, underlying risk/reward profile
Volex’s 20-year chart is a roller coaster but since banking scion Nat Rothschild took a 25% stake in 2015, becoming executive chair soon after, he has honed operations.
His timing was astute: while Volex soared from 20p at end-2008 to 365p in early 2011, it had plunged back to 30p by mid-2016.
I would still mind how financiers tend to favour corporate development by acquisition and a smaller group like this does not break down its accounts to show their contribution. Such a strategy is justifiable but if further acquisitions were to stall in an increasingly difficult economy, then mind it is going to affect group numbers.
More positively, the later stages of any recession are usually optimal for takeover pricing (assuming company owners are content to sell), which could also apply to Volex becoming a target itself.
This last summer, a leading Turkish manufacturer of leading wire harnesses for the off-highway sector was acquired for an initial £118 million (helped by a £60 million placing at 275p), hence it is likely to prop earnings, having made £29 million equivalent operating profit in 2022.
As of last 2 April, balance sheet cash had been £23 million yet despite net cash from operations trebling near £56 million, investment swallowed £30 million and borrowings’ repayment a further £35 million. Equity dilution was therefore required to make the Turkish acquisition, albeit said highly complementary and earnings-enhancing in the first year of ownership.
Volex - financial summary
Year-end 2 Apr
|Turnover ($ million)||368||320||322||372||391||443||615||723|
|Operating margin (%)||0.9||-2.1||2.7||3.5||4.4||6.9||6.7||7.4|
|Operating profit ($ million)||3.4||-6.6||8.8||13.0||17.1||30.7||41.0||53.8|
|Net profit ($ million)||-2.3||-7.1||3.9||9.2||14.7||38.9||30.4||36.8|
|EPS - reported (cents)||-2.6||-7.9||6.0||6.7||9.5||25.5||18.1||22.1|
|EPS - normalised (cents)||1.7||10.0||8.4||10.1||11.6||27.4||20.4||24.9|
|Cash flow per share (cents)||2.0||17.9||5.3||-4.9||33.3||25.4||11.0||33.4|
|Capex per share (cents)||7.4||2.9||2.7||2.4||3.2||5.1||9.0||11.0|
|Free cash flow/share (cents)||-5.4||15.0||2.7||-7.3||30.1||20.3||2.1||22.5|
|Dividends per share (cents)||0.0||0.0||0.0||0.0||3.7||4.6||4.7||1.6|
|Covered by earnings (x)||0.0||0.0||0.0||0.0||2.5||5.6||3.8||13.8|
|Return on total capital (%)||3.9||-9.5||12.9||10.5||11.6||12.0||12.3||15.3|
|Cash ($ million)||30.7||29.6||24.8||20.9||32.3||36.6||29.1||22.5|
|Net debt ($ million)||3.3||-11.3||-10.0||-20.6||-21.2||27.3||95.3||104|
|Net assets ($ million)||51.4||46.3||48.1||116||131||184||201||225|
|Net assets per share (cents)||56.9||52.1||54.1||79.6||86.2||118||127||142|
Source: historic Company REFS and company accounts.
Prospects for the US economy will be very significant
Reporting in US dollars is appropriate given the US comprises 47% of group revenue versus 29% from Europe and 24% Asia. Holding Volex equity, therefore, quite assumes you believe the US can avoid recession.
My stance remains on how higher interest rates may only be at the early stage of exacting a toll on activity. Rates may stay higher for longer, especially if oil strength keeps inflation sticky like we saw for the UK in September. On the other hand, some economists already say that if conflict spreads in the Middle East then central banks will cut rates to manage yet another crisis. It is not impossible, but if they are serious about restoring 2% inflation while energy prices remain elevated, I find it hard to envisage rates falling soon.
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The upshot for major economies and demand is, I believe, the chief reason why Volex is rated modestly relative to its reporting.
Despite an apparently cheap PE multiple, the expected dividend is only about 4.5p a share – equivalent to a circa 1.5% yield, hence little prop should the earnings scenario become challenged. The stock also trades at nearly three times book value where goodwill/intangibles comprise 53% of net assets (reflecting historic acquisitions).
Another example why AIM is not simply a gambling den
Like I recently mentioned with regard to telecoms’ software group Cerillion (LSE:CER), there are jibes, with AIM stocks being very high risk, yet Volex exemplifies how this market includes businesses of proven substance.
Last 22 September, for example, Investec declared a 5.4% stake (albeit it could have been close to the 3% disclosure threshold) implying that it sees value at current pricing. I believe, however, that the stock remains a test of whether “cheap on earnings” at the early stage of a possible slowdown is more like fair pricing. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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