Acal — Update 6 December 2016

Acal

Positive outlook

H117 results

Industrial support services

6 December 2016

Price	227.0p
Market cap	£146m
€1.19:NOK10.67:£1
Net debt (£m) at end H117		41.1

Shares in issue	64.2m
Free float	99%
Code	ACL

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	2.5	(9.6)	(18.9)
Rel (local)	1.6	(7.7)	(24.1)

52-week high/low

285.00p

204.50p

Business description

Acal is a leading international supplier of customised electronics to industry. It designs, manufactures and distributes customer-specific electronic products and solutions to 25,000 industrial manufacturers.

Next events

Trading update

February 2017

Analysts

Katherine Thompson	+44 (0)20 3077 5730
Dan Ridsdale	+44 (0)20 3077 5729

tech@edisongroup.com

Edison profile page

Acal is a research client of Edison Investment Research Limited

Acal’s H117 results reflected the weaker demand that was previously flagged combined with positive FX trends. Design & Manufacturing (D&M) continues to grow as a proportion of total revenues and profits and management has raised its targets for this part of the business. The company continues to consider further acquisitions, recently increasing its debt facility to support its growth strategy. The outlook for FY17 is unchanged – based on H117 order inflow, H217 is expected to be stronger and we leave our earnings forecasts substantially unchanged.

Year end	Revenue (£m)	PBT* (£m)	EPS* (p)	DPS (p)	P/E (x)	Yield (%)
03/14	211.6	6.9	13.1	6.8	17.3	3.0
03/15	271.1	12.4	16.4	7.6	13.8	3.3
03/16	287.7	15.2	17.8	8.1	12.8	3.6
03/17e	321.7	16.4	18.4	8.4	12.3	3.7
03/18e	331.3	17.7	19.3	8.5	11.8	3.7

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

H117 results reflect weaker economy & currency

Acal reported H117 revenue growth of 10%, although stripping out the effects of currency and acquisitions, organic revenues declined 7% y-o-y. Underlying operating profit and EPS grew 14% and 10% respectively. The company had already flagged the challenging trading conditions in H1, and reacting to this, launched an efficiency programme which aims to generate cost savings of £4m pa. Despite short-term economic weakness, management has raised its mid-term targets (originally set two years ago), looking for a higher contribution from D&M, stronger operating margins, and growth in international revenues.

Order pick up; FY17 outlook maintained

Order recovery from Q217 and the record period-end order backlog supports management’s confidence that the outlook for FY17 is unchanged. We have raised our revenue forecasts to reflect the weakness of sterling since June (80% of revenues are generated outside of the UK) although our operating profit forecasts are substantially unchanged, reflecting the impact of non-sterling costs.

Valuation: Unwarranted discount

The stock has declined from its recent 280p high in October and is trading at a discount to the peer group average on EV/EBITDA and P/E multiples. These results should go some way to reassuring investors that underlying trading is returning to a healthier situation and that management is willing to take action to maintain profitability in the shorter-term as well as focusing on the longer-term evolution of the business. Increasing geographic coverage, integration benefits and the cross-selling potential of recent acquisitions, and a growing proportion of revenue generated from design and manufacturing should support revenue growth above market levels and operating margin expansion. The stock is supported by a dividend yield above 3%.

Review of H117 results

Exhibit 1: H117 results highlights

£m	H117	H116	y-o-y
Revenues	156.7	142.2	10.2%
Gross profit	51.7	44.9	15.1%
Gross margin	33.0%	31.6%	1.4pp
Normalised** operating profit	9.1	8.0	13.8%
Underlying* operating profit	8.8	7.7	14.3%
Reported operating profit	3.4	5.8	-41.4%
Normalised net income	5.9	5.4	9.2%
Adjusted net income	5.7	5.2	9.6%
Reported net income	1.2	3.6	-66.7%
Diluted EPS (normalised**) – p	8.8	8.1	8.9%
Diluted EPS (underlying*) – p	8.5	7.7	10.4%
Diluted EPS (reported) – p	1.8	5.4	-66.7%
Net debt	41.1	21.9	87.7%

Source: Acal, Edison Investment Research. Note: *Excludes amortisation of acquired intangibles, exceptional items and IAS 19 pension charge. **As for underlying, also excludes share-based payments.

Exhibit 2: Half-yearly divisional results

Revenues	H117	H116	H116 CER	Reported y-o-y	CER y-o-y	Organic y-o-y
Design & manufacturing	81.8	65.9	72.4	24.1%	13.0%	-4.0%
Custom distribution	74.9	76.3	83.5	-1.8%	-10.3%	-10.0%
Total revenues	156.7	142.2	155.9	10.2%	0.5%	-7.0%
Underlying* operating profit
Design & manufacturing	10	7.7	8.5	29.9%	17.6%
Custom distribution	1.6	2.6	2.8	-38.5%	-42.9%
Unallocated	-2.8	-2.6	-2.6	7.7%	7.7%
Total underlying* operating profit	8.8	7.7	8.7	14.3%	1.1%
Operating margin
Design & manufacturing	12.2%	11.7%	11.7%	0.5pp	0.5pp
Custom distribution	2.1%	3.4%	3.4%	-1.3pp	-1.2pp
Total operating margin	5.6%	5.4%	5.6%	0.2pp	0.0pp

Source: Acal. Note: *Excludes amortisation of acquired intangibles, exceptional items and IAS 19 pension charge.

Acal reported 10% revenue growth in H117, which was boosted by acquisitions in H216 and the weaker pound since the Brexit vote. At constant exchange rates (CER) revenues grew 1% y-o-y and organic revenues (which include pre-acquisition sales of Flux, Contour and Plitron) declined 7% y-o-y. On a divisional basis, D&M saw a 4% decline in organic revenues, after weakness in the Nordic region resulting from the lower oil price. CD saw a 10% decline in organic revenues – this was expected based on the year-end order book and taking into account a large one-off order that was fulfilled in H116. The company noted that organic order intake declined 1% in H117, but rose 3% in Q217.

Gross margins increased to 33%, the highest level to date, helped by the higher proportion of D&M sales. The weaker CD revenues resulted in a lower underlying operating margin for the division. Conversely, D&M operating margins increased y-o-y and D&M now makes up 86% of profit contribution (H116 75%).

Exceptional charges included £2.6m for the efficiency programme (more detail below), £0.5m for integration of acquisitions and £0.3m in earn outs. The effective tax rate of 22% was lower than the 24% we were forecasting for FY17 owing to successful conclusion of several tax audits (this is unlikely to repeat in H217). Underlying EPS grew 10% y-o-y, in line with reported revenue growth.

The company announced an interim dividend of 2.45p, 5% higher than a year ago.

Business update

Restructuring underway

In July, the company announced restructuring within the D&M division and expanded this to the CD division several months later. The efficiency programme is expected to cost £8m in FY17, of which £2.6m was incurred in H117. This should result in cost savings of £4m pa. On a divisional basis:

■

Custom Distribution: Acal is closing the Spanish business as it has been loss-making for some time. The company is also reducing the number of country managers, instead shifting to a regional management structure. To reduce costs, the business is integrating purchasing functions.

■

Design & Manufacturing: the company already announced that it had closed three Nordic manufacturing facilities and transferred production to other lower-cost facilities.

Upward revision to medium-term targets

With these results, management has raised the medium-term targets it originally set in November 2014. We show below the progress the company has made with its KSIs and KPIs over recent years, and the revisions to the medium-term targets.

The company expects to achieve the higher proportion of D&M revenues through a combination of organic growth (D&M is growing faster than CD) and acquisitions. As D&M businesses tend to generate double-digit operating margins compared to the low- to mid-single digit margins generated by CD, this should automatically raise the group operating margin. We would expect the company to take North American and/or Asian presence into account in future D&M acquisitions.

Exhibit 3: Key strategic indicators (KSIs) and key performance indicators (KPIs)

Key Strategic Indicators						Previous	New
Key Strategic Indicators	FY10	FY14	FY15	H116	H117	mid-term target	mid-term target
Increase Design & Manufacturing revenue	c 5%	18%	37%	46%	52%	65%	75%
Increase underlying operating margin	-0.3%	3.4%	4.9%	5.4%	5.6%	7.0%	8.5%
Build sales beyond Europe	0%	5%	12%	16%	18%	20%	30%
Key performance indicators							3-yr target (FY20)
Organic sales growth	-16%	2%	3%	2%	-7%		Well ahead of GDP
Increase cross-selling		£0.3m	£0.9m	£1.5m	£1.9m		£10m pa
Attractive ROTCE		24%	24%	23%	22%		>25%
Generate strong free cash flow		86%	76%	74%	88%		>75% of PBT
Generate long-term value for shareholders (3 yr TSR)		5%	101%	78%	23%
Percentile (vs FTSE small cap index)		71st	20th	18th	39th		Upper quartile

Source: Acal

Appointment of new Chairman

The current non-executive chairman, Richard Moon, has announced his intention to step down on 31 March 2017. The board has appointed Malcolm Diamond (currently a non-executive director) to take over the role of non-executive chairman from 1 April 2017. Malcolm is currently the executive chairman at Trifast, and will move from executive to non-executive chairman from 1 April 2017.

Outlook and changes to forecasts

Order inflow supports stronger H217

Acal closed H117 with a record period-end order book (£94m vs £85m at the end of FY16). Orders received in H117 increased 18% y-o-y (8% CER), helped by growth in orders for new projects and the pull-in of orders on existing projects (until recently, customers had been deferring orders). We note that the company has received a large order in CD since the end of H117 which should be delivered in H217. Management’s full year expectations are unchanged.

Debt facility increased and extended

In H117, the company increased its syndicated debt facility from £90m to £120m and extended the term from July 2019 to July 2021. The company also has a £30m accordion facility, taking total potential debt facilities to £150m. At the end of H117, the company had used £62m of its facility, and with cash of £21m had a net debt position of £41m. This leaves the company with significant headroom to make further acquisitions.

Net debt/EBITDA stood at 1.9x at the end of H117 – the company expects this to be in the range 1.7-1.8x by the end of FY17 and aims to remain below 2x.

Mixed effect from currency moves

Around 80% of revenues are generated outside of the UK. As sterling has weakened against all the currencies in which Acal transacts, this is having a positive translational impact on non-sterling revenues (eg H117 reported revenue growth of 10% vs CER revenue growth of 1%). In the UK, the majority of material/component costs are US$-denominated and Acal is not able to immediately pass on all of the price increase to customers – this is having a negative impact on UK gross margins. The company hedges transactional exposures from order through to payment.

Changes to forecasts

We have revised up our revenue forecasts to reflect the weakness of sterling against the euro, Nordic currencies and US dollar. As this also affects Acal’s cost base, our normalised/underlying operating profit forecasts are substantially unchanged. We have factored in the £8m cost of the efficiency programme in FY17. Our net debt forecast increases to take account of the higher exceptional costs partially offset by better working capital management.

Exhibit 4: Changes to forecasts

£m	FY17e old	FY17e new	Change	y-o-y	FY18e old	FY18e new	Change	y-o-y
Revenues	309.8	321.7	3.9%	11.8%	319.6	331.3	3.7%	3.0%
Custom distribution	150.8	153.1	1.6%	2.0%	153.0	155.4	1.5%	1.5%
Design & manufacturing	159.0	168.6	6.0%	22.5%	166.5	175.8	5.6%	4.3%
Gross margin	32.8%	33.0%	0.2%	0.8%	32.8%	33.0%	0.2%	0.0%
Underlying operating profit	18.7	18.7	0.2%	14.7%	19.9	19.9	0.0%	6.6%
Underlying operating profit margin	6.0%	5.8%	-0.2%	0.1%	6.2%	6.0%	-0.2%	0.2%
Normalised operating profit	19.5	19.4	-0.3%	14.1%	20.7	20.7	0.0%	6.9%
Normalised operating margin	6.3%	6.0%	-0.3%	0.1%	6.5%	6.3%	-0.2%	0.2%
Normalised PBT	16.5	16.4	-0.4%	7.8%	17.7	17.7	0.0%	8.2%
Normalised net income	12.5	12.5	0.0%	6.1%	13.4	13.4	0.0%	6.7%
Normalised EPS (p)	18.4	18.4	0.0%	3.1%	19.3	19.3	0.0%	5.2%
Reported EPS (p)	11.7	1.5	-86.9%	-86.5%	13.2	12.6	-4.2%	721.8%
Net (debt)/cash	(38.1)	(43.1)	13.1%	13.2%	(35.4)	(40.3)	13.8%	-6.7%

Source: Edison Investment Research

Valuation

The table below shows key valuation and operating metrics for Acal and its peer group. The stock has declined from its recent 280p high in October and is currently trading at a discount of 30% for FY17e and 26% for FY18e on a P/E basis and 25% for FY17e and 23% for FY18e on an EV/EBITDA basis. We believe that H117 results should go some way to reassuring investors that underlying trading is returning to a healthier situation and that management is willing to take action to maintain profitability in the shorter term, as well as focusing on the longer-term evolution of the business. Continued growth in the proportion of revenue generated from design and manufacturing should support revenue growth above market levels and operating margin expansion, and should help to reduce the discount to peers.

Exhibit 5: Peer group valuation metrics

	EV/Sales (x)			EV/EBITDA (x)			P/E (x)			Dividend yield (%)
	Last yr	This yr	Next yr	Last yr	This yr	Next yr	Last yr	This yr	Next yr	Last yr	This yr	Next yr
Acal	0.6	0.6	0.6	9.2	8.2	7.7	12.6	12.2	11.6	3.6	3.7	3.8
Specialist distributors
Diploma	2.7	2.5	2.4	14.9	13.5	12.9	22.3	20.1	19.1	2.0	2.3	2.5
Solid State	0.9	0.9	0.9	7.5	10.4	9.8	8.1	12.9	12.0	2.9	3.0	3.1
High service & commodity distributors
Brammer	0.4	0.4	0.4	7.5	9.4	8.2	11.4	16.1	12.4	6.3	4.4	4.9
Electrocomponents	1.7	1.5	1.4	19.2	14.3	13.0	35.5	24.0	21.4	2.6	2.6	2.7
Design & manufacturing
E2V	1.7	1.5	1.5	7.5	6.7	6.2	11.9	11.7	10.7	3.0	3.3	3.5
Gooch & Housego	2.6	2.3	2.1	12.9	11.2	10.1	23.6	20.9	18.7	0.9	1.0	1.1
XP Power	3.1	2.7	2.5	11.4	10.6	9.6	16.9	16.4	14.7	3.7	3.9	4.1
Total average	1.9	1.7	1.6	11.6	10.9	10.0	18.5	17.4	15.6	3.1	2.9	3.1

Source: Thomson

Exhibit 6: Peer group operating metrics

	Gross margin			EBITDA margin			EBIT margin			Revenue growth
	Last yr	This yr	Next yr	Last yr	This yr	Next yr	Last yr	This yr	Next yr	Last yr	This yr	Next yr
Acal	32.2%	33.0%	33.0%	6.9%	6.9%	7.2%	5.9%	6.0%	6.3%	6.1%	11.8%	3.0%
Specialist distributors
Diploma	35.9%	36.5%	36.5%	18.3%	18.2%	18.3%	17.2%	16.8%	16.9%	14.6%	11.4%	3.5%
Solid State	31.8%	28.1%	28.2%	11.6%	8.4%	8.7%	10.2%	7.5%	7.8%	20.6%	-1.1%	3.4%
High service & commodity distributors
Brammer	30.9%	30.0%	30.7%	6.0%	4.7%	5.1%	4.7%	3.3%	3.8%	-0.9%	2.3%	4.1%
Electrocomponents	43.5%	43.8%	43.9%	8.6%	10.2%	10.8%	6.4%	8.2%	8.8%	2.0%	12.9%	4.3%
Design & manufacturing
E2V	40.3%	41.4%	41.6%	22.4%	23.0%	23.6%	17.8%	18.2%	18.7%	5.5%	8.1%	5.1%
Gooch & Housego	40.6%	41.6%	41.6%	20.3%	20.4%	21.3%	16.5%	15.9%	15.6%	6.0%	15.0%	6.8%
XP Power	49.8%	49.2%	49.4%	27.1%	25.2%	25.9%	23.6%	21.8%	22.6%	8.5%	16.0%	7.2%
Total average	37.5%	35.8%	37.5%	16.3%	15.7%	16.2%	13.8%	13.1%	13.5%	8.0%	9.2%	4.9%

Source: Thomson

Exhibit 7: Financial summary

	£m	2011	2012	2013	2014	2015	2016	2017e	2018e
Year end 31 March		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		264.8	257.8	177.4	211.6	271.1	287.7	321.7	331.3
Cost of Sales		(189.6)	(179.9)	(123.0)	(148.6)	(186.7)	(195.1)	(215.6)	(222.0)
Gross Profit		75.2	77.9	54.4	63.0	84.4	92.6	106.1	109.3
EBITDA		9.1	10.2	7.4	9.1	16.6	19.8	22.3	23.7
Operating Profit (before am, SBP and except.)		7.7	8.7	6.1	7.7	14.0	17.0	19.4	20.7
Operating Profit (before am. and except.)		7.4	8.1	5.5	7.1	13.4	16.3	18.7	19.9
Amortisation of acquired intangibles		(0.3)	(0.8)	(0.7)	(1.0)	(2.1)	(2.8)	(3.6)	(3.6)
Exceptionals		(4.6)	(3.4)	(3.4)	(0.9)	(5.2)	(2.1)	(10.1)	(2.2)
Share-based payments		(0.3)	(0.6)	(0.6)	(0.6)	(0.6)	(0.7)	(0.7)	(0.8)
Operating Profit		2.5	3.9	1.4	5.2	6.1	11.4	5.0	14.1
Net Interest		(0.3)	(0.9)	(0.5)	(0.8)	(1.6)	(1.8)	(3.0)	(3.0)
Profit Before Tax (norm)		7.4	7.8	5.6	6.9	12.4	15.2	16.4	17.7
Profit Before Tax (FRS 3)		1.9	2.7	0.7	4.2	4.3	9.4	1.8	10.9
Tax		(0.2)	(0.6)	1.4	(0.5)	(1.4)	(2.2)	(0.8)	(2.8)
Profit After Tax (norm)		5.8	6.4	4.6	6.0	10.0	11.8	12.5	13.4
Profit After Tax (FRS 3)		1.7	2.1	2.1	3.7	2.9	7.2	1.0	8.1

Average Number of Shares Outstanding (m)		39.1	39.2	39.2	43.1	57.6	63.3	64.2	64.2
EPS - normalised & diluted (p)		14.2	15.7	11.3	13.1	16.4	17.8	18.4	19.3
EPS - IFRS basic (p)		4.3	5.4	(4.8)	3.0	5.0	11.4	1.5	12.6
EPS - IFRS diluted (p)		4.2	5.1	(4.7)	2.8	4.8	10.9	1.4	11.7
Dividend per share (p)		5.4	5.8	6.2	6.8	7.6	8.1	8.4	8.5

Gross Margin (%)		28.4	30.2	30.7	29.8	31.1	32.2	33.0	33.0
EBITDA Margin (%)		3.4	4.0	4.2	4.3	6.1	6.9	6.9	7.2
Operating Margin (before am, SBP and except.) (%)		2.9	3.4	3.4	3.6	5.2	5.9	6.0	6.3

BALANCE SHEET
Fixed Assets		27.7	32.5	30.9	33.1	88.6	108.4	104.4	100.7
Intangible Assets		21.1	25.7	24.2	25.5	69.9	88.2	84.5	80.8
Tangible Assets		3.8	3.5	3.1	3.5	13.8	14.7	14.4	14.4
Deferred tax assets		2.8	3.3	3.6	4.1	4.9	5.5	5.5	5.5
Current Assets		98.3	86.8	81.8	92.7	127.3	128.3	132.1	138.4
Stocks		25.3	25.7	19.3	19.4	39.8	42.9	45.8	47.2
Debtors		59.3	48.8	44.7	48.3	60.2	65.5	71.4	73.5
Cash		13.6	12.3	17.8	18.1	26.7	19.9	14.9	17.7
Current Liabilities		(63.9)	(58.8)	(50.9)	(58.3)	(62.1)	(61.7)	(74.6)	(81.6)
Creditors		(58.8)	(53.6)	(46.6)	(51.5)	(61.9)	(60.9)	(68.8)	(70.8)
Short term borrowings		(5.1)	(5.2)	(4.3)	(6.8)	(0.2)	(0.8)	(5.8)	(10.8)
Long Term Liabilities		(10.8)	(11.4)	(10.3)	(19.0)	(61.1)	(73.1)	(68.1)	(63.1)
Long term borrowings		(1.8)	(0.8)	(1.7)	(9.5)	(45.5)	(57.2)	(52.2)	(47.2)
Other long term liabilities		(9.0)	(10.6)	(8.6)	(9.5)	(15.6)	(15.9)	(15.9)	(15.9)
Net Assets		51.3	49.1	51.5	48.5	92.7	101.9	93.8	94.5

CASH FLOW
Operating Cash Flow		0.5	9.1	5.7	6.1	6.6	14.6	11.7	20.5
Net Interest		(0.3)	(0.9)	(0.6)	(0.8)	(1.6)	(1.8)	(3.0)	(3.0)
Tax		0.5	(1.1)	(1.4)	(0.9)	(3.3)	(4.3)	(2.8)	(4.8)
Capex		(1.3)	(1.4)	(1.3)	(1.4)	(2.5)	(2.3)	(2.5)	(2.9)
Acquisitions/disposals		(4.4)	(3.9)	(0.5)	(9.2)	(37.3)	(19.8)	(3.2)	(1.5)
Financing		0.0	0.3	5.7	0.1	52.7	0.0	0.0	0.0
Dividends		(2.0)	(2.2)	(2.3)	(2.7)	(3.6)	(4.9)	(5.2)	(5.4)
Net Cash Flow		(7.0)	(0.1)	5.3	(8.8)	11.0	(18.5)	(5.0)	2.9
Opening net cash/(debt)		13.9	6.7	6.3	11.8	1.8	(19.0)	(38.1)	(43.1)
HP finance leases initiated		0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Other		(0.2)	(0.3)	0.2	(1.2)	(31.8)	(0.6)	(0.0)	0.0
Closing net cash/(debt)		6.7	6.3	11.8	1.8	(19.0)	(38.1)	(43.1)	(40.3)

Source: Acal, Edison Investment Research

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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