Lights the Way Ahead
Carclo is a precision engineering business that has been re-focussed towards its three core businesses. Two of these, Technical Plastics and LED Technologies are growing fast. The third Aerospace is a solid earner and gradually transitioning away from the control cable business as that system is being phased out by aircraft manufacturers. What we like:
High recurring revenues
Tier 1 Clients / High barriers to Entry
High Growth within segments
In addition non-performing segments have been disposed of and there is consequently a likely improvements in margins as the costs of disposal come out of the numbers in the current year.
The Group is geared with a £24m debt which is not onerous for the business given the levels of recurring business and the significant increase in capacity it has put on to grow the business.
The valuation multiple is low for where we are, not giving much credence to this change of model and particularly the growth potential.
For FY 2016 the dividend increased by 3.6% to a total of 2.85p for the year. Yielding around 1.9% at 151.5p share price.
The Business and Outlook
1) Technical Plastics – Contract manufacturing – synergies between Medical and Auto businesses:
70% Medical Market – customers include five of top ten medical device OEMs (Smith & Nephew / Siemens Medical) – market grows around 3% pa but Carclo growth around 10%. Long sales cycle (~2yrs) but also long product life. Sticky business.
30% Industrial & Electronic - shorter product cycles, can use older assets (manufacturing equipment), suited to lower cost regions (India & Czech), new products quicker to profitability, fits well alongside medical business.
This division has recently expanded capacity in its Pennsylvania ‘clean rooms’, in China (by 3x) and in Czech (x2). This has given it around £10-15m of extra capacity and also has allowed it to upgrade its medical customer list. The Tuscon and Bangalore sites are also set to be doubled in size this year. Sales are around £70m and the plan is to grow this to around £100m within three to four years, with operating margins around 10%.
2) LED Technologies – Design and manufacturing of LED lighting units for niche high end Auto OEMs (Bentley, McLaren, RR, Bugatti et al.) growing 15-20% pa. Top brand market still 2-5 years from peak.
Sales came in around £40m for FY March 2016. Niche sector with little competition. 2 – 3 years of design work with specialist manufacturers creates high barriers to entry. It is about quality, not price, and the runs tend to be small. Scope to move into mid-tier volume market using expertise and reputation created in top tier. Operating margins should be between 13-15%
3) Aerospace (Formerly Precision Engineering) – control cables and machined components for European civil aerospace market (Airbus) – high free cashflow.
The Aerospace division is highly profitable with low investment needs and sales are around £6m with operating profit around £1.3m. Growth is limited though as the use of control cables in aircraft declines. However the business is re-focussing towards OEM and spare components and is well equipped for this.
There are significant recurring revenues, though pinning a precise percentage down is difficult. There are fluctuations in schedules on programmes, programmes coming to their end etc., but an approximate split between tooling and product sales for the year just ended would have product sales at approximately £90 million with £29 million of sub contract tooling sales. Obviously the tooling sales are not repeated but often replaced by other tooling demands.
CDS or Carclo Diagnostics is a standalone pre-revenue technology company. The Board has concluded that it should discontinue its investment in CDS, currently c. £1.5 million per annum. As a result of this decision, the Board has determined that the carrying value of the intangible assets relating to CDS held on the Group's balance sheet, being c.£4.9 million at 31st March 2016, should have been fully impaired in the financial statements for the year ended 31st March 2016. This non-cash impairment cost has been disclosed as an exceptional write down. The Company expects to have up to £1m of closure costs in respect of CDS in the current year.
Pension – there is a legacy pension deficit. Liabilities are calculated at £197m and scheme assets around 174m giving a deficit – net of deferred tax – of £19m. Where the pension goes depends on the performance of the markets and other factors such as corporate bond yields. Carclo will continue to pay in the annual recovery payment of around £1.2 million and pay annual scheme administration costs of around £600k
Debt – Net Debt was £24.8m (£24.5m 2015) slightly higher than the year before reflecting an increase in capex. The forecasts have debt holding at around £25 million for the next two years reflecting the increased upfront working capital burden in respect of the mid volume lighting project win where payment for upfront design and development work will be amortised over production.
There are plenty of good initiatives underway at Carclo that are not included in the share price. There are high barriers to entry through the design, lead time and life cycle of the projects. The customers are more interested in quality than price so will be difficult to shift as the products are of the highest quality. There is consequently very good visibility of earnings and also high barriers to entry in terms of relationship, know-how and reputation.
Money has been spent building out capacity in the growth segments, and closing down non-core businesses. The management are confident they can grow the overall business significantly over the next several years. The current published broker forecasts give a forward rating of around 13.5x March 2017 and 11.7x March 2018 eps; based on sales growing to £123.9m and £135.7 respectively. Given the quality of the earnings and the 2% dividend, this does not seem at all demanding. If like me you think it could grow a little faster than that, it looks even better value.