Shares in optical applications specialist Gooch and Housego (LON:GHH) today declined by 25% as its interim results delivered a double whammy. First half profits were down a quarter on the previous year, but perhaps even worse was the fact that the promised H2 recovery cited in a previous trading update will now not materialise and as such profit for the full year will be cut. The share price action was as such:
The share price perhaps saw this coming as always. The price topped out at 1500p approximately one month ago and had drifted down a little before the results announcement today, perhaps motivated by the general US/China trade war.
Despite sounding like a firm of lawyers, Gooch % Housego are actually at the sharper end of technology, lasers to be precise. Photonics have a wide range of applications in industry, life sciences and aerospace and it is clear that their technology is popular. Growth here has been two-fold, both organically and via acquisition, and hence Gooch & Housego have become a well-regarded share on the AIM market, commanding a premium valuation.
The warning comes today in the interim results, which cover the period up to 31 March 2019. The headline figures don’t read well to start:
Perhaps most alarming is the swing from net cash to net debt. Where the warning takes place are the outlook statements:
We anticipate non- industrial laser business will perform in line with our expectations. Industrial laser orders have increased since our last update, but we are now assuming that industrial laser business will not return to ‘normal’ levels in FY 2019 and instead we only supply known / high certainty orders.
This is quantified as follows:
Given revised industrial laser outlook, Board’s expectations for the Group’s adjusted PBT for FY 2019 now reduced by circa £3.5- 4.0 million
This is a bit of a large hit. Industrial is their largest segment by far in terms of profit, and £4m represents a significant proportion of overall profit. Their reporting metric is adjusted profits before tax, and for good reason: there are plenty of adjustments. Previous reports have seen the desire to equalise divisions, but perhaps this is not the way to go about it.
It is easy to see why the market has liked Gooch & Housego. Their business faces towards the future, and further innovations in their fields could lead to a very strong position in their markets. Although profits have remained flat, turnover has increased at a fast rate of knots thanks to organic growth and acquisitions:
Other metrics have looked good here. Until most recently, there was no net debt at the group at all. This changed in the past year with some £18.5m of debt entering the balance sheet. With a large US-facing business, debt is denominated in USD and appears to be long-term and manageable. The total facility is $60m so they are well within this.
There is also a modest dividend being paid out, which is progressive and increasing. Relatively speaking this has been manageable and looks to be in no danger of being cut, although even at this reduced share price the dividend yield is very small.
The balance sheet is relatively solid, although acquisitions have seen both the intangible asset position and borrowings jump accordingly. Receivables jumped sharply at the end of FY18 but have been largely unwound in the interims. There could be even scope for further acquisitions here.
Perhaps in a nod to the challenges, there have been some shakeups at the top level with both the CFO and COO departing. There is no replacement for the COO.
On a quick cursory glance there is nothing that really jumps out here.
There is a lot to like about Gooch & Housego, and I would imagine that there would be several happy longer-term holders even after these profit warnings. In the past 10 years to April 2019 it has delivered a ten-fold increase in returns even before dividends are taken into account, and not many can match that.
The outlook from the board is also positive, as one might expect. Their order book stands at an all-time high and the dividend is also increased. The Life Sciences division is also growing rapidly with acquisitions as part of their strategy. Without literally testing them, their output seems high quality.
One fly in the ointment appears to be the ongoing US/China trade war. This represents quite a large unknown and recent events suggest that this will be quite a drawn out affair. Reduced demand is obviously very bad, because Industrial represents a large part of profits.
Perhaps the biggest factor is the valuation. Gooch & Housego have commanded a premium valuation for a very long time, having doubled in the space of a few years before today. Revenues have doubled but crucially profits have not, although it is worth bearing in mind that investments do not yield profit straight away, and that good companies will always be expensive. And everything so far has pointed to them being a good company.
So it is fair to say that quite a lot of growth is still baked into the share price. Like IQE, I think a number of factors at play combined with the still high valuation make this a little too complicated for me. 3/5.