Tristel (TSTL)


Tristel: Caught in the expectations trap

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Tristel’s share price has dived because it’s not doing as well as managers led credulous investors to believe it would. That isn’t to say it’s doing badly.

Maybe it was the harsh office lighting, maybe it was the gruelling two-day schedule of schmoozing in the City, but my first impression when tuning into Tristel’s interim results webcast on Thursday was that chief executive Paul Swinney and finance director Liz Dixon could do with a good night’s sleep.

Maybe the near 35% drop in the share price on Wednesday kept them awake.

It’s not often a company announces a 36% rise in pre-tax profit (before share based payments), strong cash flow, and that happens.

To their credit, Swinney and Dixon were facing the public and they started with the substantive issues: a slower than expected growth rate and a £1m charge for a windfall in shares enjoyed by staff and executives. It’s larger than usual by a factor of more than ten, and enough to wipe much of the profit out.

Revenue growth has stalled in the UK, and although revenue abroad grew 20%, overall revenue was up just 8% compared to the same period the previous year. The results dashed investors’ expectations set by management’s revenue target of £20m by 2017, a target that implied roughly 15% annual growth. The company no longer believes it will achieve that. With 64% of revenue earned in the UK, the limits it’s reaching at home are a drag on growth.

Tristel manufactures disinfectant products mostly for hospital outpatient departments. Its proprietary formulation and patented foams and wipes have taken a big share of the market in the UK, and may well repeat the trick worldwide.

The company explains high levels of market penetration and financial crisis in the NHS did the damage.

Its big three customers are cardiology, ENT, and ultrasound departments. Only in ultrasound, where Tristel has 50% of the market, is there much room for growth. It has a 78% market share in ENT, and a 95% share in cardiology.

The adoption of Tristel’s products is slowing in other departments, as well as hospitals that have yet to adopt them, because of financial austerity. Though infection control officers want them, their managers won’t allow them to make the switch.

The outlook for profit is better. Tristel is still comfortable with another published target, 15% net profit margin or more. Rising profit margins may come from increasing efficiencies as it grows, and as the company axes some older low-margin and loss-making disinfectants.

Some of the exceptional share price charge is probably innocuous, the result of staff share options vesting as the share price has risen from its 20p low in 2013. The more dubious part relates to the vesting of share options granted to Liz Dixon and Paul Swinney in April 2015, in a Long Term Incentive Plan that’s proved to be anything but long-term.

Maybe we shouldn’t have been surprised, the scheme was announced in August, when the two executives were granted options exercisable for one penny that would vest if the share price rose above 134p and remained there for 30 consecutive days, which it did, just, from late November 2015 to early January this year. In other words, Swinney and Dixon received a windfall, vesting is when the shares become theirs, just because the share price had risen so strongly.

I don’t think this is sensible remuneration. And I don’t think Dixon and Swinney do any more. Dixon reassured us the charge was a one-off, and Swinney stressed he wanted to go on the record to say it wouldn’t happen again, although he qualified the statement by saying not in the next three, four or five years.

But investors were encouraged in their beliefs by Tristel’s unfulfilled revenue target, which puts me in two minds about company.

It’s one of the most investor friendly companies I know. And I applaud the way it explains its business. But Tristel had a pretty good idea what its revenue for the half-year would be at the AGM in December just before the half-year ended and while the shares were trading above the magical 134p mark. It gave us a favourable profit forecast but declined to tell us the less favourable revenue figure even though it had divulged this information in previous years. I know, because I was there, and I asked*.

I don’t know the reason for silence, but the subsequent drop in the share price to little more than 100p when the revenues were divulged on Wednesday suggests the directors may not have got their payoff (contingent on the share price remaining above 134p) if they had disclosed lower revenue growth at the AGM.

The lesson for investors, is not to be seduced by management targets but recognise they are ambitions that may not be fulfilled. We should make our own, usually more conservative, expectations. Oh, and to scrutinise mundane looking announcements about share options more carefully.

Tristel’s a good business, its domination in the UK validates management’s claim that it’s moving, albeit only as fast as the regulatory approval process will let it, into pretty uncontested markets. I’m confident it will grow.

I hope it remains open with shareholders. But I also hope it takes a step back from precise financial targets. Swinney says Tristel’s agonising how to frame expectations for the next few years, when regulatory approval for two products in the USA is anticipated.

The USA is the world’s biggest healthcare market and according to Tristel has no comparable product. There’s plenty of room for excitement, but I would urge caution, and, as Swinney and Dixon promised, they should not allow their remuneration to be pegged to achieving a share price that could swing wildly based on what they say, and may not deliver.

*Another investor, Maynard Paton put me up to it. He has much more to say on this.


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