SMALL CAP SHARE IDEAS: Electrical components supplier Discoverie stands to gain from shift towards automation accelerated by Covid
After some disruption from Covid-19, Discoverie Group’s trading update this month underlined the company was again on the front foot and looking to expand.
The electrical components supplier has already come a long way in a relatively short space of time. Formerly known as Acal, the group has grown ten-fold since 2009, but there seems every chance it will become a lot larger.
That decade of expansion has been fuelled by a combination of acquisitions and organic growth and Nick Jefferies, the company’s chief executive, says it is already working through the plan for the next five years.
Automation: The World Economic Forum forecast half of the jobs previously carried out by people will be automated by 2025 – and Discoverie could benefit from this
A pipeline of potential purchases has been identified, he says, all of which fit in with the Discoverie ‘style’ and focus on its target markets of renewables, industrial processes, medical equipment and transportation.
It has echoes of how Halma, one of the UK’s most successful companies, went from a modest base to the FTSE 100.
Halma started in markets such as controls and fire protection products and has grown steadily by buying businesses that complemented its range.
In a similar vein, CEO Jefferies say identifying companies with the same DNA and way of thinking is key to the acquisition plans.
Whether Discoverie can be as successful as Halma remains to be seen, but it is certainly in the right areas. Product trends, for example, are moving in the company’s favour.
While automation was well underway before the coronavirus outbreak, the impact of the pandemic is accelerating the process according to a recent report from the World Economic Forum.
That study forecast half of the jobs previously carried out by people will be automated by 2025. To keep these machines running will require components of the type supplied by Discoverie.
Customers are international businesses based in Europe, the US and increasingly Asia and developing long-term relationships is another key part of the Discoverie strategy.
As it has grown larger, those ties have helped the company move up the value chain. Profit margins have risen steadily and were running at 8.5 per cent at the end of the last financial year to March.
Chief executive Jefferies says that to raise them to 12.5 per cent over the next five years is the aim. It is ambitious and selective acquisitions will play a decisive part.
In a typical deal, Discoverie announced the purchase of US sensors business Phoenix alongside this month’s trading update.
Costing $11million, Phoenix generated sales of $6.4million in 2019 and supplies industrial firms with magnetically actuated sensors and encoders.
The acquisition process is something the company is very familiar with now, having made fifteen such design and manufacturing purchases since 2011 at a cost of more than £245million.
According to broker Berenberg, there will be more as it says the ‘market for customised electronic components is extremely fragmented and of consists of many sub-scale designers that lack the distribution channels to unlock their full value’.
Discoverie ended its last financial year to March with a record order book, which is a clear indicator that the strategy works believes Nick Jefferies.
How the pandemic develops will have an impact in the current financial year, but management was sufficiently confident about the prospects to reinstate the dividend this month.
Having facilities in 27 countries also gives it the flexibility to cope if one area is badly affected.
The recent trading update showed sales starting to recover from the effect of the pandemic and, assuming no further disruption, revenues are predicted by brokers to push ahead again in the second half.
Forecasts for the year to March 2021 are for revenues of around £440million and underlying profits of £44million, rising to £392million and £54million in the following year.
On some yardsticks that might look punchy given the current market value of £550million at 620p, which is close to the all-time high.
The same argument though could have been made two or even four years ago, since when the share price has risen by 50 per cent and 125 per cent respectively.
Jefferies adds that is it is when recovery from COVID-19 comes through it will reap the full benefits of the strategy, but he is not waiting for that.
‘We have a clear map of we want to buy to keep the story developing and growing.’
One to buy for the long-term.