Commiserations to any holders of Quixant shares (LON:QXT) as today’s profit warning saw share prices halve in early trade as their interim results revealed full-year profits would be below expectations. There has been a smidgen of recovery since, but that will be of scant consolation to anyone except those buying the warning:
Much shareholder value has been lost here over the past year. In fact, just a year ago, the company looked set to be breaching the 500p mark, so it’s all come crashing down quite quickly. Looking back through the notes it seems that this profit warning was coming, as in January we were warned that profits would be significantly second-half weighted. Today’s note makes for even worse reading as it appears that these profits will not materialise.
Quixant will be a share that many investors would be aware of, having a very good track record. They specialise in the production of PC-based systems for gaming software, used in the entertainment and gambling industries. Products such as the machines in betting shops as well as the monitors would come under this umbrella.
In 2015 the company made a major acquisition in the form of Denistron, a display specialist. This also broadened the firms markets through to industrial applications, as well as providing the foundations for a large growth in revenues. Since floating, turnover has risen almost fivefold.
The warning comes today with the interim results. Firstly H1 was in line, which is no surprise given this was how things stood in the July trading update. But it appears the H2 weighting won’t be happening, or at least as much as it hoped:
Quixant’s revenue has historically been second half-weighted and as previously announced, management expect this trend to be reflected in full year 2019 results. However, new information from some customers regarding order levels for the remainder of 2019 indicates that, while this second-half weighting will occur, due to lower than expected demand for our customers’ gaming machines, Quixant’s total revenues will be below previous expectations and consequently will result in a reduction in full year profits for the Group to between $12.0m and $13.0m.
No mention is given to these expectations, but a quick look at broker notes (available on Research Tree) shows that the figure for full-year profit was $20.0m So this represents quite a large miss of up to 40% and is almost commensurate with the share price fall. Trading on a punchy valuation beforehand, this is no longer the case.
It is well worth mentioning that unlike many other IPOs (including that of Alfa Financial, covered yesterday), management have performed a very good job since, and longer-term shareholders would have been on a terrific ride where their investment would have bagged many times over, had they sold out towards the top of the market.
The reasons in retrospect seem obvious, in that Quixant manufacture quality products which are highly regarded by the industry. This is underpinned by some very impressive financial figures as well: it is not the case that Quixant are peddling commodities, and their operating margins and return on capital is very impressive. It has to be said operating margins have been on the decline:
Quite why this is may be subject to a few reasons, the primary one could be the Densitron acquisition (which offers lower margins) but the effect is mitigated by a large increase of revenues over the years which means that although margins have roughly halved in this time, operating profits have doubled.
Capex costs are low, and the company is genuinely cash generative. The acquisition was paid for via debt, but the business has since paid this off out of profits and now has a positive net cash balance. Additionally, dividends have resumed in the last two years and at roughly 40% of free cash flow are sustainable.
The balance sheet seems healthy, with a positive tangible asset value and given the nature of the business (which is still profitable) there appears to be no chance of insolvency.
So the questions must turn to what has gone wrong, and what has caused such a large profit miss. From the interims we get this:
So while Densitron has pretty much been fairly stagnant, the real damage has occurred in the Gaming divisions, which accounts for almost all the decrease in revenues. Specifically it mentions a slowdown in Australia and a loss of business, but this has been going on for some time, which we can see from the last annual report:
Revenues from Australia have taken quite a large tumble, and it is the UK that has picked up most of this. There was good growth in other areas last year, so it could be logical that for a large fall in revenues, more than one area is affected. But this comment demonstrates that key customer concentration is an issue, and the report quotes:
With the broadening of our customer base, we anticipate revenues from our largest customer to continue to fall from 2018 levels (17% of Group revenue) to approach 10% of revenues in 2020.
Longer-term the company are bullish about its prospects, and have poached a Product Director from a bigger competitor.
The rate of decrease in profits is quite surprising, and the fall in share price is understandable. The large multiple it traded on was perhaps contingent on it continuing its quick growth curve and that seems off the table, if not forever. There are only so many games machines, and it is also the case that there are several firms vying for business.
At present, there would appear to be headwinds from a few places. In the UK, many betting shops are slated to close, which would be a major market for these gaming machines. Other places that may see this technology such as arcades or pubs are also on the wane. The reason for closure in the case of betting shops is not a case of lack of demand, but rather the limitations put on them by government. A similar argument could be held for the US, where the touch-screens are limited to casinos and physical sports betting is still in its infancy.
Allied to the key customer risk still present, the fact that visibility of revenues is tough and that many machines may realistically be need to be replaced inside a few years as better technology becomes available, perhaps this re-rating may be permanent.
On the flip-side, as mentioned before Quixant management have delivered in the past for shareholders and have grown their company many times using internally generated funds instead of dilution. The company is also in a fairly good spot financially. Although the potential upside seems to be much lower I would have some confidence in them turning it around. 4/5.