Smart Metering Systems (SMS)

 
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Stockwatch: A rare growth play

Projected to make nearly £25 million pre-tax profit in 2017, this £500 million AIM-listed business enjoys a tasty operating margin of over 36%. Installing and operating smart meters on behalf of energy companies, Smart Metering Systems' (SMS) focus on the high-revenue industrial and comercial markets that's led to its sucess.

Heavy investment in its gas and electricity metering portfolio boosted the total number of assets under management by 28% to 1.25 million at the end of 2016. Bosses haven't been shy about capital spending, forking out 48.6p per share compared to cash flow of 26p per share and earnings per share (EPS) of 16.8p.

Delving into September's interim results to end-June 2016, however, shows net cash generated from operations rose 34.4% to £15.4 million as net cash used for investment fell 33.3% to £14.5 million. The dynamics look to be altering favourably for shareholders, possibly over a capex hump.

Towards the end of 2016, SMS installed 51,000 domestic smart meters - these contracts were signed with some of the UK's "fastest-growing energy suppliers" throughout the year - with eight energy suppliers serving 2.5 million homes.

Relatively new and small, the consumer switch from the big six suppliers is accelerating this growth. SMS had a 2.8% hold on the domstic gas meter market in 2015 and a 1.4% share of electricity meters. The group has added around 400,000 domestic smart meters (20% of the UK market) with the acquistions of CH4 and Trojan. It's unknown whether the pair will continue installing domestic metres now under the SMS wing, but it's clear these acqusitions position the company well for their ongoing domestic roll-out.

Another question is the margin upshot as energy prices rise. Npower's shock 10% hike to its average energy bill could spread to other suppliers, or controversy could check margins.

A regulatory response seems unlikely because it would be a reaction against smart meters, whose advocates proclaim better energy efficiency.

But energy firms may review contracts with companies like SMS if energy price rises lead to consumers switching suppliers. Since meter contracts are with energy firms and not households, it's unclear how consumers switching suppliers would leave the status of the meter. So mind how all this works out in real life, versus the government crusade.

Capital growth to income play?

The 3 February update cites total annualised recurring income up 20% to £41.3 million, driven by electricity meter recurring rents more than doubling and those for gas rising 13%. This is relevant for earnings quality and dividend growth where the forward price/earnings (PE) multiple is currently about 25 times and the yield is sub-1% after the stock's recent re-rating.

I initially drew attention at 111p in April 2012 and at 324p exactly two years ago; after advancing to test 610p last year it currently trades at about 560p. So it's priced very much as a growth play, helped by an easy-to-grasp story as smart meter installation gathers pace.

The government wants to get as many households as possible onto smart metering by end-2020, so sparkling growth rates could continue for another four years, potentially above the 20% projected for 2017.

A relatively tight market (normal size of 2,000) also means a PE multiple in a twenties range is likely sustainable, amid a scarcity of growth stocks.

Last September's interims showed underlying pre-tax profit up 15% to £9.2 million on revenue up 25% to £32.5 million with underlying earnings per share rising 23% and the interim dividend by 25%.

But at some point the market will try to anticipate when installation rates will peak, which could de-rate the PE and price the stock to exact a yield sufficient to attract income-seekers as growth investors exit.

It depends how the financial dynamics evolve: whether capital expenditure reduces substantially to free up much greater funds for distribution, also the sustainability of margins. Will smart metering prove an enduring solution, only to get more competitive? In the US there are claims of utility bills jumping by a third after smart meters have been installed, and stories of billing woes here.

Probably they are teething problems that won't stop the march of new technology, but some adoption risk is involved.

Debt-funded growth

SMS's figures benefit from acquisitions such as CH4 Gas Utility and Maintenance Services, Trojan Utilities and Qton Solutions, as part of strengthening the group's installation and IT support capability for UK smart meter roll-out. Yet the company hasn't recently had to dilute equity (apart from share options), a moderate 89.5 million shares issued help profits drop through to EPS.

It appears a very bankable proposition: last March a £150 million revolving credit facility was established to fund the full value of meters acquired for installations, the end-June 2016 balance sheet showing long-term debt up 22.6% to £77.4 million and short-term debt up 31.8% to £12.4 million.

Meanwhile, cash jumped from £2.7 million to £9.3 million meaning £80.5 million net debt that required £1.2 million interim interest costs, 8.7 times by operating profit. So while net gearing of 139% may raise a few eyebrows, it's manageable. As of end-June, available cash and unutilised debt facility comprised £69.5 million.

Director buying

Despite the 2016 share price rise, insiders haven't hedged their bets by selling stock; indeed, the last such announcement in September involved a non-executive director buying 4,650 shares at 545.5p to own 14,650 overall. The chief executive owns just over 8% of SMS.

It's possible this stock now consolidates before the late March prelims - "in line with expectations" - assert the growth story in more detail. But the odds favour upside on a two to three-year view before the market questions this purple patch of growth.

SMS - financial summary Broker forecasts
year ended 31 Dec
2011 2012 2013 2014 2015 2016 2017
Turnover (£ million) 16 21 27.9 42.4 53.9    
IFRS3 pre-tax profit (£m) 3.3 5.2 7.5 11 17.5    
Normalised pre-tax profit (£m) 3.6 6 7.5 11.7 17.5 20.6 24.6
Operating margin (%) 25.9 31.8 29.3 31.5 36.3    
IFRS3 earnings/share (p) 2.9 5 7.4 10.1 16.8    
Normalised earnings/share (p) 3.3 5.9 7.4 10.8 16.8 18.2 21.8
Earnings per share growth (%) 118 76 26.4 45.1 55.7 8.4 20
Price/earnings multiple (x)         33.7 31.1 25.9
Price/earnings-to-growth (x)    0.63.71.3

Annual average historic PE

  48.848.4322630.6
Cash flow/share (p) 6.7 9.2 7.5 27.6 26    
Capex/share (p) 12.8 20 29.2 42.7 48.6    
Dividends per share (p)   0.5 1.9 2.6 3 4 4
Yield (%)         0.5 0.7 0.8
Covered by earnings (x) 14 12.2 4.3 4.4 5.9 4.6 5.5
Source: Company REFS

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.