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Has £180 million small cap Luceco (LSE:LUCE) achieved a stable platform in electrical accessories to capitalise on expansion of LED?
Luceco gets tagged as an LED lighting group, although, as yet, its first-half 2019 results showed 84% of operating profit deriving from wiring accessories versus portable power around 13% and LED lighting sub 3%. In September 2017 it did however acquire Kingfisher Lighting – a longstanding name in exterior lighting e.g. in roads and streets – for £9.75 million to augment "Luceco LED".
Such technology ought to have good long-term prospects given its low energy demands in a climate-conscious society where smart lighting (options beyond a simple on/off switch) is expanding.
Warrants more a cyclical or growth rating?
Despite a long-term growth angle, accessories' demand from consumers and businesses is currently the chief driver for revenues, and subject to the economy. Luceco's stock rating is also affected by how well management navigates factors such as exchange rates and copper prices, given it manufactures in China. So, even if LED demand takes off, a growth price/earnings (PE) ratio towards 20x looks optimistic.
Luceco is fully listed on the London Stock Exchange, although its relatively short history includes the kind of episode found more commonly on AIM. The company floated three years ago at 130p a share and a year later tested 270p. The price then slumped after a trading update revealed inventory mis-valuation where the Chinese yuan had strengthened and the pound fallen.
Not only did the financial controller resign, but three weeks earlier the CEO had sold 2 million shares, "principally to settle tax liabilities", at 234.5p, despite continuing to own 31.4 million. It all meant a chronic festering of sentiment that took until early this year to improve.
Currency risks now appear significantly mitigated
A hedging policy was beefed up such that 75% to 95% of exposure is nowadays hedged (according to timescale) to reduce the risk of adverse shifts. Some 40% of group revenue is denominated in US dollars (although a loss-making US operation was sold in 2018) and 75% of cost of sales in Chinese Yuan. Pledges were also made towards internal efficiency savings and overhead reductions, to restore margins to respectably high single digits.
So, I drew attention to Luceco shares as a 'speculative buy' at around 90p in February 2018, targeting a return to at least 130p given Luceco's otherwise strong market positions and free cash flow strengths.
I was wary at the extent Luceco could resist the economy turning down, hence Brexit uncertainties complicated a view. The September 2018 interims struck a £3.1 million operating loss on flat turnover around £75 million, as commodity inflation and exchange rates conflated with a decline in UK consumer-facing retail. The UK has represented circa 80% of group revenue versus 11% for Europe and 9% rest-of-world.
With a broad stock market slump in the second half 2018, the stock had fallen as low as 35p by year-end, and I felt cynical at a rise to 50p last January before an end-January update asserted "in line" trading.
So, I missed that turning point, although a repeated message of "in-line" together with restored margins drove a rally to my 130p target by last June. The stock then relapsed below 70p over the summer, reinforcing the sense of a cyclical stock more volatile than the market.
Source: TradingView Past performance is not a guide to future performance
Curiously mixed UK trading amid the Brexit malaise
The narrative has shifted somewhat towards resilient UK consumer demand versus slower uptake from professional customers. Might the proliferation of different gadgets nowadays within households, with wi-fi in every room, be driving this?
Luceco's chief "accessories" side includes switches, sockets and circuit protection. Otherwise, the chronically weak housing market isn't much of a stimulus for an electrics makeover after a house move.
Anyway, the first half of 2019 saw group revenue up 7% at constant exchange rates to £82.7 million, with operational improvements turning a £3.1 million like for like operating loss into a £7.0 million profit.
Management said the second half-year had started ahead of expectations, although a potentially disruptive Brexit meant the board was sticking to its full-year guidance. Obviously, a hard-exit from end-October was averted, but controversy rages as to the economic results of implementing Brexit.
Buyers may have pushed the stock back up to around 110p in a sense that management is now prone to conservative guidance, given scars of the recent past. It could also be speculation about how a Brexit withdrawal agreement has been finalised and election polls continue to suggest a Conservative majority to implement it – i.e. a sense of "buy domestic equities including cyclicals".
If forecasts are fair - for £11.3 million net profit this year, rising to £13.5 million in 2020 – then the prospective PE is around 15 times, reducing to 13x on a normalised basis. So, it is pricing in a fair extent of recovery, while consensus for a 1.8p dividend in respect of this year, rising to 2.2p in 2020, supports confidence in cash generation, although a sub-2% yield is no support if Brexit results in a weaker economy.
|Luceco - financial summary|
|year-end 31 Dec||2013||2014||2015||2016||2017||2018|
|Turnover (£ million)||65.6||82.3||103||134||168||165|
|Operating margin (%)||9.0||10.3||11.1||8.9||8.5||3.0|
|Operating profit (£m)||5.9||8.4||11.5||11.9||14.2||4.9|
|Net profit (£m)||1.3||4.5||5.8||6.6||10.0||1.5|
|IFRS3 earnings/share (p)||0.8||2.8||3.6||4.6||6.2||0.9|
|Normalised earnings/share (p)||0.8||2.8||3.6||5.9||6.5||2.7|
|Operating cashflow/share (p)||4.4||0.9||4.6||1.8||10.7||7.7|
|Capital expenditure/share (p)||1.6||2.3||3.3||5.3||6.4||3.1|
|Free cashflow/share (p)||2.8||-1.4||1.3||-3.5||4.3||4.6|
|Covered by earnings (x)||15.3||7.8||1.6|
|Net Debt (£m)||36.7||42.5||46.1||29.5||37.2||32.2|
|Net assets per share (p)||-9.9||-4.8||2.6||32.8||40.0||41.2|
|Source: historic Company REFS and company accounts|
Ambitious balance sheet albeit not stretched
June's balance sheet showed a restructuring where £40.8 million short-term debt had become £38.5 million longer-term, offset by £5.2 million cash. It meant the interim finance expense reduced from a total £2.2 million to £1.7 million, although in 2018 there had also been £0.3 million finance income. It put net gearing at 80%, where net assets were comprised 55% by intangibles (the premium paid to net asset values when making acquisitions).
Management said it had achieved a return to target leverage and, indeed, the cash flow statement cited £2.3 million spent buying back shares, additional to £0.9 million going out as dividends, conveying belief in headroom.
With hindsight I was premature with my 'buy' call in 2018 and too cautious earlier this year to re-iterate it. Quite whether that's all down to me or a reflection of how Luceco operates in a quite capricious context: as a relatively small company on the international scale, and where demand can fluctuate.
I think it has potential as a long-term tuck-away, assuming the LED lighting side can grow in significance. Moreover, its return on capital of 18% and on equity of 26% flags a decent business financially, in addition to high single-digit margins.
Insider buying post interim results
My positive stance is backed up by director deals last September when a non-executive bought £18,283 of Luceco shares at 80.76p and his partner £10,000 worth at 80p. The chief financial officer's partner also bought £12,588 worth at 97p and the CEO added £3,600 at 93p, albeit as part of an incentive plan.
I should point out, however, that while lighting represented 31% of interim revenue versus 41% for wiring and 25% portable power, its adjusted operating margin was a paltry 1.6% (even if an improvement on losses in 2018). A way to go then before Luceco LED can be rated a growth entity. I also wonder if this hints that LED lighting is already highly competitive.
Assuming there's a Conservative majority and Brexit can be more competently expedited, then I think the stock is a 'buy', and one to average into, anticipating at least some easing in UK uncertainties. In a hung parliament, the rating might slip to 'hold'.
So, take action significantly as to your political expectations and on Brexit. Broadly, and for the long term, I maintain: Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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