17 December 2014
By Maynard Paton
Today I’m catching up with Tristel (LON: TSTL), a small-cap supplier of patented chemical products that are used to disinfect medical equipment and hospital floors. I’m pleased the company has progressed well since my initial write-up back in March 2014.
To recap, here’s what attracted me to the business:
- A very prominent market position in a niche sector;
- Repeat, everyday and somewhat mandatory products;
- A substantial roster of patents;
- Strong growth prospects, including sizeable overseas potential;
- A cash-rich balance sheet and solid cash flow, and;
- Long-time management and the board’s ‘takeover options’.
I bought the shares between December 2013 and April 2014, paying a low of 41.8p, a high of 48.4p and an average of 45.6p.
I said back in March that, if all went to plan, the price could trade beyond 100p by 2017. Well, here we are at the end of 2014 and the price is 78p.
With 0.36p collected via dividends, too, this investment has returned me 72% to date — not bad.
I top-sliced a fifth of my holding in October 2014 at 78.7p and while I would not buy more right now, I continue to hold.
It’s what you’d call ‘positive newsflow’
I certainly can’t complain about the updates that have emerged from Tristel following my purchases (my bold below):
A statement in April revealed:
“The Company is now confident that the momentum evident throughout the first half will continue through to the end of the financial year and beyond, resulting in pre-tax profit for the year to 30 June 2014 of no less than £1.5m… This level of profit is ahead of current market expectations.”
Then during June, Tristel lifted the projection to “not less than £1.75m” and notably, anticipated “further acceleration in revenue growth and as a consequence has raised its internal expectations both for the current and subsequent financial years.” (note the plural of years).
And in July, another statement disclosed:
“The Company enjoyed a strong second half performance which has led to a fifth profit upgrade this financial year. The preliminary results for the year ended 30 June 2014…will show revenues and pre-tax profit ahead of expectations that were last updated in June.”
Sales and pre-tax profit both reach fresh highs
The 2014 annual results published in October showed very positive progress:
| Year to 30 June | 2010 | 2011 | 2012 | 2013 | 2014 |
| Sales (£000) | 8,764 | 9,287 | 10,939 | 10,558 | 13,470 |
| Operating profit (£000) | 1,504 | 522 | 757 | 493 | 1,819 |
| Other items (£000) | 233 | – | (174) | (2,231) | 8 |
| Net interest (£000) | (13) | (16) | (6) | (14) | (4) |
| Pre-tax profit (£000) | 1,724 | 508 | 578 | (1,750) | 1,823 |
| EPS (p) | 3.84 | 1.27 | 1.77 | (3.16) | 3.25 |
| DPS (p) | 1.83 | 0.56 | 0.62 | 0.40 | 1.62 |
Sales jumped 28%, which helped operating profits more than triple. The dividend was raised four-fold.
Stars of the show were the group’s wipes for cleaning small medical instruments (with sales up 44% to £7.3m) and the disinfectants for cleaning floors and other surfaces in hospitals (with sales up 57% to £1.2m).
Tristel helpfully clarified the long-term sales advances of its medical instrument and surface disinfectants within the annual statement:
| Year | Instrument (£000) | Surface (£000) | Total group sales (£000) |
| 2005 | 207 | – | 3,009 |
| 2006 | 442 | – | 3,746 |
| 2007 | 647 | 30 | 5,148 |
| 2008 | 1,178 | 230 | 5,961 |
| 2009 | 1,698 | 434 | 6,847 |
| 2010 | 2,073 | 598 | 8,764 |
| 2011 | 2,552 | 867 | 9,287 |
| 2012 | 4,366 | 1,055 | 10,939 |
| 2013 | 5,087 | 784 | 10,558 |
| 2014 | 7,329 | 1,229 | 13,470 |
These lead products now represent almost two-thirds of total group revenues.
Elsewhere in the group, specialist sprays and wipes for keeping ‘cleanrooms’ free of contamination rallied 31% to £1.2m. Meanwhile, overseas sales continue to make headway — up 33% during 2014 to £4.5m and up more than ten-fold since 2008.
Cash flow continues to look reasonable, too:
| Year to 30 June | 2010 | 2011 | 2012 | 2013 | 2014 |
| Operating profit (£000) | 1,504 | 522 | 757 | 493 | 1,819 |
| Working capital movement (£000) | (761) | (617) | (487) | 155 | 524 |
| Depreciation (£000) | 312 | 392 | 499 | 464 | 419 |
| Amortisation (£000) | 187 | 271 | 551 | 566 | 466 |
| Tangible expenditure (£000) | (272) | (860) | (369) | (91) | (677) |
| Intangible expenditure (£000) | (3,095) | (1,533) | (630) | (345) | (479) |
The net cash position advanced from £0.5m to £2.6m during the year and management claimed cash stood at £2.9m at October 2014.
Could this business actually have a sustainable competitive advantage?
Possibly. Here are a few soundbites from the 2014 annual report that I liked (my bold):
“[Tristel] is one of a very small number of companies with an established global footprint that can describe itself as being exclusively an infection prevention business.”
“Tristel has created a unique position in high level instrument disinfection in the ambulatory care market as well as sporicidical surface disinfection in hospitals – by focusing on chlorine dioxide.”
“Tristel’s instrument decontamination and surface disinfection products are innovations that have proven to be both innovative and disruptive to existing technology. New and anticipated guidelines as well as the pending Biocidal Products Regulation lend support for our chlorine dioxide chemistry. Additionally, the investment costs required for compliance will ensure that only those companies who have invested in sufficiently rigorous manufacturing and quality control processes will meet these new challenges. Tristel is well placed on both counts.”
“Our chlorine dioxide chemistry benefits from strong intellectual property protection as well as know-how. Patent lives extend up to 2031 and we will continue to invest in a constant stream of new patent applications which are related to both new concepts as well as extensions of existing products.”
“Our business model is further enhanced by a high percentage of recurring revenues (c.96%) from consumable products that perform essential functions for our customers and which enable them to minimise capital spend, ongoing maintenance costs and investment in supporting infrastructure.”
“The products currently being developed are expected to make significant contributions to the future growth of the business.”
Such comments suggest Tristel does enjoy a respectable competitive position with dependable revenues.
Still, the annual figures were not perfect…
The first-half/second-half split revealed a few numbers to think about:
| (£000) | H1 2013 | H2 2013 | FY 2013 | H1 2014 | H2 2014 | FY 2014 | |
| Sales | 4,402 | 6,156 | 10,558 | 6,442 | 7,028 | 13,470 | |
| Gross Profit | 2,818 | 4,196 | 7,014 | 4,490 | 4,914 | 9,404 | |
| Op Profit | (623) | 1,126 | 493 | 723 | 1,096 | 1,819 | |
| HH Sales | 3,273 | 5,639 | 8,912 | 5,536 | 5,982 | 11,518 | |
| HH Gr Profit | 2,155 | 3,952 | 6,107 | 3,987 | 4,315 | 8,302 |
In particular:
i) the H2 group operating profit declined by £30,000 to £1,096k during 2014.
ii) the group’s largest division, Human Healthcare (HH), which covers the popular instrument wipes and hospital-surface disinfectants (as well as a range of other cleaning gels, foams and sprays), witnessed its H2 sales improve by just 6% to £5,982k.
Looking at i), there was no major difference between H1 and H2 administration costs during 2014, so I can only surmise the greater sales of 2014 came with higher general costs that were not reflected in 2013.
On ii), I get the impression Tristel’s largest customer — the NHS buying agency that represents 26% of total group sales — can create some ‘lumpy’ orders.
If you look back at the second table above, you will see ‘Surface’ sales declined during 2013, only then to rebound strongly for 2014 — management claims NHS “bulk buying” in 2012 was the cause. Anyway, after HH sales surged 69% in H1 2014, perhaps it was too much to except a lot in H2.
This company webinar contained some useful management comments
In terms of the future, a company webinar covering the 2014 results provided a few bullish slides.
The first, at 9m26s, indicated a “minimum” year-on-year sales growth target of 17% and a margin target of 15%.
Another, at 10m54s, revealed the current market size for medical instrument decontamination — assuming all the instruments were cleaned after use by a Tristel product! — could be £91m a year. That contrasts to the £7.3m achieved by the firm during 2014.
Then right at the end of the webinar, at 43m40s, management disclosed the group’s cash pile could be £4m by the June 2015 year end.
(That £4m target suggests the cash pile could improve by £1.3m during the current year, which in turn suggests cash earnings could be almost £2m, or 4.9p per share, if annual dividends of nearly £0.7m are once again paid out. See my valuation sums below.)
AGM reveals higher sales and much higher margins
Tristel’s AGM statement this week revealed further progress:
“In relation to the six months ending 31 December 2014, unaudited revenues are expected to be in excess of £7 million, which is at least 9% ahead of the same period last year. We expect unaudited pre-tax profit to be no less than £1 million for the period, compared to pre-tax profit of £0.7 million for the same period last year and £1.8 million for the full year ended 30 June 2014.”
With sales up at least 9% and profits up by more than 38%, the statement appeared reasonable.
I note especially that H1 pre-tax margins have improved from 11% to 14%, which bodes well for the group achieving the 15% target it has set for full year 2015.
However, sales of £7m and profits of £1m does equal that achieved in H2 of 2014, so the overall business does seem to have consolidated its momentum — rather than advance even further.
That said, at the 2013 AGM, management did state this:
“In relation to the six months ending 31 December 2013, unaudited revenues are expected to be in excess of £6 million, which is 36% ahead of the same period last year. We expect unaudited pre-tax profit to be no less than £0.6 million for the period, compared to adjusted pre-tax profit of £0.5 million for the full year ended 30 June 2013 and adjusted pre-tax loss of £0.6 million for the same period last year.”
In the event, H1 2014 sales came in at £6.442m and pre-tax profits came in at £0.724m
So I guess the same AGM ‘sandbagging’ could mean H1 2015 sales actually come in at £7.4m while pre-tax profits actually come in at £1.1m (or even a bit more). Such a performance would be quite respectable I think against H2 2014.
Plus, it’s worth bearing in mind H1 2014 was not spectacular when set against H2 2013.
All told, I get the impression this business experiences some seasonality with customer buying patterns (as well as the aforementioned lumpiness). It is not obvious there are any worrying H1/H2 signs here, and I dare say something as simple as currency movements may have impeded progress slightly of late.
Sadly Tristel shares are no longer as attractively priced as they were
My original sums from March said:
“Sales for 2013 were £10.6m, so 17% annual growth for three years would give sales of £17m. Then applying margins of 15% and standard tax at 20%, I come to earnings of £2m or about 5.1p per share.
Mix in a P/E rating of 20 — quite fair I feel for a business that would have shown organic 17% sales growth for three years — and my target price for 2017 comes to 101p.”
I am now guessing current-year 2015 sales could advance from £13.5m to £15m (up 11%) and then a further 10% for both 2016 and 2017 to £18.2m. (Maybe these forecasts are too conservative — back in October, the FD was happy to suggest to me that a compound 17% was still the target for the next three years.)
Management’s 15% margin target looks very beatable and I’m now predicting 17% by 2017. Apply standard UK tax at 20% (although tax on foreign profits may be higher) and I arrive at earnings approaching £2.5m or about 6.1p per share.
Apply a lower P/E of 17.5 this time, to reflect the lower potential growth rate I’ve used, and I now get 107p three years out.
Alternatively, going back to that company webinar and the company prediction of £4m cash, and my suggestion of cash earnings potentially running at nearly £2m…
If you subtract that £4m cash from the current £32m market cap, the underlying business could be valued at 14 times that possible £2m cash earnings projection.
To me, that multiple does not seem too outlandish given Tristel’s recent accomplishments , sector niche and future prospects.
A reminder of the downsides
The NHS: I have sadly seen many quoted small-caps become croppers over time after the UK Health Service decided to switch tack or defer projects. As mentioned, the NHS buying agency accounts for 26% of group sales and one day may play hardball with Tristel.
Nonetheless, I understand from management that Tristel managed to pass on a very small price increase to the NHS in September 2014, which indicates negotiations are not entirely one-sided.
Paying up for growth: These shares at 78p are not an obvious bargain on a trailing P/E of 24 and yield of 2.1%. If my projections are too rosy, the downside could be considerable.
Further management mishaps: Though I’m hopeful this business has now become settled, Tristel has a blemished history and I do wonder if the same management will endure more setbacks. I must admit, the executives are not the owner-dominated, shareholder-aligned managers that I prefer at my investments (although the non-exec chairman does boast a sizeable 26%/£8m stake).
Still, the business has done very well in the last couple of years while the chief exec has led the group since flotation and overseen a quadrupling of sales. So for now I’m happy to give those in charge the benefit of the doubt.
Competition: Tristel’s success may be due to a lack of current rivalry rather than any technical excellence. The 2014 annual report admits: “We have targeted these niches because they are not addressed by our competitors”. Competition in this sector includes a handful of major American firms, who could prove troublesome if they ever decide to muscle in on Tristel’s patch.
I cannot complain how this investment has performed so far
I said in March that Tristel was one of the most attractive growth shares I had come across for some time.
The market has since latched onto the group’s achievements and the shares have performed well in what has been a rough time for many small-caps.
There’s a lot still going for the company — the products are simple consumables that enjoy patent protection, a prominent market position and regular demand regardless of economic conditions.
Plus, the long-term track record of the main instrument and surface disinfectants is immense –and the growth prospects overseas could extend that record for some time.
Sadly I do not foresee massive share-price gains in the short term, but I’d like to think the recent AGM statement involved further ‘sandbagging’. I am happy to hold Tristel shares at the current 78p.
Maynard Paton
(Disclosure: Maynard owns shares in Tristel.)
