Shares in LED lighting specialist Dialight (LON:DIA) today slipped by as much as 30% as the company revealed that second quarter trading was weak and this trend may persist for the rest of the year. The share price reaction was immediate:
Rarely for a profit warning, this has not produced a new low – the share traded at less than this in December 2018. But in common with many companies giving out warnings, there has been a longer-term trend of shareholder value evaporating. Two years ago, the share sat pretty at almost 1100p, so it has been a fair ride down to today.
We may think that Dialight is a company that is highly correlated to the general economy. It manufactures lighting systems for industry which has a wide range of applications from general lighting of warehouses to electronic signalling within components, something we may take for granted. With a large-scale shift in lighting towards LED, it was no surprise that this was a highly fancied share in the past with large-scale growth and profits expected in the future. Given the potential size of the market it has been no surprise that this has almost always been a very expensive company to own relative to the profits it was making.
The warning comes in a morning RNS ahead of the half-year results. First up, the CEO is stepping down, although this seems to be a orderly succession. The lines that spooked investors come in the outlook:
We have seen a weakening in order intake in the second quarter. These trends may continue for the remainder of the year.
After a very strong year in 2018, our Signals & Components business has weakened due to market uncertainty and high levels of inventory in the distribution channel.
Given the potential impact on order intake, referred to above, we now expect our underlying operating profit for the year ending 31 December 2019 to be within the range of £10-£13m. This is before incurring c£4m of non-underlying costs.
It seems that in real terms, profits will be below the £7.6m the year before as £4m exceptional costs are booked (previous year £0.4m). The costs are explained by having a high inventory and although non-underlying still may have a factor in the future if excess inventory stifles demand.
There is a bullish note to the proceedings, but it has always been thus:
The Board believes the Group is increasingly well positioned for FY20, with a stronger operational base, expanded product offering and a wider addressable market.
Reading back on the history shows Dialight to be one big rollercoaster for investors: this may be the second period where sales have gone downhill: the company managed to turn itself around from a loss-making one into a profitable one. This has been underpinned by a constant confidence in the company products and the addressable market.
The latest woes seem to stem from its production facilities. It has partnered with a Mexican firm, Sanmina which was slated to reduce costs and on paper a very sensible move. North America dominates the company revenues, with £124m of £169.6m being attributed to this region. Unfortunately, it does not seem that this move has worked out, with plenty of costs on product delays. Whilst not the only reason, net cash has slipped from a net positive position to a negative.
In terms of cash, there appears no need for worry. Net tangible assets are positive, although there has been a rather rapid build up in inventories, which almost doubled from 2017-2018. The explanation for this is in the warning. This may be the source of impairment in the future, although it could be the case that LED lights have much longer working lives than other types of product. Debt is covered via a £25m revolving credit facility plus £25m accordion of which the group operated ‘well within’ covenant.
A striking note is that the company reports in pounds, yet virtually all its earnings are in USD. Given the performance of the exchange rates over the last couple of years this should have added an extra boost to earnings.
Virtually all capex is on research and development, an intangible asset. This is not necessarily anything bad, but the level of spend has been relatively high: £6.3m in the past year. This level is high relative to the levels of operating cash flow and as a result the free cash flow here has been poor. It is no surprise that there have been no dividends here for a few years.
It may be plainly easy to see why investors are not pleased with the update and marked the share price down so sharply (although it has since recovered from the 300p earlier seen in the day). Previous updates had shifted weightings to H2, and now this warning seems set to cancel that out.
On top of this there seems to be yet more operational issues with heavy costs involved in moving production half-way across the world, and it is yet to be demonstrated whether this will become successful, although cynics might add that it probably could not get worse.
And the consistent line underscoring this all is that the company produces quality products which will always be in demand in industry, and the addressable market will be large.
So with good points and bad points the bear and bull cases seem nicely balanced here. The share price reflects a bit more reality. It is still expensive, but if you believe the production issues can be smoothly ironed out and order will be restored soon there could be good value here, if not there may be another profit warning in store which will hammer the share price even more. For certain at the moment it appears that the sentiment will be against them for a while until better results come through, but I am overall neutral. 3/5.