discoverIE Group — Raising the bar

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discoverIE Group

Raising the bar

FY23 results

Electrical components

9 June 2023

Price	915p
Market cap	£882m
€1.16:$1.24:£1
Net debt (£m) at end FY23		42.7

Shares in issue	96.4m
Free float	96%
Code	DSCV

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	13.5	15.0	28.3
Rel (local)	16.0	19.8	29.6

52-week high/low

915p

597p

Business description

discoverIE is a leading international designer and manufacturer of customised electronics to industry, supplying customer-specific electronic products and solutions to original equipment manufacturers.

Next events

AGM	24 July 2023

Analyst

Katherine Thompson

+44 (0)20 3077 5700

tech@edisongroup.com

Edison profile page

discoverIE Group is a research client of Edison Investment Research Limited

For FY23, discoverIE reported double-digit organic revenue growth, operating margin expansion to 11.5% and strong free cash generation. On track to meet its FY25 operating margin target of 13.5%, the company has set a more testing target of 15% by FY28. We have upgraded our forecasts, which reflect more modest revenue growth than in FY23 as the order book normalises and continued operating margin expansion, and we expect further M&A activity to boost growth and profitability.

Year end	Revenue (£m)	PBT* (£m)	Diluted EPS* (p)	DPS (p)	P/E (x)	Yield (%)
03/22	379.2	37.6	29.4	10.80	31.1	1.2
03/23	448.9	46.3	35.2	11.45	26.0	1.3
03/24e	457.3	46.9	35.3	12.00	25.9	1.3
03/25e	472.1	48.9	36.4	12.50	25.1	1.4

Note: *PBT and EPS as per discoverIE’s underlying metric, excluding amortisation of acquired intangibles and exceptional items.

FY23: Organic revenue +10%, underlying EPS +20%

FY23 revenue came in slightly ahead of the April trading update expectations, with reported revenue growth of 18% (10% organic, 5% from acquisitions, 3% FX) and underlying operating profit growth of 25%. Underlying EPS came in 5.6% ahead of our forecast and grew 20% y-o-y. Net debt was significantly lower than we expected, resulting in year-end gearing (net debt/EBITDA) of 0.7x.

Outlook: Raising operating margin target to 15%

As previously flagged by management, the order book has started to normalise as supply chain disruption has eased, although in terms of revenue visibility it is still higher than before COVID-19. Based on FY23 performance, we have revised up our forecasts for FY24 (underlying EPS upgrade of 3.5%) and introduce forecasts for FY25. As a progression from the 13.5% underlying operating margin target for FY25, the company has introduced a new target of 15% to be achieved by FY28. We expect these targets to be reached through a combination of organic growth and the acquisition of higher-margin businesses.

Valuation: Reflects growth potential

The stock is trading at a small premium to its broader UK industrial technology peer group on a P/E basis for FY24, but at a discount compared to peers with a similar decentralised operating model (such as Halma and Spirax). The focus on strategic growth markets supports sustained organic revenue growth and we see potential for upside to earnings through operating margin expansion and accretive acquisitions. We note that over the last year, we upgraded our forecasts four times on better trading and twice to reflect accretive acquisitions. The company has ample headroom for further acquisitions and a strong pipeline of opportunities, which could well be boosted by the current uncertain macroeconomic environment.

Review of FY23 results

Exhibit 1: FY23 results highlights

£m	FY22a	FY23e	FY23a	Diff	y-o-y
Revenues	379.2	439.8	448.9	2.1%	18.4%
EBITDA	56.1	64.8	65.4	1.0%	16.6%
EBITDA margin	14.8%	14.7%	14.6%	(0.2%)	(0.2%)
Underlying operating profit	41.4	49.8	51.8	4.1%	25.1%
Underlying operating margin	10.9%	11.3%	11.5%	0.2%	0.6%
Normalised operating profit	44.8	52.2	54.3	4.1%	21.2%
Normalised operating margin	11.8%	11.9%	12.1%	0.2%	0.3%
Underlying PBT	37.6	44.4	46.3	4.3%	23.1%
Normalised PBT	41.0	46.8	48.8	4.3%	19.0%
Normalised net income	30.8	34.6	36.1	4.3%	17.4%
Normalised diluted EPS (p)	32.1	35.1	36.7	4.5%	14.4%
Underlying diluted EPS (p)	29.4	33.3	35.2	5.6%	19.5%
Reported basic EPS (p)	27.1	19.2	22.3	16.1%	(17.6%)
Dividend per share (p)	10.8	11.5	11.5	0.0%	6.0%
Net (debt)/cash	(30.2)	(54.6)	(42.7)	(21.8%)	41.4%
Net debt/EBITDA (x)	0.6	0.9	0.7

Source: discoverIE, Edison Investment Research

discoverIE’s 19 April trading update expected reported revenue growth of 16% and organic revenue growth of 8% for FY23. The final reported revenue for FY23 came in ahead of this, partly due to a revenue contribution of £5m for a one-off pass-through of elevated semiconductor costs. At constant exchange rates (CER), the group generated revenue growth of 15% and organic revenue growth of 10% (which includes the semiconductor cost pass-through). The company noted that of the 10% growth, c 5% was from volume, 4% from pricing and 1% from the semiconductor cost pass-through.

While the margin is not disclosed, the company noted that organic gross margin improved by 1pp at the group level. Underlying operating profit grew 25% y-o-y and was 4% higher than we forecast, resulting in the underlying operating margin increasing 0.6pp to 11.5% (versus our 11.3%). The company estimates that the drop-through from organic revenue growth (excluding the semiconductor cost pass-through) to underlying operating profit was 19%, mainly due to scale and internal efficiencies. Acquisitions made over the last two years contributed revenue of £14.9m and underlying operating profit of £2.2m.

Reported operating profit included £15.8m amortisation of acquired intangibles and exceptional charges totalling £1.4m (£1.8m acquisition costs and £1.5m contingent consideration accrual offset by a £1.5m insurance receipt and a £0.4m credit relating to last year’s disposal of Acal BFi). The tax rate on reported PBT was 26.8%; on an underlying basis the rate was 25.3%. Overall, this resulted in underlying diluted EPS of 35.2p (+20% y-o-y), 5.6% ahead of our forecast and 4.5% ahead of consensus.

The final dividend of 7.9p was in line with our forecast, resulting in a full year dividend of 11.45p (+6% y-o-y, 3.1x cover).

Net debt came in significantly lower than forecast at £42.7m. The company converted 94% of underlying operating profit to operating cash flow (EBITDA less working capital and capex) and generated free cash flow of £33m in the year. The company had estimated a year-end net debt/EBITDA of 0.9x in its April trading update, but the lower net debt position brought this down to 0.7x.

Exhibit 2: Divisional performance

£m	FY23	FY22	Reported y-o-y	CER y-o-y	Organic CER y-o-y
Revenues
Magnetics & Controls	280.8	234.7	20%	16%	11%
Sensing & Connectivity	168.1	144.5	16%	14%	8%
Total revenues	448.9	379.2	18%	15%	10%
Underlying operating profit
Magnetics & Controls	38.4	29.8	29%
Sensing & Connectivity	25.6	23.3	10%
Unallocated	(12.2)	(11.7)	4%
Total operating profit	51.8	41.4	25%
Underlying operating margin			pp change
Magnetics & Controls	13.7%	12.7%	1.0%
Sensing & Connectivity	15.2%	16.1%	(0.9%)
Total operating margin	11.5%	10.9%	0.6%

Source: discoverIE

■

Magnetics and Controls: revenue growth was 20% or 11% on an organic CER basis. The £5m semiconductor cost pass-through was reported in this division and, stripping it out, organic growth was 9%. Orders remained at a high level (£263.9m), although were down 9% on a CER basis resulting in a book-to-bill of 0.96:1. On a regional basis, organic growth was 22% in the UK, 19% in Europe and 21% in North America, whereas growth declined by 12% in Asia. China saw a 25% decline in organic revenue due to lower demand for wind energy-related products, as well as some customers opting to have their products manufactured nearer to their end-customers. Growth in India was 2% – stronger growth in H1 was tempered by inventory correction by one large customer in H2. Underlying operating profit grew 29% y-o-y and the margin increased by 1pp to 13.7%, helped by revenue growth and operating efficiencies.

■

Sensing and Connectivity: revenue growth was 16% or 8% on an organic CER basis. On a geographic basis, organic CER revenue growth was 6% in the UK, 5% in Europe, 13% in North America and 15% in Asia and rest of the world (China saw strong demand for solar-related products). The division received orders worth £173.7m, essentially flat y-o-y, resulting in a book-to-bill of 1.03:1. Underlying operating profit was up 10% y-o-y, resulting in a 0.9pp operating margin decline to 15.2%. This was due to increased investment, particularly for recent acquisitions, in sales resource and back office support.

Update on KSIs and KPIs

discoverIE sets and tracks key strategic indicators (KSIs) and key performance indicators (KPIs). Exhibit 3 summarises the company’s performance since FY14.

The current underlying operating margin target of 13.5% is for FY25. The company has introduced a new target of 15% over the next five years. In both cases, it expects to achieve these margins through a combination of organic and acquisitive growth.

The company targets four key markets: Industrial & Connectivity, Medical, Renewables and Transport. Revenue from these markets made up 77% of group revenue, up 1pp from FY22 and equivalent to 12% organic growth in FY23. This compares to organic growth of only 3% from other markets. Within the target markets, Renewables saw a 6% decline, mainly due to lower demand for wind power-related products, but the three other markets more than compensated for this with 15% growth. The focus on four markets helps diversify the risk from any one market.

Until last year, the company had a target to reduce scope one and two carbon emissions intensity (tCO2e/£m revenue) by 50% from CY19 to CY25. In November 2022, it changed the target to reduce carbon emissions on an absolute basis (including acquisitions) by 65% from CY21 to CY25. By the end of FY23, it had already achieved a 35% reduction, mainly from installing renewable energy at manufacturing sites (eg solar panels in Sri Lanka and Thailand). It expects to achieve the remaining reduction through a combination of manufacturing site renewable energy generation, switching energy providers to renewable sources, shifting from gas heating to electric options and, where this is not possible, buying renewable energy certificates. To support this process, M&A due diligence specifically includes ESG considerations to enable the company to quickly reduce the target company’s carbon footprint once acquired.

Exhibit 3: KSI and KPI track record and targets

Source: discoverIE

M&A still a key part of the strategy

The company was slightly less active in terms of completed acquisitions during FY23, mainly due to the elevated price expectations of vendors. According to management, expectations came down earlier this year but have started creeping up again more recently. However, pricing is now within the company’s target range. At the same time, it has a very active pipeline of potential deals and with gearing of 0.7x, plenty of headroom to fund these deals (its target gearing range is 1.5–2.0x).

The company has a £240m syndicated bank facility and in May, it extended the remaining term by one year to June 2027. It also has an £80m accordion facility which it can use to extend the facility to £320m. At the end of FY23, it had drawn down £88m of the facility. We estimate that it has headroom of £70–100m at its target gearing range.

Outlook and changes to forecasts

The group received orders totalling £437.5m in the year (£236.9m in H123, £200.6m in H223), resulting in a book-to-bill of 0.97x (H1: 1.08x, H2: 0.88x). This resulted in an order book of £223m at the end of FY23, essentially flat y-o-y. At the end of FY22, management noted that the order book revenue visibility was c 6.5 months, compared to 4.0–4.5 months pre-COVID. As expected and flagged by management, this has reduced over the course of the year to stand at roughly 5.5 months now. As supply chain issues have eased, customers have not felt the need to place orders as far in advance. Management believes that the order book may not revert to pre-COVID levels but could sit at more like five months’ visibility, as the recent memory of supply chain disruption may make customers more cautious in their ordering behaviour. For the same reason, the company is likely to carry a slightly higher level of inventory than pre-COVID.

In FY23, the company won new project designs with a lifetime value of £273m, up 11% y-o-y – this is a key driver of organic growth.

So far this year, management commented that it had seen organic revenue growth in the mid-single digits. We have revised our forecasts to reflect FY23 results and introduce forecasts for FY25. We note that our FY24 revenue forecast equates to 1.9% growth over FY23. However, if the £5m one-off semiconductor cost pass-through is excluded from FY23 revenue, the growth is 3%. Overall, we upgrade our FY24 underlying EPS forecast by 3.5%. Based on lower net debt at the end of FY23, we reduce our end-FY24 net debt forecast by 17% and expect net debt/EBITDA to reduce to 0.5x from our previous 0.7x forecast.

Exhibit 4: Changes to forecasts

£m	FY24e old	FY24e new	Change	y-o-y	FY25e new	y-o-y
Revenues	453.4	457.3	0.9%	1.9%	472.1	3.2%
EBITDA	68.2	68.9	1.0%	5.3%	71.2	3.4%
EBITDA margin	15.0%	15.1%	0.0%	0.5%	15.1%	0.0%
Underlying operating profit	52.1	53.5	2.6%	3.2%	55.5	3.8%
Underlying operating margin	11.5%	11.7%	0.2%	0.2%	11.8%	0.1%
Normalised operating profit	54.5	55.9	2.5%	2.9%	57.9	3.6%
Normalised operating margin	12.0%	12.2%	0.2%	0.1%	12.3%	0.0%
Underlying PBT	45.3	46.9	3.5%	1.3%	48.9	4.3%
Normalised PBT	47.7	49.3	3.3%	1.1%	51.3	4.1%
Normalised net income	35.6	36.6	2.7%	1.3%	37.8	3.4%
Normalised diluted EPS (p)	35.9	37.1	3.3%	1.2%	38.2	2.9%
Underlying diluted EPS (p)	34.1	35.3	3.5%	0.4%	36.4	3.1%
Reported basic EPS (p)	20.7	23.1	12.0%	3.7%	24.4	5.5%
Dividend per share (p)	12.0	12.0	0.0%	4.8%	12.5	4.2%
Net (debt)/cash	(41.1)	(34.0)	(17.3%)	(20.4%)	(25.2)	(25.9%)
Net debt/EBITDA (x)	0.7	0.5			0.4

Source: Edison Investment Research

Valuation

Exhibit 5 shows financial metrics for discoverIE’s peer group and Exhibit 6 shows the valuation metrics. For the peer group, we use companies active in the electronics market and acquisitive industrial companies. The stock has gained 15% since results were announced, so despite an upgrade to our forecasts, the stock trades at a small premium to its broader UK industrial technology peer group on an FY24e P/E basis. However, it trades at a discount compared to peers with a similar decentralised operating model (such as Halma and Spirax). The focus on strategic growth markets supports sustained organic revenue growth (we note that for FY18–23, the five-year CAGR for organic revenue was 10%) and we see potential for upside to earnings through operating margin expansion and accretive acquisitions. The company has debt headroom for further acquisitions and a strong pipeline of opportunities.

Exhibit 5: Peer group financial metrics

	Year end	Share price	Market cap	Rev growth (%)		EBITDA margin (%)		EBIT margin (%)
		(p)	£m	CY	NY	CY	NY	CY	NY
discoverIE	31-Mar	915	882	1.9	3.2	15.1	15.1	11.7	11.8
Diploma	30-Sep	3056	4096	17.4	4.7	20.9	20.9	18.4	18.5
Gooch & Housego	30-Sep	563	141	10.7	5.0	13.8	15.1	7.4	8.9
TT electronics	31-Dec	163.4	289	2.0	0.6	10.7	11.6	8.0	8.7
XP Power	31-Dec	2205	435	4.9	2.9	21.2	22.6	15.3	16.4
Avon Protection	30-Sep	890	269	5.3	-6.1	10.8	16.3	4.7	10.2
Halma	31-Mar	2462	9347	7.2	5.7	24.3	24.5	21.1	21.4
Spectris	31-Dec	3695	3864	6.4	4.7	20.8	21.4	16.6	17.4
Spirax-Sarco Engineering	31-Dec	11180	8248	12.7	5.3	27.0	27.5	22.6	23.2
Average				8.3	2.8	18.7	20.0	14.3	15.6
Median				6.8	4.7	20.9	21.2	16.0	16.9
Premium/(discount) to average				(77.5)	13.7	(19.4)	(24.6)	(18.0)	(24.5)
Premium/(discount) to median				(72.5)	(31.8)	(27.8)	(28.7)	(26.7)	(30.4)

Source: Edison Investment Research, Refinitiv (as at 5 June)

Exhibit 6: Peer group valuation metrics

	EV/sales (x)		EV/EBITDA (x)		EV/EBIT (x)		P/E (x)		Div yield (%)
	CY	NY	CY	NY	CY	NY	CY	NY	CY	NY
discoverIE	1.8	1.8	12.1	11.7	15.0	14.4	25.9	25.1	1.3	1.4
Diploma	3.6	3.5	17.3	16.6	19.7	18.8	25.2	24.2	1.9	2.0
Gooch & Housego	1.2	1.1	8.4	7.3	15.8	12.4	20.2	15.8	2.3	2.4
TT electronics	0.7	0.7	6.4	5.8	8.5	7.8	8.8	7.8	4.1	4.5
XP Power	2.1	2.0	9.9	9.0	13.7	12.4	13.9	12.5	4.3	4.4
Avon Protection	1.5	1.6	13.9	9.8	32.1	15.7	48.5	19.7	4.2	3.8
Halma	5.1	4.8	21.0	19.8	24.3	22.7	30.5	28.7	0.9	1.0
Spectris	2.6	2.5	12.6	11.7	15.8	14.4	20.0	18.5	2.2	2.3
Spirax-Sarco Engineering	5.0	4.7	18.4	17.1	21.9	20.3	27.9	25.7	1.5	1.6
Average	2.7	2.6	13.5	12.1	19.0	15.6	24.4	19.1	2.7	2.7
Median	2.4	2.3	13.3	10.7	17.7	15.0	22.7	19.1	2.2	2.3
Premium/(discount) to average	(32.8)	(32.3)	(10.0)	(3.2)	(21.1)	(7.1)	6.2	31.4	(50.9)	(50.3)
Premium/(discount) to median	(22.5)	(22.0)	(8.5)	9.4	(15.7)	(4.0)	14.1	31.6	(41.6)	(41.8)

Source: Edison Investment Research, Refinitiv (as at 5 June)

Exhibit 7: Financial summary

	£m	2020	2021	2022	2023	2024e	2025e
Year end 31 March		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		297.9	302.8	379.2	448.9	457.3	472.1
EBITDA		43.6	44.0	56.1	65.4	68.9	71.2
Normalised operating Profit (before am, SBP and except.)		31.6	31.9	44.8	54.3	55.9	57.9
Underlying operating Profit (before am. and except.)		29.8	30.8	41.4	51.8	53.5	55.5
Amortisation of acquired intangibles		(9.0)	(11.1)	(14.0)	(15.8)	(16.0)	(16.0)
Exceptionals		(4.3)	(2.6)	(6.5)	(1.4)	(1.0)	(1.0)
Share-based payments		(1.8)	(1.1)	(3.4)	(2.5)	(2.4)	(2.4)
Operating Profit		16.5	17.1	20.9	34.6	36.5	38.5
Net Interest		(4.3)	(3.6)	(3.8)	(5.5)	(6.6)	(6.6)
Profit Before Tax (norm)		27.3	28.3	41.0	48.8	49.3	51.3
Profit Before Tax (FRS 3)		12.2	13.5	17.1	29.1	29.9	31.9
Tax		(3.3)	(4.0)	(7.4)	(7.8)	(7.7)	(8.4)
Profit After Tax (norm)		21.8	21.6	30.8	36.1	36.6	37.8
Profit After Tax (FRS 3)		8.9	9.5	9.7	21.3	22.2	23.5
Discontinued operations		5.4	2.5	15.5	0.0	0.0	0.0
Net income (norm)		21.8	21.6	30.8	36.1	36.6	37.8
Net income (FRS 3)		14.3	12.0	25.2	21.3	22.2	23.5

Ave. Number of Shares Outstanding (m)		84.0	88.8	93.0	95.4	95.9	96.4
EPS - normalised & diluted (p)		25.1	23.4	32.1	36.7	37.1	38.2
EPS - underlying, diluted (p)		24.4	22.4	29.4	35.2	35.3	36.4
EPS - IFRS basic (p)		17.0	13.5	27.1	22.3	23.1	24.4
EPS - IFRS diluted (p)		16.5	13.0	26.3	21.7	22.5	23.8
Dividend per share (p)		2.97	10.15	10.80	11.45	12.00	12.50

EBITDA Margin (%)		14.6	14.5	14.8	14.6	15.1	15.1
Normalised operating margin (before am, SBP and except.) (%)		10.6	10.5	11.8	12.1	12.2	12.3
discoverIE underlying operating margin (%)		10.0	10.2	10.9	11.5	11.7	11.8

BALANCE SHEET
Fixed Assets		236.4	244.6	326.5	335.9	323.0	311.0
Intangible Assets		182.2	190.8	263.3	272.0	257.7	243.4
Tangible Assets		46.3	45.9	45.4	44.4	45.8	48.1
Deferred tax assets		7.9	7.9	17.8	19.5	19.5	19.5
Current Assets		197.4	183.6	266.2	249.8	265.6	279.0
Stocks		68.4	67.7	77.8	90.0	92.7	95.7
Debtors		90.1	84.9	78.0	74.6	83.9	90.5
Cash		36.8	29.2	108.8	83.9	87.6	91.4
Current Liabilities		(103.6)	(107.8)	(190.3)	(151.2)	(153.0)	(151.8)
Creditors		(94.0)	(102.2)	(114.2)	(107.3)	(109.1)	(107.9)
Lease liabilities		(5.3)	(4.8)	(4.7)	(4.0)	(4.0)	(4.0)
Short-term borrowings		(4.3)	(0.8)	(71.4)	(39.9)	(39.9)	(39.9)
Long-term liabilities		(129.7)	(112.0)	(112.0)	(130.9)	(120.9)	(110.8)
Long-term borrowings		(93.8)	(75.6)	(67.6)	(86.7)	(81.7)	(76.7)
Lease liabilities		(14.7)	(16.7)	(16.4)	(14.8)	(14.8)	(14.8)
Other long-term liabilities		(21.2)	(19.7)	(28.0)	(29.4)	(24.4)	(19.3)
Net Assets		200.5	208.4	290.4	303.6	314.7	327.4

CASH FLOW
Operating Cash Flow		48.0	56.8	42.5	52.1	55.7	57.5
Net Interest		(3.7)	(3.1)	(3.3)	(4.8)	(6.1)	(6.1)
Tax		(6.4)	(7.2)	(7.1)	(9.0)	(12.7)	(13.5)
Capex		(6.3)	(3.9)	(6.2)	(5.6)	(9.0)	(9.2)
Acquisitions/disposals		(73.6)	(20.5)	(46.8)	(25.1)	(2.0)	(2.0)
Financing		53.9	(6.6)	47.2	(7.5)	(6.0)	(6.1)
Dividends		(8.1)	(2.8)	(9.4)	(10.5)	(11.2)	(11.8)
Net Cash Flow		3.8	12.7	16.9	(10.4)	8.8	8.8
Opening net cash/(debt)		(63.3)	(61.3)	(47.2)	(30.2)	(42.7)	(34.0)
HP finance leases initiated		0.0	0.0	0.0	0.0	0.0	0.0
Other		(1.8)	1.4	0.1	(2.1)	(0.0)	(0.0)
Closing net cash/(debt)		(61.3)	(47.2)	(30.2)	(42.7)	(34.0)	(25.2)

Source: discoverIE, Edison Investment Research

General disclaimer and copyright

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General disclaimer and copyright

Australia

New Zealand

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This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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