The numbers look promising at face value, but our companies analyst is not entirely convinced.
Have shares in the near £500 million power products group Volex (LSE:VLX) reached a nadir after a 43% drop in three months, with potential to rebound?
Its items support electric vehicles, a division said to be growing at over 200% in last November’s interims (covering 26 weeks to 3 October). Consumer electrical is up 74% over the period, benefiting from increasing numbers of new devices; medical equipment is up 15% as Covid abates and access to hospitals improves; and complex industrial technology has seen mixed sales.
Technology would seem to guarantee a mercurial narrative with occasional setbacks, but Volex’s markets look attractive overall – as affirmed by Nat Rothschild, a scion of the legendary banking family, who owns 26% of the company and has buckled down as executive chairman to make Volex a long-term success.
New credit facility to capitalise on growth prospects
Interim results to 3 October proclaimed “strong trading and strategic progress with investment in growth”.
Last Monday, Volex announced that it had effectively tripled a credit facility to $300 million (£220 million) to support its “ambitious growth strategy based on organic investments and acquisitions”. This was accompanied by reassurance about “successfully navigating the current supply chain challenges while demonstrating our ongoing ability to pass through inflationary cost increases”.
Then on Tuesday, the CFO bought £5,000 worth of shares at around 279p, which helped the price continue rising from 270p at the start of this week to over 300p. It has since slipped back to 280p while a short-seller remains active.
This followed news of 357,500 nil-cost options awarded to the top three directors, which attracted criticism – of “a multiplier up to 2.5x” to be applied to the awards, if the stock doubles over three years. That implies the stock only has to rise 10% from last September’s 490p high, to about 540p.
A cynical view would be: yes, option schemes put directors and shareholders in different boats; but do not lose sight of the fact that the board believes the stock can rise materially from the price at which those schemes are struck.
Other industrial technology stocks have de-rated lately
Undoubtedly, Volex has been caught up in general fears about higher input costs and supply chain delays. For example, the near £9 billion Spirax-Sarco Engineering (LSE:SPX) has a very similar recent chart and is down 29% since last November.
Some such stocks had looked fully valued or overvalued by last autumn: I recall Volex trading at over 20x projected earnings, and even after de-rating to £12 Spirax is on 35x. So there is an element of mean-reversion happening too; the question is whether that trend has – selectively – gone too far.
While Volex says it is coping with, for instance, higher copper prices and supply challenges, its interims did note slightly lower margins given a time lag in passing on price rises. The gross margin was also slightly affected by “more simple products and foreign exchange movements”.
The six-year table does however show consistent growth in the annual operating margin, which was over 7% at the interim reported level and over 9% on an underlying basis.
A 17% rise in underlying operating costs was due to investment, and also to marketing. It is tricky to decipher what is required merely to stay competitive as technology advances, and what may imply value creation.
But if Volex is on course to meet consensus for $40.4 million net profit in its current year to 4 April, that equates to EPS of around 19p, and therefore a near-term PE near 15x.
Acquisitions blur the real rate of organic growth
This, I believe, is the dilemma in the perception of Volex. Some investors will respond positively to the reported “underlying” revenue and earnings growth; others will wonder at the extent to which acquisitions are providing a boost.
Reporting in US dollars, interim underlying pre-tax profit rose a respectable 22% to $25 million, on revenue up 45% to $293 million. EPS growth was just 8%, however, despite the number of issued shares growing by only 2.5%.
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The interim dividend rose 9%, which affirms cash generation, and the table does show strong free cash flow in the last two years.
True, Volex is of a size where most plcs’ income statements and notes do not distinguish organic performance from the contribution of acquisitions. Moreover, takeovers do make sense here, in that they contribute towards competitive advantage.
Last January, two acquisitions in Mexico and Canada were completed for £13 million equivalent, enhancing capability in the key US market. They follow last autumn’s acquisition of a US manufacturer of printed circuit boards serving the defence and medical markets. North America is justifiably a strategic priority. But you cannot be sure of organic performance.
European acquisition contributed all interim profit growth
Note two, on geographic analysis, showed profit from Europe jumping 123% to $15.2 million, on revenue up by 125% to $100.9 million. This was due to the February 2021 acquisition of DE-KA, a leading power cord-with-plug manufacturer, for £52 million equivalent.
Volex did cite interim growth across its medical, industrial and electric vehicle markets, albeit chiefly from revenue.
In the US, revenue rose 30% to $121.2 million while profit was nearly flat at $9.9 million. This was despite “some of the strong growth we experienced” coming from electric vehicle customers; bulls say this area is a key hope going forward.
In Asia, revenue is chiefly derived from consumer electrical markets and rose 9% to $70.7 million. Profit fell 27% to $5.1 million.
Overall, it is a mixed picture, with “growth” at the half-way stage essentially rescued by an acquisition.
Volex - financial summary
Year-end 4 April
|Turnover ($ million)||368||320||322||372||391||443|
|Operating margin (%)||0.9||-2.1||2.7||3.5||4.4||6.9|
|Operating profit ($ million)||3.4||-6.6||8.8||13.0||17.1||30.7|
|Net profit ($ million)||-2.3||-7.1||3.9||9.2||14.7||38.9|
|EPS - reported (cents)||-2.6||-7.9||6.0||6.7||9.5||25.5|
|EPS - normalisted (cents)||1.7||10.0||8.4||10.1||11.6||27.4|
|Cash flow per share (cents)||2.0||17.9||5.3||-4.9||33.3||25.4|
|Capex per share (cents)||7.4||2.9||2.7||2.4||3.2||5.1|
|Free cash flow/share (cents)||-5.4||15.0||2.7||-7.3||30.1||20.3|
|Dividends per share (cents)||0.0||0.0||0.0||0.0||3.7||4.6|
|Covered by earnings (x)||0.0||0.0||0.0||0.0||2.5||5.6|
|Return on capital (%)||3.9||-9.5||12.9||10.5||11.6||12.0|
|Cash ($ million)||30.7||29.6||24.8||20.9||32.3||36.6|
|Net debt ($ million)||3.3||-11.3||-10.0||-20.6||-21.2||27.3|
|Net assets ($ million)||51.4||46.3||48.1||116||131||184|
|Net assets per share (cents)||56.9||52.1||54.1||79.6||86.2||118|
Source: historic company REFS and company accounts
Recent rise in trade payables
A further dilemma with Volex’s acquisitions is confusing the ability to compare working capital on a like-for-like basis.
Calculating trade payables or receivables as a percentage of turnover should be done against annual revenue; however, using interim revenue does at least highlight any change.
At 3 October 2021, trade receivables as a percentage of interim revenue were 38.0%, versus 34.9% in 2020; while trade payables against revenue rose from 23.7% to 29.8%.
A relatively greater increase in money due to suppliers looks to have followed from higher inventories. These were up 45%, in response to customer requests for more stock in customer hubs in the face of extended shipping times.
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That looks fair, but when companies with differing working capital profiles are brought into the fold, you cannot decipher whether profit might have benefited from letting trade payables rise.
So, while Volex bulls interpreted the raised bank facility as reason to celebrate – enabling more acquisitions, and implicitly an indicator that the banks were satisfied with Volex’s current trading – it was possible to sense greater scope for a blurred assertion of “growth”.
My disciplines say this stock can potentially rate “buy” if management publishes accounts showing like-for-like organic performance – and it stacks up.
GLG has recently disclosed a short position
This hedge fund went above the disclosed 0.5% level (of Volex’s issued share capital) on 8 February and has further sold short four times this month, up to 0.95% as of 15 February.
Implicitly, they reckon Volex is just another “buy-to-build” acquisition vehicle and investors are starting to see through it. But it has not reached a size where over-stretch is a concern, and Rothschild would be sensible to avert that.
The question is whether a growth rating is truly merited for tech businesses that appear promising yet could prove mercurial. It is up to Volex to show us the real money. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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