Interactive Investor

Is superstar Tristel unbeatable?

10th November 2017 16:11

Richard Beddard from interactive investor

I'm wondering about Tristel, Richard. You named it as one of the 'popular' shares in the Share Sleuth portfolio. And by popular I sensed you meant it may be overpriced.

Hmmm. Kind of. There's lots of speculation in the price. At 280p it values the enterprise at about 36 times adjusted profit. The earnings yield is 3%.

It's worth considering what that actually means. If the price you pay is 36 times profit, you would receive 1/36th of that every year if the company were to pay all its profit out as a dividend. That's roughly 3% a year - supposing the business continues performing as it did in its last financial year, which ended in June.

Now, I have a question for you. Is that good?

Is a 3% annual return good? I think most investors would expect more…

Exactly… There are plenty of shares on lower valuations promising higher returns, so there can only really be one reason Tristel's share price is so high. Traders expect it to earn a higher return than 3%, and that means they expect Tristel to make more profit in future.

Tristel has played a part in setting those expectations by publishing targets. It expects revenue to increase by an average of 10% to 15% a year over the three years between June 2016 and June 2019, and maintain pre-tax profit margins above 17.5%. If profit margins stay the same, profit should increase by between 10% and 15% a year too.

Tristel may be wrong, but lets go with its projection and extend it. If profits compound at 10%, it will take Tristel between seven and eight years to double profit. If profits compound at 15%, it will take five years.

At that point Tristel would be earning 6% on an investment at today's price, and if its prospects remained good, you might well be invested in a good company at a reasonable initial price. Though the shares look expensive now, the danger if the firm lives up to expectations, is that you will never be able to buy them any cheaper.

Of course, it could do much better and I'll have something to say about that later, but a lot can happen in five or more years and you have to be careful about paying up-front for profit that may never come.

Tell me then, what do you think the future holds?

Well, that's the problem. I'm not good at predicting the future. I didn't predict the iPhone. I didn't predict Donald Trump. As my wife will testify, a long time ago I did predict we'd do our shopping on the Internet, but I didn't buy shares in Amazon.

I am not in the prediction game, which is what makes holding shares in Tristel so difficult, because you can't avoid it. The higher the share price, the more growth is implied and the more implied growth, the more you must speculate on how it might be achieved, and what might stop it.

There are good reasons to believe Tristel could grow dramatically…

Dramatic growth? I like the sound of that…

OK let's start with the promise.

Tristel says (I paraphrase!) it has an unbeatable product. It's the only infection control company selling disinfectants used in the decontamination of simple medical instruments in hospital outpatient departments.

The disinfectants are unique because they use chlorine dioxide, which is as effective as much more noxious chemical formulations used in washing machines for larger surgical implements.

But they can be applied by hand, using Tristel's patented delivery methods (foams and wipes), which is a quick, safe, procedure that reduces a hospital's outlay on expensive capital equipment.

You can imagine, in today's infection and cost-conscious environment, it's just what hospitals need. And in little more than a decade, Tristel's become the dominant supplier of disinfectant in its niche in the UK. The company has reported extraordinary market share in some NHS hospital departments, the highest being 95% in cardiology.

Tristel has decades of experience with chlorine dioxide, a library of studies confirm its efficacy, its approved for use by the authorities in many different countries, and by the manufacturers of medical instruments.

Since it's nearly saturated the UK market, its growth focus has turned abroad, where Tristel already earns nearly 50% of revenue. So, when it predicts 10 to 15% growth, it's really predicting a few per-cent of UK growth and foreign growth in the teens.

Sorry to sound a bum note, but it didn't quite achieve that in 2017, if you strip out the effect of currency movements and the acquisition of its Australian distributor.

Nevertheless, Tristel's dominated one market, could dominate others, its debt free, highly profitable, growing, and most importantly it seems to have competitive advantages that will sustain growth.

Add to that the fact that it's two years into a project to get its products registered in the US, a ginormous market, and you can, perhaps see the potential?

Its first sales there are anticipated in 2019, and who knows? It might revise growth targets up if things go well.

Sounds like a slam-dunk to me. Why would you not want a bit of Tristel?

Well, exactly. The company talks the talk, and judging by the numbers its walking the walk. Normally, that's enough for me. But with the valuation this high it must keep walking, or rather running, for quite some time.

The problem is, when you're talking about popular shares, there are almost always good reasons to buy them, that's why they're so popular. If there are reasons not to buy them, they're not so obvious.

As Donald Rumsfeld once discovered, talking about unknown unknowns makes you sound demented, but here goes:

It's an inviolable rule of capitalism that when a company is making big profits, other companies will compete for a share of them. Tristel's defences may be tested. Rivals may look for ways around the patents. They may use expertise of their own to develop different, even non-chemical solutions. The cost of registering products in different jurisdictions may not put off larger infection control companies, now Tristel has demonstrated there's a global market.

US registration may turn out to be harder than Tristel anticipates. As students of Tristel's history know, competition doesn't always come from direct rivals, it was squeezed out of the market for disinfectant for instrument washing machines by the manufacturers.

Just because I don't know threats exist, doesn't mean they don't. And the fact that they could exist must put some limit on the share price we're prepared to pay.

Tristel's management, its veteran chief executive and its finance director, have pinned an escalating and potentially humongous share bonus on the share price reaching targets up to 500p in the period to June 2021.

This "performance share plan" could be a sign of confidence in the long term, but it isn't necessarily.

The promise of big profits in the future, successful registrations in the USA, say, could deliver a speculative surge in the share price, whether or not Tristel goes on to earn big profits after that. Either way, the executives will have got their reward, although, if they exercise their options earlier, they can't actually sell the shares until June 2021.

Even if Tristel's executives can't eat it straight away, it seems management want jam sooner rather than later.

Having already cashed in some of the portfolio's Tristel shares once, I'm wondering if I should take some more jam today.

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

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