FW THORPE: P/E of 21-25x May Be Justified After FY 2020 Figures Reveal 18th Consecutive Dividend Increase, £63m Cash Reserves And Exciting SmartScan Growth Potential

23 October 2020
By Maynard Paton

Results summary for FW Thorpe (TFW):

  • Creditable” figures that revealed second-half profit sliding 17% due to the lockdown.
  • A 2% final dividend lift, cash reserves of £63m plus the commendable funding of furloughed staff did not imply imminent financial difficulties.  
  • The SmartScan light-monitoring system provides exciting potential, with sales up 18% to represent 23% of total revenue. 
  • Talk of a “global recession” and a “downturn in orders” suggests trading during 2021 will be challenging.
  • A P/E of 21-25 seems generous but may reflect the ‘pandemic-proof’ balance sheet, SmartScan growth and/or resilient profit history. I continue to hold.

Contents

Event: Final results and annual report for the twelve months to 30 June 2020 published 01 October 2020

Price:
290p
Shares in issue: 116,593,336
Market capitalisation: £337m

Disclosure: Maynard owns shares in FW Thorpe. This blog post contains SharePad affiliate links.

Why I own TFW

tfw fw thorpe fy 2020 results thorlux light test
  • Manufactures commercial lighting systems with a long-established reputation for high product quality, leading technical innovation and tip-top customer service.
  • Board led by a veteran executive and assisted by family non-execs that steward a 50%-plus/£169m-plus shareholding.
  • Conservative accounts showcase ‘pandemic-proof’ cash reserves, resilient profit history and confident dividend advance.

Further reading: My TFW Buy report | All my TFW posts | TFW website

Results summary:

tfw fw thorpe fy 2020 results summary

Coping with Covid-19

At the time of writing, the [pandemic] situation is dynamic and uncertain, but we continue to support our customers where practical, whilst being mindful of employee wellbeing and government guidance.  It is highly likely however that Group companies will see considerable disruption to delivery schedules due to customers’ and government containment actions, for at least the next few months. The extent of this disruption and the period over which the impact is felt, cannot be estimated at this time.” 

  • However, those March interims also stated:

We feel our robust balance sheet is structured more than adequately to deliver an increased interim dividend of 1.46p (Interim 2019: 1.43p) for the six months to 31 December 2019.”

  • The 2% interim dividend lift suggested TFW would not face a catastrophic lockdown.
  • These FY 2020 results confirmed the lockdown had prompted some employees to be furloughed:

No factory staff have been on furlough since early June.”

  • However, TFW commendably did not rely on government handouts:

The Board decided not to apply for any government support for furloughed employees during lockdown; this impacted operating costs by £0.6m, as the Group paid all employees normal salary whilst they were not working. This decision was duly considered and leaves the Group free of debt to external supporters, protects its reputation, and gives management ongoing freedom to make choices for the good of the business and its shareholders.

  • The £0.6m spent in lieu of government support represented 2% of the total £28m paid as staff wages for the year.
  • The outlook for the current year was very mixed.
  • Although recent trading has been supported by a backlog of orders…

Whilst the Group’s present order book is healthy and daily orders are good, this is partly attributable to an amount of pre-COVID work carried forward and to pent-up demand in the market”

  • …the talk further out was gloomy: 

It seems inevitable, however, that there will be a global recession, and that the UK, against a backdrop of Brexit uncertainly and the intense lockdown enforced by the Government, could be affected worse than many countries.

It is difficult to predict anything other than a downturn in orders at the end of the 2020 calendar year.

  • A fire at the Dutch Lightronics subsidiary during September has not helped matters. At least TFW claimed the disruption would not cause a “significant impact” on the division.

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Revenue, profit and dividend

  • TFW described the FY 2020 performance as a “creditable result”.
  • Revenue gained 2% to set an all-time high, while profit fell 7% to a level last seen during 2016:
Year to 30 June20162017201820192020
Revenue (£k)88,946105,448109,614110,643113,342
Operating profit (£k)15,95918,18919,22517,35716,068
Net finance income (£k)75(249)1013(389)
Other items (£k)2354112412,209264
Pre-tax profit (£k)16,26918,35119,56719,56915,493
Earnings per share (p)11.2412.5413.9113.9111.45
Dividend per share (p)4.054.905.405.535.66
Special dividend per share (p)2.0----
  • Once again TFW said its “robust” balance sheet allowed a dividend improvement, with the final payout lifted 2%.
  • TFW has now raised its dividend for 18 consecutive years:
tfw fw thorpe fy 2020 results sharepad dividend chart
  • Raising the dividend through both the banking crash and the pandemic is some achievement.
  • The lockdown impact was reflected within TFW’s second half, during which profit dived 17%:
GroupH1 2019H2 2019FY 2019H1 2020H2 2020FY 2020
Revenue (£k)52,66957,974110,64357,41255,930113,342
Operating profit (£k)7,01910,33817,3577,4898,57916,068
  • The quote below is encouraging. TFW remained profitable during the lockdown: 

During each of the worst months — in March, April and May — the Group still returned an operating profit. Inevitably, however, profit in those months was much reduced, dampening the year-end result, which, until the COVID pandemic, the Board had expected to be an improvement on the previous year.

  • TFW’s main division, Thorlux, suffered a deeper H2 profit slump than the rest of the group:
ThorluxH1 2019H2 2019FY 2019H1 2020H2 2020FY 2020
Revenue (£k)28,44233,86262,30432,36333,25265,615
Operating profit (£k)4,6596,91911,5784,8395,31110,150
  • Thorlux’s H2 profit fell 23%. 
  • Although Thorlux delivered a respectable-in-the-circumstances 16% H2 margin, the previous five years witnessed H2 margins of 20% or more.  
  • As well as the lockdown, “some major contracts” that had “attracted lower margins” held back Thorlux’s profitability. 
  • Other parts of the group — covering Dutch subsidiaries Lightronics and Famostar alongside various smaller UK operations — witnessed their collective H2 profit slide only 4%:
Non-ThorluxH1 2019H2 2019FY 2019H1 2020H2 2020FY 2020
Revenue (£k)24,22724,11248,33925,04922,67847,727
Operating profit (£k)2,3603,4195,7792,6503,2685,918

Thorlux and SmartScan

  • Thorlux manufactures a range of commercial lighting equipment as the video below shows:
tfw fw thorpe fy 2020 results thorlux light examples
  • Thorlux’s most exciting product is not actually a light, but a lighting control system called SmartScan.
  • SmartScan provides customers with energy reports, emergency lighting tests, “occupancy profiling” information and even air-quality data:
tfw fw thorpe fy 2020 results smartscan overview
  • More features were added last year, including “vehicle activity monitoring”:

This [SmartScan] solution has been developed further this year, outside pure lighting controls technology, by integrating new sensor technology such as dock usage and vehicle activity monitoring. Some third party technologies have also been included to enable mains electricity usage monitoring and solar photovoltaic generation data, all reporting back to the end user via the SmartScan website.

  • Clearly the SmartScan service is no longer just about controlling lights. The annual report talked of “Built Environment Analytics”:

Working closely with a particular client, Thorlux has taken this a step further and introduced the provision for Built Environment Analytics (BEA). Built Environment Analytics was created for building tenants, to give them a greater understanding of how their facility performs in operation.” 

  • Customers seem to like SmartScan. The annual report disclosed product revenue gained 18% to almost £26m during the year.
  • Launched only in 2016, SmartScan has become an increasingly significant source of revenue:
Year to 30 June20162017201820192020
SmartScan revenue (£k)-7,00014,00022,00025,900
Proportion of Group revenue -7%13%20%23%
Proportion of Thorlux revenue-11%22%35%39%
  • This remark from the annual report is important:

Development work was undertaken in-house.”

  • Perhaps TFW’s first-class lighting products will be complemented by equally first-class building-monitoring services, the revenue from which ought to be recurring and hopefully quite predictable.
  • Wishful thinking perhaps, but ongoing SmartScan success could lead to TFW becoming more of an IT/data/analytics business than a lighting manufacturer. 
  • Emphasising the importance of SmartScan, four pages of the annual report were devoted to the product’s new features:
tfw fw thorpe fy 2020 results smartscan screenshots
tfw fw thorpe fy 2020 results smartscan product manager

Lightronics and Famostar

  • TFW now lumps Dutch subsidiaries Lightronics and Famostar together within its financial reporting:
tfw fw thorpe fy 2020 results lightronics and famostar financials
  • The aggregate Dutch performance was encouraging in the circumstances. Total full-year Dutch revenue climbed 1% but profit gained 14%. 
  • The Dutch businesses represent approximately a quarter of the wider group.
  • The annual report revealed Lightronics, which manufacturers street lights, produced a “slightly subdued performance”. 
  • Lightronics’s revenue slid 3% to £22.7m during the year and the annual report did admit “Lightronics fell short of improving its figures this year”. 
  • Good preparation at the start of the pandemic appeared to help:

The company was largely unaffected by COVID-19, since operational measures were put in place in the early phases to enable Lightronics to continue to service its customers during the last quarter. In fact, June operating results were some of the strongest on record.

  • The annual report claimed Famostar, a specialist emergency-lighting company, had “exceeded expectations” during the year.
  • Famostar’s revenue gained 12% to £8.8m.
  • Once again good preparation at the start of the pandemic appeared to help:

Famostar has been the standout performer for the Group this year, following on from a strong performance last year. As at Lightronics, performance seemed unhampered by COVID-19 in the final quarter, actions having been taken in the initial stages of the outbreak to protect operations and ensure continued supply to customers.”

  • TFW hinted that near-term progress at Lightronics and Famostar may not be as positive as the past:

Economic and sector forecasts in the Netherlands are pessimistic; this will put some pressure on results in the next 12 months.” 

Other divisions

  • Among TFW’s smaller divisions, only TRT (street/tunnel lighting) reported positive progress. 
  • Full-year TRT revenue gained 14% to £10m following “several large scale projects”. 
  • Revenue at Portland (retail/hospitality lighting), Solite (cleanroom lighting) and Philip Payne (emergency lighting) meanwhile fell a collective 20% to £8m.
  • Aggregate profit from all the ‘Other’ businesses amounted to only £1.4m for the full year, and without TRT may have registered a loss. 
  • Selling lighting to shops and pubs in particular could be difficult during the current year. 
tfw fw thorpe fy 2020 results thorlux lights

LEDs

  • Recent years have seen TFW capitalise on an industry shift towards LEDs. The annual report revealed 90% of revenue now relates to LED products.
  • Adjusting for the Dutch acquisitions, group revenue between 2013 and 2020 improved by approximately 73% supported in part by the LED boom. 
  • These FY results implied LEDs had practically sold themselves: 

Sales of LED luminaires were relatively easy to achieve, primarily on the basis of significant energy savings and increased reliability.” 

  • These FY results gave a mixed update on the LED market:

Projects that can benefit from LED technology remain firm targets, such as where projects are still lit with luminaires using fluorescent lamps…Opportunities to replace non-LED lamps are, however, fewer now. Early LED installations are now eight to ten years old, so the replacement market will soon become a target again.

Group companies need to offer features beyond energy saving and reliability alone. Options include improving the quality of the white light from LED luminaires, reducing glare, and improving the ecological impacts of our product designs.

  • The LED shift underlines the technological treadmill TFW must continue to run upon.
  • A lot of treadmill running does not always produce instant success. A good example is the Flex System. 
  • The 2019 annual report devoted two full pages to this “radical approach to lighting”…
tfw fw thorpe fy 2020 results thorlux flex system
  • …yet the 2020 annual report mentioned the product just once in passing.
  • Has the Flex System flopped? Or will it come good during the next few years? 
  • For now at least, the Flex System does not yet seem to be ‘the next SmartScan’.

Financials

  • The term “robust balance sheet” was used five times within the 2020 annual report.
  • The balance sheet continues to carry an array of financial assets as well as sizeable ‘deferred considerations’:
tfw fw thorpe fy 2020 results balance sheet
  • Cash and term deposits ended the year at a record £63m. Other assets include investment property of £2m, loan notes of more than £2m plus an equity portfolio and an associate investment of close to £4m.
  • Conventional debt remains at zero. 
  • The chart below shows how the cash and term deposits have piled up over time:
tfw fw thorpe fy 2020 results sharepad cash and deposits
  • ‘Trade and other payables’ of £36m include almost £16m earmarked as deferred considerations for the former owners of Lightronics and Famostar.
  • These deferred considerations are due to be paid on or before 30 June 2021.
  • Cash and the various investments less the deferred considerations come to £56m or 48p per share.
  • I am sure TFW’s “robust” asset position helped reassure customers and suppliers that, during the lockdown, orders would still be completed and bills would still be paid.
  • Perhaps that is why the group could say its present order book was “healthy” and its daily orders were “good”.
  • Cash generation during the year was very respectable:
Year to 30 June20162017201820192020
Operating profit (£k)15,95918,18919,22517,35716,068
Depreciation and amortisation (£k)3,8003,9994,5955,0225,817
Cash capital expenditure (£k)(4,307)(7,286)(7,819)(5,473)(8,495)
Working-capital movement (£k)(909)1(241)2,234627
Cash (£k)33,20541,65943,95857,29063,002
  • Total capital expenditure once again exceeded the deprecation and amortisation charged against earnings. 
  • However, past differences have been due to TFW purchasing property — which should not lose its value in the way other plant and equipment can.
  • During the last five years, TFW has spent £14m acquiring freehold assets — which more than explains the £10m variation between the aggregate capex expense (£33m) and the associated depreciation and amortisation charge (£23m). 
  • Working-capital management was favourable once again, and supported total cash generation of approximately £12m. Dividends of £6m left £6m to bolster the cash position.
  • TFW’s defined benefit-pension scheme sported a £269k surplus, although the associated accounting does not always reflect the true-life demands of a final-salary plan. 
  • Important pension-scheme figures to consider are the benefits being paid and the plan’s asset value:
tfw fw thorpe fy 2020 results pension scheme assets and benefits
  • For TFW, paying annual benefits of £1.7m from scheme assets of £42.9m requires an investment return of 4.1%. 
  • Employee and employer contributions of £0.9m appear more than enough to sustain benefits of £2.1m should a market slump erode the £42.9m scheme assets.
  • Note that pension contributions of £170k bypassed the income statement — with the cash flow statement highlighting the expense:
tfw fw thorpe fy 2020 results cash flow
  • The lockdown caused a reduction to both operating margin and return on average equity:
Year to 30 June20162017201820192020
Operating margin (%)17.917.217.515.714.2
Return on average equity* (%)26.227.226.524.021.2

(*Adjusted for cash, various investments and Lightronics/Famostar earn-outs)

  • Both measures have been trending lower for a few years now.
  • The aforementioned lower profitability from larger projects within Thorlux is one reason for the declining group margin.
  • Other explanations (aside from the pandemic) may include:
    • Greater competition/loss of technical advantage;
    • Less profitable LED sales;
    • Higher SmartScan/new product investment, and/or;
    • The struggling/sub-scale smaller subsidiaries.
  • The return on average equity figures in the table above are adjusted by excluding TFW’s significant cash and investments.
  • Assume the cash and investments are essential to the business rather than ‘surplus to requirements’, and the 21.2% calculation for 2020 falls to a rather modest 10.6%.

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Valuation

  • TFW’s gloomy remarks concerning a “global recession” and a “downturn in orders” could herald a difficult year ahead.
  • Assuming a repeat of FY 2020 for FY 2021, operating profit of £16.3m translates into earnings of 11.4 per share after standard 19% UK tax.
  • Subtract the 48p per share net cash and investments from the 290p share price, and the underlying P/E might be 21.
  • The P/E rises to 25 if the cash and investments are in fact essential to the business and not really ‘surplus to requirements’.
  • The 21-25x rating appears generous given the Covid-19 uncertainty and the likelihood of stagnant near-term earnings. 
  • Perhaps investors are willing to apply a premium multiple for the reassurance of TFW’s ‘pandemic-proof’ balance sheet.
  • And/or perhaps investors are willing to apply a premium multiple because profits were sustained during the banking crash: 
tfw fw thorpe fy 2020 results sharepad profit history
  • And/or perhaps investors are willing to apply a premium multiple because of SmartScan going from nothing to revenue of £26m within four years.
  • In today’s growth-obsessed market, SmartScan could represent a disproportionate part of TFW’s £338m market cap.   
  • The 5.66p per share dividend meanwhile provides a modest 2.0% income. 

Maynard Paton

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