The Share Sleuth portfolio is Richard Beddard's hand-picked collection of mostly small-cap value shares. You can keep up to date with its progress here.
Share Sleuth's June Watchlist
Richard Beddard introduces a handful of companies with the right credentials to go on his Watchlist. He analyses their key strengths and reveals a few nagging weaknesses.
The analogue printing industry is giving way to digital, with different sectors rolling over at different rates. Digital printhead manufacturer Xaar (XAR) is one of the agents of change.
The adoption of Xaar's 1001 printhead for decorative printing by the ceramics industry has doubled the company's turnover in three years. It is increasing production capacity for Platform 3, the current generation of printheads, and pushing ahead with research and development for the next generation, Platform 4.
Xaar's patented technology promises higher quality and reliability, while manufacturing the printheads requires custom equipment that is difficult to replicate.
The company has made big inroads into markets around the world, and although 64% of revenues now come from ceramics, P3 technology can print on laminates (flooring, cladding and furniture) and labels. P4 promises even more applications.
The company has opportunities to grow and is investing in them from a position of financial strength. However, it faces risks that might cause investors to curb their enthusiasm, especially given that Xaar shares are expensive relative to earnings while yielding just 3%.
Demand for Platform 1 printheads - for graphic arts and packaging - has been declining since competitors entered the market but Xaar launched P3 in 2007 - when the credit crunch led to a slump in demand for printers.
At the same time, new applications demanded a bigger sales push and more support for printer manufacturers adopting the new printheads - underlining the point that each time Xaar extends its technology, it must persuade manufacturers to use it. The increased costs and lower sales scuppered profits in 2008 and 2009.
Investors foreseeing uninterrupted growth may find it comes in lumps.
Like Xaar, investors have re-rated Dialight (DIA) since 2009, based on its rapid growth since it entered a new market.
Dialight is an LED lighting and component manufacturer. Prior to 2009, it had concentrated on traffic lights, obstruction signals that warn aircraft of lofty structures, and components for servers and network equipment, for example. Then it launched a range of LED lights for industrial facilities.
The company's LED pedigree goes back as far as 1990, and since 2005 it has focused on lighting. This year the industrial lighting segment grew 73%, and the company doubled the size of its sale force in preparation for future growth.
The result is resplendent finances, a lofty share price, a somewhat off-putting valuation and an earnings yield of just 4%.
Dialight claims a number of firsts in its 2012 results: it has produced the first 100 lumen/watt product (the most efficient lighting) and it is the first company to offer a 10-year guarantee on some products - a mark of reliability.
These qualities, the company says, are vital to heavy industry, oil and gas production, power generation, manufacturing, and food and beverage production, where around-the-clock operations are common and companies can't shut down easily. The company promises a 50% reduction in energy costs and uninterrupted lighting.
FW Thorpe (TFW), a competitor, has reported that the adoption of LED lighting systems, which last longer than conventional ones and save energy, is slowing as some customers balk at the higher initial cost. However, Dialight's customers aren't being put off.
That doesn't make Dialight a good investment at its current share price. But with so much growth expected, there's little room for disappointment.
Bunzl (BNZL) is a big company with sales of more than £2 billion in North America and total sales exceeding £5 billion - most of the rest is in Europe.
Scale is Bunzl's competitive advantage, so acquisitions, often regarded sceptically by investors, are an important aspect of the company's strategy, and its value. Bunzl has made 70 acquisitions since 2004, with 13 of those in 2012. Since 31 December it has made three more.
The company supplies a huge range of consumables - packaging, cleaning and hygiene supplies, safety equipment and workwear - to retailers, hospitals, hotels, and construction and industrial companies. The range offered allows customers to consolidate their suppliers, reduce costs and liberate space for profit-generating activities.
Bunzl's warehouse and distribution network can supply customers wherever they operate. Where there are gaps in its network, it fills them by gobbling up a local rival. The bigger the company gets, the more efficient it becomes.
Bunzl's scale enables it to get good terms from suppliers, while the efficiency of the service and the savings for customers mean it can charge enough to profit handsomely.
Such stable growth is probably worth paying well for, on the assumption that it will continue, especially since Bunzl supplies vast global growth markets. However, its lease obligations mean it is quite heavily indebted, which could prove debilitating should growth falter.
The current share price puts Bunzl on an earnings yield of just 4%, so it may not be worth the risk.
Senior (SNR) manufactures structural components for airframes and engines as well as ducting, pipework and hoses. It has positioned itself in industries demanding continual improvements in efficiency to reduce fuel costs and emissions. Its 2012 results - the latest in a positive series - showed healthy growth in turnover and profit, and a reduction in debt.
Boeing (BOE) and Airbus are currently redesigning their most popular aircraft, the B737 and the A320 respectively, which account for 73% of all large aircraft sales. Senior expects to provide a bigger proportion of the components needed to make the planes than it has in the past.
Senior will also contribute more of the new Boeing 787 Dreamliner's complete shipset (all the components required for a plane) by value than it has for any other plane. The company's profitability depends on demand for planes and motor vehicles, but aircraft manufacturers are reporting record orders.
In 2012, 51% of the aerospace division's sales came directly or indirectly from large planes manufactured by the Airbus/Boeing duopoly, so investors should expect profitability to fluctuate with the development cycles of Airbus and Boeing, as well as passenger numbers, the cost of raw materials and general economic conditions.
There are other reasons to be wary. Between 2002 and 2004 aircraft orders declined because of recession, while the Sars epidemic, which temporarily reduced air travel, ate into Senior's profitability.
If the current level of profitability is sustained, Senior could be reasonable value on an earnings yield of 7%. However, a dip in profitability will probably happen at some point, and that might be a better time to buy shares in a good company in a cyclical market.
Croda's (CRDA) share price has risen more than fivefold since 2005, mainly in the past few years. Unbroken profit growth stretches back to 2000.
The company manufactures ingredients that end up in consumer care products (haircare, skincare and cosmetics), fungicides, insecticides and herbicides, industrial lubricants and plastics, and detergents and other home care products.
Its strategy is eerily familiar, possibly because chairman Martin Flower is also a director of Morgan Advanced Materials (MGAM) and Low & Bonar (LWB). It operates globally, although Europe is its biggest market, and it is expanding research and development and sales most aggressively in Asia and Latin America, where the strongest growth is likely to be.
In consumer care, where it earns impressive returns, Croda maintains its position by capturing new technology - through, for example, the recent acquisition of an Italian biotech company that uses plant stem cells to produce leaf, flower and seed tissue without the fertilisers and water usually required.
Croda plans to lift profit margins in a division that produces additives for lubricants and plastics through specialisation, and maximise the profitability of industrial chemicals through cost control. Specialisation and technological leadership rolled out globally is a strategy followed by many highly profitable companies. They tend to shed less profitable non-core businesses and develop or acquire businesses in more lucrative niches.
To remain highly profitable Croda has to stick to a plan it has been following for years. However, an earnings yield of 5% indicates investors expect growth and the share price is accordingly high.
The share prices of all five companies may have drifted away from the levels most value investors would pay, but companies that get away sometimes come back, which is why they are on the Watchlist.
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