Small Cap Value Report (Fri 18 June 2021) - VLX webinar, CGS, DPP

Good morning, it’s just Paul here today (Friday), as Jack is having a well-deserved day off.

Timing – I have to be finished by lunchtime, due to an afternoon appointment. Fridays are usually quiet, so hopefully we don’t have any more bombshells.
Update at 10:53 – there’s hardly any news today, so I’ll look back at a couple of things I missed earlier this week.
Update at 12:50 – I’ll leave it there for today, and this week. So today’s report is now finished. Wishing you a pleasant weekend. Thanks for all the positive amp; supportive reader comments. We read them all, and genuinely appreciate your support. We’ve noticed how much more polite nearly everyone has become, since the thumbs down facility was withdrawn – smashing to see. After all, investing should be fun, as well as lucrative, and it’s very much a team sport in my view, with us all helping each other.

Agenda – (all written by Paul today, as Jack’s got a prior engagement) -

Volex (LON:VLX) (I hold) – my notes from the InvestorMeetCompany webinar held yesterday. You can watch this yourselves, using this link to the recording. Lots of positives in my opinion, so I’m sitting tight on my position here, as a coffee can (hold forever) investment. It ticks a lot of the boxes in the 100-Bagger book actually – large owner/manager stake (c.26%), accomplished at making acquisitions (6 done so far), large growth runway (big, global markets), favourable industry tailwinds (esp. electric cars, and data centres).

Castings (LON:CGS) – review of its results FY 03/2021. Nice company, main attraction being the reliable 4% yield, and bulletproof balance sheet. A difficult year, but remains profitable, and production is now back to normal. Selling into the EU presents a risk though.

Dp Poland (LON:DPP) – FY 12/2020 results published – another year of absolutely hopeless performance, to add to the very long list. As it stands, it just isn’t a viable business. They’re not blaming covid to be fair, because most of the business is delivery/takeaway pizzas. It’s almost out of cash again, but has done a recent £3.5m fundraise, to keep the wolf from the door, for now. It remains to be seen how the larger business (another Polish pizza company has merged with it) will perform. Current market cap of £52m looks ludicrously high to me, unless they can pull something out of the bag. It’s gone absolutely nowhere in the 11 years it’s been listed. My Polish friends tell me that Dominos pizzas are too expensive, and there are loads of good, cheaper competitors. (no section below, as this covers everything).

Quick note – a friendly reminder that we don’t recommend any stocks. We aim to cover notable trading updates amp; results of the day and offer our opinions on them as possible candidates for further research if they pique your interest. We tend to stick to companies that have news out on the day, and market caps up to about £700m. We avoid the smallest, blue sky type companies, and a few specialist sectors (e.g. resources, pharma/biotech).

A central assumption is that readers then DYOR (do your own research) and discuss in the comments below. The comments, incidentally, sometimes add just as much value as the articles. We welcome all rational views, whether bull or bear!

(I hold)

Paul’s notes from Volex webinar on IMC yesterday.

I came away with a really positive impression of this webinar, which was held yesterday early afternoon, on the wonderful platform InvestorMeetCompany. There are few things I enjoy more than listening to management of many companies talking about the business in their own words. It seems to bring RNSs alive, and saves so much time – to be honest, I rarely fully read RNSs these days, there just isn’t time, or the inclination. A 30-60 webinar is vastly superior, so please can more (indeed, all) companies do these every time results are put out.

I tend to concentrate on what’s being said, and I only jot down anything particularly striking.

Here are my personal notes from the Volex presentation, NB not comprehensive, just what struck me as important, and my views on it -

Electric vehicle charging cables – Volex is the leading manufacturer. Revenues rose from $18m to $53m in the last year. “Very exciting future” for these products. Competition will increase, but they’re difficult to make to required quality – e.g. have to be able to withstand adverse weather, cars being driven over the cables, etc. My view – we’re only at the start of an industry changeover, so this market looks set to grow by maybe 20x or more in the coming decade. Exciting potential for Volex here in my view.

Overall progress – turnaround has increased operating margin from 2% to nearly 10% from 2016 to 2021. Achieved global scale amp; efficiency.

Patents – small number, but important, particularly for growth sectors. Also focusing on product development, which is often funded by customers.

Demand is recovering in sectors impacted by pandemic, especially medically, seeing pent-up demand returning. Very positive on growth in this sector. Revenues are very sticky from medical, aerospace – because part have to be tightly approved, so tend to be repeat ordered for the life of the product.

Acquisitions – 6 done in 3 years, so “we know what works”. “Extremely disciplined approach”. Acquisitions are “generating great returns”. Expect acquisitions to add c.10% to revenues each year in future. Competing with high prices paid by private equity. Volex turns down deals if not right, but a very fragmented market. Local management is given a lot of autonomy, so fast decision-making. Cultural fit has to be right. Sang the praises of previous acquisitions, which have paid back rapidly, and hit their earn-out targets. Rolling out a new ERP system across the group, to improve efficiency, collaboration amp; reporting.

Recent DE-KA acquisition in Turkey – only contributed 6 weeks figures into FY 03/2021 ($9m revenues). But did $60.7m revenues amp; $13.0m EBITDA for the full year, which implies a substantial boost to FY 03/2022 group results. Won a major new customer through Volex exiting relationship. Operating at full capacity, so DE-KA has increased from 8 to 10 automated production lines. “Extremely pleased” with the acquisition. Management work great with Volex mgt, same values amp; work ethics, etc.

Data centres – have to upgrade their cabling about every 18 months. Data speed was 100 thingummies, it’s now being upgraded to 400 (Volex new products meet customer testing requirements), then in 18 months will all be replaced with 800. So constant flow of new business for Volex.

Inflation – can pass on copper price increases, with a short time lag. Used to dealing with inflation in emerging economies (e.g. Turkey, Indonesia, where it has factories). Factories there are adept at passing on cost increases, and driving efficiency gains to mitigate cost increases.

Copper price rises – impacted profit by only $0.4m in FY 03/2021

Raw materials amp; component shortages – is an issue, but not had major impact as yet. Volex has scale, and great relationships (esp in Far East) with suppliers, so has managed the problem OK, but aware of it.

Employers tax – one-off help from Govts, added 0.5% to the operating margin. Won’t repeat next year.

Doubled production in Indonesia, and this avoids tariffs selling into the USA on Chinese goods.

Tax – cash tax of 10% is low, as still have tax losses to be utilised.

Question asked about “underlying” EPS of 32.1 cents being boosted by negative deferred tax. CFO confirmed this is correct, and said it boosted EPS by 8.9 cents, so my calculations in yesterday’s report were correct. I feel the company should have made this very much more apparently, as it gave a misleading impression of EPS in the highlights.

Freight – goods are slower to ship from the Far East to USA amp; Europe. So Volex has more inventories, as more on the water. Also, customers are demanding buffer stocks.

Outlook – “firmly on track”. “Our journey has only just begun”. Want to exceed 5 year plan to reach $650m revenue at 10% operating margin. Volex is an “incredibly compelling proposition”. Big opportunities, especially Electric Vehicles, and data centres’ next generation products.

My opinion – as you can probably gather from the above, the Chairman in particular sounds really upbeat about the prospects. It’s subjective of course, but to me this presentation seemed more upbeat than previous ones last year, which seemed to strike a much more cautious tone.

It seems to me that, with a proven ability to make value adding acquisitions, and strong industry tailwinds, Volex deserves a premium valuation. I think a price of 400-500p looks justified (c. 20-25 times my guess of 20p EPS this new year). Longer term, and with more acquisitions, there’s no reason we couldn’t see maybe 10-20% p.a. further share price gains.

It feels to me like a very well run owner-managed business, doing everything right, and with a lot of potential to continue growing. We can pick that up for a current PER of about 18 on this year’s likely earnings, which I think is good value.

Something might go wrong of course, but I’m reassured it sailed through the pandemic, able to produce record profits.

Lots to like here, I feel.

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382p – mkt cap £167m

This is a traditional business, making iron castings, machining, amp; similar, things like turbocharger housings for trucks. It seems a steady, mature, efficient business, generating a decent profit margin in normal times, and has a particularly robust balance sheet.

The share price hasn’t made any real progress in the last 10 years, so the main attraction here are the divis – look at this for a track record! Also note that, due to the bulletproof balance sheet, it has continued paying divis throughout the pandemic – here’s part of the Stockopedia dividend page, which you can find for any company under the “Accounts” tab on the StockReport.

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The current divi yield is about 4%, so this share might be of interest to income-seekers.

Final Results – FY 03/2021

Poor results, as I would expect covering the pandemic period, in “a very difficult year”.

Revenue of £115m, down from £139m LY

Profit before tax (pre exceptional items) of £4.4m, down 65% on LY.

Customers “stopped building trucks” during H1 – I like the plain-talking commentary we always get from CGS.

H2 demand recovered, but the pandemic impacted production

Back to full production now

Customers experiencing shortages of semiconductors amp; other materials

Large cost increases for raw materials, e.g. copper and steel scrap

Passing on cost increases to customers, but short term impact in Q4

Outlook – sounds positive, although I would have liked some more specific financial guidance -

Our customers are forecasting increased volumes in the second half of this financial year and despite some problems in their supply chain we are maintaining full production and increasing our stock back to our previous levels.

Balance sheet – incredibly strong. It has £129.4m NTAV.

It could easily afford to pay a £30m special dividend, and still have a net cash position.

So financial risk is almost zero in my view, but it must be frustrating for shareholders to see management sitting on the cash like a comfort blanket.

My opinion – it’s a decent income stock I think – 4% dividend yield, and with large dividend paying capacity, due to the net cash of £36.1m.

My main worry with this stock is over Brexit. So far there’s been little serious disruption, but if European customers decide to bring their supply chains closer to home, CGS could see demand tail off disastrously. There again, it’s got the cash to set up a factory within the EU, if necessary. Brexit is mentioned as a material risk in the notes to this announcement, which I found by doing CTRL+F “Brexit”.

For that reason, I’m not minded to get involved here, but it’s a good company, and I love the balance sheet. Something might eventually happen with all that surplus capital sitting there doing nothing.

Here’s the long-term chart. Remember if you were to overlay divis on top, the total shareholder return would be much better than it looks. That would be such a nice feature if it could be added to Stockopedia in future. Although it’s easy enough to manually add up the divis from the dividends page.

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Stockopedia