Ventilation systems specialist Titon Holdings (LON:TON) today produced a rather vague update which warned that profits in its South Korean operations would be materially lower than anticipated. The markets took the predictable route out, and the shares were marked down over 30%: a very costly RNS:
However, this has been a rather good micro-cap stock for investors over the years. It has been listed for some time, and while never becoming a giant, it has produced some solid performances and also paid out dividends to investors. Today’s news would have delivered some disappointment, not least because of the nature of the warning but the way it was delivered.
Titon could be said to be a niche supplier of ventilation products, in practice this means doors, windows (natural) and also systems (mechanical). They are a small company, employing just over 230 people and rather uniquely have a split between the UK and South Korea, where it has manufacturing facilities.
As such they are well-placed in the market, as they are not dependent on property prices, demand is constant (as older properties can be upgraded) and there may be trends which favour them, such as an increasing efficiencies in recycling heat.
The warning is short and comes out in a Trading Update RNS. It is short on context and numbers, which perhaps has gone some way to explain the share price drop.
Explaining that South Korea have favoured mechanical ventilation systems as opposed to natural ones, there is a comment:
Whilst the Company has continued to take steps to re-design its existing natural ventilation products and to introduce new products for this market, it is not expected that these will be available until later in the current financial year. As a result, the trading performance in Titon Korea for the year ended 30 September 2019 is expected to be substantially below existing market forecasts
This seems at odds with a previous update made in December 2018: which although mentioned this trend did not state the impact on profits, and indeed that trading for the first two months of 2019 was in line with expectations. It is not mentioned exactly what ‘substantially’ below means, but either something has gone wrong since December, or the company did not mention this in the preliminaries.
There was better news for the rest of the business:
Trading in the UK and the Rest of the World is in line with expectations.
The question is, what is the impact of Korea? From the annual report, it appears that Titon is a market leader in natural ventilation products with over a 75% share. It has two subsidiaries (Titon Korea and Browntech Sales) and this from the annual report:
Taking Titon Korea and BTS together, South Korea is thelargest contributor to the Group’s profit after tax at £1.8million for the year. (2017: £1.5 million)
Profit after tax for 2018 was £2.6m, so as we can see the news from South Korea is a major setback.
Titon could be described as a great little company until today. Stockopedia rates it highly, with an overall score of 94 and a rating of Super Stock, and looking at this financial summary, it is obvious why:
Rising revenues and profits is a good sign. Margins have remained stable (although not large), and on reading the annual report, the overall impression is that the company is extremely well run. Shareholders are clearly getting some very good value from management, with remuneration levels much below that of other companies.
Company valuation is also perhaps behind investor appetite. Relative to the competition, the share has traded on a very undemanding multiple, although arguably many of these companies are not deserving of anything higher because of the relative ease of being replaced by another (windows can be had from multiple suppliers).
But the other signs from the company are good. There is no debt, and the cash balance has risen to £3.4m – almost a quarter of the latest market cap. Profits in conjunction with prudent running have led to a consistent small positive cashflow.
It is clear that South Korea features very heavily in the company future. The house broker note (available on Research Tree) projects that the bulk of future growth will come from this region. The group has operations in the United States, but have found it harder to grow profits here, perhaps lacking the market leading position that it does in Korea.
In short, there is a lot to like, and whilst the nature of the profit miss is not disclosed, it does not seem to present any immediate risk to the company.
As with most profit warnings, the question is whether the source of the warning is something temporary or more structural. It is unsure just why South Korea have made a sudden switch in preference to mechanical products (when the natural ventilation products were performing just fine for it), and certainly why the projected sudden jolt to profits is only found out now as opposed to in December.
Growing competition could be an factor at play here. If the UK experience is anything to go by, competition can be intense in these areas, with several companies fighting it out for deals in what is a commodity product.
The one comforting factor is that Titon hold a large market share in the natural ventilation market, which should assist in the development of the new mechanical products. But it does seem that if there is any delay or setbacks to this implementation then next years profits would also show a fall.
As a business, I do think there are further opportunities for it – perhaps an expansion into another territory using a similar model to the Korean operations. But I do also believe that the valuation will always remain on the cheap side. The margins and relatively low turnover show that there is little proprietary in their products. There is more potential to add this in the mechanical systems, but with a low R&D spend, a breakthrough may be unlikely.
I would be uncertain on the future but at these lower prices, perhaps a takeover awaits which might produce a final bounty for shareholders. 3/5.