Interactive Investor

Stockwatch: Post-IPO plunge offers scope for recovery

6th February 2018 09:20

Edmond Jackson from interactive investor

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Has £150 million LED lighting, wiring and portable power equipment group Luceco just had its eye briefly off the ball? Or does a two-thirds slump in its market value – with a profit warning only three weeks after the chief executive sold £4.7 million worth of shares – portend more bad news? Luceco has wider relevance, whether to trust published fundamentals or the market.

The 24 November 2017 sale by John Hornby was declared "principally to settle personal tax liabilities" and represented only 6% of the CEO's stake. He's agreed not to sell any further shares for six months.

On 15 December, the company then revealed weaker gross margins in the second half due to an incorrect assessment of stock, and the financial controller had resigned. Currency exchange rate movements were cited, saying hedging activities will increase, especially regarding the Chinese renminbi, where Luceco manufactures.

Page 12 of the October 2016 flotation prospectus cited 61% of cost of sales and 19% of overheads relating to the group's operations in China. The warning thus begged various questions about control of the Chinese arm: the CEO damned if he did know (and sold shares), but also if he didn't keep tabs.

Let's get this in overall perspective

Luceco is a company showing quite diversified organic growth across LED lighting products, wiring accessories, portable power equipment and home entertainment.

A business school would likely give this a tick for managed diversification with strategic focus, to offset volatility within segments. When the company floated at 130p the prospectus did cite exchange rates among key risk factors.

The stock proceeded to soar 80% in market value to a forward price/earnings (PE) of about 30 times, a mid-May 2017 update citing progress "marginally ahead" of expectations.

Possibly it was typical mature bull market sentiment, where new small-cap stocks get overblown, the sell-off similarly going too far - just lately around 90p, up from a 70p low, with volume spiking as if an institution has capitulated.

Yet, fundamentally, Luceco is not the kind of company that's engaged years of debt-driven acquisitions, where directors' selling is most pertinent. AIM-listed Boohoo.com warned on sales only nine months after listing, then saw its shares trashed before multiplying 12-fold as profits soared.

Mike Ashley was also pilloried for selling stock in Sports Direct when it floated in 2007, only to warn a few months later, but which proved a buying opportunity. Business can be inherently uncertain.

Although AIM-listed Photonstar doesn't inspire

A dilemma for perception, now that Luceco has warned, is a troublesome profile at Photonstar LED Group – well off the radar to most investors, at 0.48p and capitalised at just £1.07 million after the stock has declined from 9.75p in 2014.

Annual revenue declined from £9.4 million in 2013 to £5.3 million in 2016 when it struck a £1.5 million pre-tax loss. 2017 reporting twice declared: "the board views the future with increased optimism", and the price did spike to 3.03p last spring, albeit now at an all-time low.

This company is engaged in LED lighting fixtures and drivers, also control solutions, in commercial and residential situations. The LED story has thus yet to prove bountiful for investors.

Company broker cuts forecast by 20%

Numis responded to the 15 December warning of a £3.5 million hit to after-tax profit in 2017 – implicitly a 21% shortfall at the pre-tax level – by also taking 20% off its 2018 numbers (updated in the table in this article). The sense is for an impact in the current first half-year then margin recovery, assuming Luceco can pass on price rises.

This puts the stock on a single-figure PE if it can prove a 2018 scenario of pre-tax profit rising over £20 million. At flotation, the management estimated a £1 billion UK market for LED lighting alone, versus Luceco's circa £150 million annualised revenues (currently).

Interims to end-June 2017 had shown revenue and operating profit both up 25%, chief drivers being LED lighting up 22.4% to £17 million, wiring accessories up 13.6% to £34.9 million and portable power up 52.2% to £20.2 million. This was organic growth, especially new products, on a stable operating margin of 11.9%, with the UK representing 83.3% of revenue and the rest well-spread internationally.

Luceco - financial summary           Broker estimates 
year ended 31 Dec   2013 2014 2015 2016 2017 2018
             
Turnover (£ million)   65.6 82.3 103 134
IFRS3 pre-tax profit (£m)   2.2 5.5 8.3 12.2
Normalised pre-tax profit (£m)   2.2 6 8.3 14.8 16.5 21.0
Operating margin (%)   9.1 10.9 11.2 13.2
IFRS3 earnings/share (p)   0.8 2.8 3.6 6.7
Normalised earnings/share (p)   0.9 2.8 3.7 8.5 8.2 10.5
Earnings per share growth (%)     231 29.9 134 -3.9 28.0
Price/earnings multiple (x)         10.6 11.0 8.6
Annual average historic P/E (x)         41.4 25.6 14.5
Cash flow/share (p)   2.6 -1.3 2.4 -0.2
Capex/share (p)         5.4
Dividend per share (p)           1.7 2.1
Yield (%)           1.4 1.8
Covered by earnings (x)           5.0 5.0
Net tangible assets per share (p)         15.8

Source: Company REFS

Mind an aspect of capitalised costs

Bear traders tend to seize on capitalised costs within accounting, although it's a quite regular technology plc "sin" and only moderately enhances Luceco's profit. The portion still rose from 9.8% of 2016 annual pre-tax profit to 14.8% in the first half of 2017; and there isn't much explanation beyond note 10 to the interim accounts:

"Intangible assets comprise development expenditure capitalised..." thus pushing up intangibles (albeit no acquisition-related goodwill) on the balance sheet to £13.7 million or 32.2% of net assets. It's material but not excessive.

Elsewhere, on the balance sheet, net debt has reduced from £47.9 million at end-2015 to £29.4 million at end-2016 (helped by circa £25 million flotation proceeds) and £26 million as of last June – the interim net interest charge covered 10.6 times by operating profit. Trade payables were 1.2 times trade receivables at end-June, but nothing like 1.7 times at Carillion which notoriously delayed suppliers' payments.

How will Luceco perform in a UK slowdown?

I'd say this is the chief unknown than a deeper malaise linked to the share sale. LED lighting is quite controversial; some people complain about light quality and bulbs being unreliable, although failures may imply a tweak required to a building's transformer.

Certainly, the cost of bulbs has come down, and their market has become more competitive. But Luceco has read the market to weight this division more towards fittings. Note 2 "segmental review" to the interims cited an expected change in the "LED Lighting" product mix with bulbs declining but higher margin fittings up 60%. Even so, what if the housing market continues to slow, also re-fits e.g. of offices and the like?

Principal directors still own sizable equity

Selling by the chief executive means that in total, since before the flotation, he and his wife have reduced exposure from 30% to 19.5%, i.e. may at least have taken out any cost and possibly profited too.

Meanwhile, the chairman reduced his personal holding from 9% to 5.5%, and EPIC Investments LLP, a company he controls, cut its stake from 48.6% to 24.3%. An extent of selling would be required anyway by the City, otherwise insiders would have control.

Looking beyond the market's knee-jerk reaction to the CEO sale and profit warning, the key issue for valuation is how sound Luceco's financials prove when the business cycle finally turns.

As yet, the economy looks finely balanced, the Bank of England resolved to maintain stimulus according to the outcome of EU trade negotiations. But if US inflation accelerates, the Federal Reserve could raise rates faster and export financial chaos.

So, if you believe the UK economy will plod on reasonably well, then Luceco now rates a 'buy'; but if you are wary of macro prospects, the stock may not anyway recover much until the company posts more financial proof this year – prelims due early April.

Luceco might not be a roaring long-term growth stock, but probably offers value at about 90p, targeting a return to at least its 130p flotation price. It has strong positions in markets that are growing but could become suddenly exposed to stock clearance issues in a slowdown. Declaring a maiden dividend - as forecast - may be needed if only to affirm cash flow. Speculative buy.

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We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

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Disclosure

We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

Please note that our article on this investment should not be considered to be a regular publication.

Details of all recommendations issued by ii during the previous 12-month period can be found here.

ii adheres to a strict code of conduct.  Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.

In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.

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