Are FW Thorpe shares a bargain?

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Are FW Thorpe shares a bargain?

FW Thorpe, then. Still doing great? Same old story?

Less of the old please, this is an old business making new products and doing very well out of it. Its resilient and adaptable - my two favourite qualities.

If a firm can make good profits and keep up with the times all we need to do is ride on its coattails, which is a lot easier than second guessing what's going to happen all the time and trying to jump off those coattails when they start looking a bit tatty.

Hang on, you're the one jumping, straight to the conclusion. I want to see the working out. What is FW Thorpe?

Do you want me to start at the beginning? In 1936, a man called Frederick William Thorpe founded a lighting company…

OK, skip the ancient history. How does it make money?

It makes luminaires, which is a technical term for light fixtures: the lenses, wiring, reflectors and controllers that make a light, all the gubbins except the lamp, which is a bulb to you and me. These days the lamps are mostly LEDs, which is why FW Thorpe has had to adapt.

Thorpe's luminaries are specified by architects and designers for commercial, industrial and public buildings as well as roads and tunnels.

Its biggest business and brand by far is Thorlux, founded by FW in 2013. It brought in 62% of revenue and 76% of operating profit in the year to June 2017.

But it also owns Lightronics, a Dutch subsidiary acquired in 2015 that specialises in outdoor and vandal resistant lighting, TRT, which it founded in 2013 to enter the market for street and tunnel lights, as well as small businesses that make lighting for shop-front signs, clean rooms, and emergency exits.

Last year, it made a 40% investment in Luxintec a Spanish firm that specialises in lenses and optics.

The businesses share expertise and, sometimes, manufacturing facilities and overseas sales offices. Thorpe earns 30% of revenue abroad by the way.

Sounds interesting. Our car's got LED headlights, we've converted the kitchen. They last longer, use less energy - right?

Yep… And they switch on and off instantly, they don't flicker like fluorescent lighting, or warm up slowly like energy saving incandescent lights. You can change the colour temperature without changing the lamp.

Lighting systems have become something of a high tech product with control systems that detect whether people are present and turn them on, off or dim them accordingly, saving more energy.

Thorpe can sell more expensive luminaires and promise better lighting and lower costs over the 10 years or more a luminaire lasts.

It's quite a compelling sales pitch don't you think?

Yep, I'm sold on LEDs, but Thorpe's hardly the only firm making them is it?

No, the whole industry's converting, but it looks like Thorpe's doing well out of it. Revenue growth has accelerated past £100 million in 2017 as LED lighting has caught on:

chart1

And profitability has held firm despite the cost of developing new product ranges, while maintaining older ones:

chart2

The company has invested, but it has hardly bet the farm. Typically, it has maintained a cash surplus equivalent to more than half of all the operating capital required by the business:

chart3

So what's special about Thorpe. I mean, apart from the numbers?

I think a lot flows from management, so let's dwell on the executives. They've been playing musical chairs.

Andrew Thorpe, grandson of FW, has just retired as chairman and co-chief executive after decades in charge. He's been replaced as chairman by his erstwhile co-chief executive Mike Allcock who joined the company as a technical apprentice in 1984. He's been replaced as co-chief executive by finance director Craig Muncaster. Muncaster remains finance director.

So Allcock runs the board now, and Allcock and Muncaster run the business as co-chief executives. I'm sure they remain very mindful of Thorpe, though, as not only is he a major shareholder but he remains on the executive board. His brother Ian, another major shareholder, is a non-executive director and James Thorpe, from the next generation has just joined the board as business development director of Thorlux.

The shared chief executive role and its combination with the chair are unusual, but this arrangement seems to have allowed for the maintenance of family influence and the promotion of talent.

They've pursued a pretty consistent strategy…

OK. Tell me about the strategy…

As you know, strategy is rarely about one thing. Thorpe says customers want a technical solution and support throughout the lifetime of the product warranty and beyond, which is why investment and financial strength are so important. Investment produces the technical solutions, financial strength ensures the company will be around to support them.

Its latest innovations are SmartScan, a wireless control system that earned £7 million revenue in 2017, its debut year, and the integration of optical technologies from Luxintec into some of Thorpe's outdoor ranges.

A company's strategy is often best defined by what it won't do. Specifically, Thorpe won't compete on price. Instead, it competes on value. It says:

"Thorlux never targets being the lowest capital cost supplier, instead it targets the lowest cost to the end user through the lifetime of a project after energy and maintenance costs are taken into consideration."

Some of what it saves the end-user in energy and maintenance costs by producing high quality products, it collects up-front in higher prices. This may be what makes it so profitable, at least in the UK where its reputation is highest.

Abroad, and in newer markets like streetlights and tunnels, where Thorpe's less well known, it may be a tougher pitch.

In 2017, a record year for the group, TRT, which stands for Thorlux Road and Tunnel, performed relatively poorly. The company's response pretty much sums up the strategy:

"TRT faces ongoing challenges from pressure in the market to reduce selling prices, and it is important that, like other Group companies, it finds features and benefits that customers will select and pay more for. Creating new product innovations is a high priority, together with tackling other growing pains."

Lightronics, the Dutch acquisition, has performed well, but it has failed to win big contracts for Thorpe's existing ranges in Europe. Thorlux thinks this too, will take time.

I'd say FW Thorpe has time to nurture TRT and Lightronics. It's highly profitable, so shareholders have few complaints, and its biggest shareholders are its far-sighted managers anyway.

Interesting. Anything else Thorpe won't do?

Lots, I'm sure, but Lightronics has reminded me about acquisitions. I like the way the new chairman phrases his company's cautious approach to buying growth, another reason its finances are in such good order:

"We have the financial capacity, so it could be said that it is easy to acquire, and there are indeed frequent options for us to review. To find the right acquisition – one that meets our criteria and does not become a future liability – is not as easy as it might seem."

Bit of a rhetorical question but just to confirm. You think Thorpe's going to prosper don't you?

Every year won't be a record year, indeed the company says 2017 will be a difficult one to follow, but I think Thorpe will prosper for a long time.

The directors are justifiably nervous about economic uncertainty due to unstable government and Brexit. They see geographical diversification as a way of mitigating that.

I also wonder about what happens when most offices, factories, hotels, shops, schools and hospitals have LED lighting, how far away that is, and whether sales volumes will fall.

There's no reason to believe that LED luminaires will need replacing any less frequently than their predecessors, and they'll be needed in new buildings, but demand must be unusually high now as customers recognise the benefits of upgrading, and so one would expect some normalisation once the upgrades are done.

But what about value? Is it a bargain.

You're not going to pick Thorpe up cheaply I'm afraid. The market likes what it sees. A share price of 350p values the enterprise at about £375 million, or about 24 times adjusted profit in 2017. The earnings yield is just 4%.

Contact Richard Beddard by email or on Twitter: @RichardBeddard.

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.