Surveillance specialist Synectics (LON:SNX) had a bad morning today, its shares plummeting by 20%. Despite spending much of the year above 200p, this level now looks a long way back after the latest Synectics profit warning:
Since this morning the share price has come back in a little but a long way off it’s all time high of over 560p back in 2014. Amazingly, the number of shares has stayed almost constant during this period.
Formerly known as Quadnetics, the company designs and manufactures surveillance technology for the use in advanced situations. This has applications in many diverse sectors, from public authorities, to oil and gas, to casinos. This has given rise to a complex business. It operates in different segments and has two business streams, systems and integrated management.
What did the Synectics profit warning say?
This becomes apparent in a rather meaty RNS we get today. As mentioned before, the core systems business is performing well. It is being let down somewhat by the integration side. This was not a new topic and was touched on last year, but it seems to have continued:
Based on the pipeline of expected new orders, and customer schedules initially indicated, the Group had anticipated a significant improvement in revenue and profits from its Integration and Managed Service division in the second half of this year. However, the weak performance reported at the half year has continued. UK market conditions remain difficult and, with apparent uncertainty among Synectics’ private and particularly public sector customers, the pattern of order deferrals and customer-led delays in the progress of existing contracts continues.
Integration and Managed services made up roughly £24m of the £71m revenue booked last year, so this is significant. With 55% of sales inside the UK, this is also significant.
There is further bad news:
In addition, the Group’s on-vehicle security activities were expected to deliver an acceptable positive profit contribution in the current financial year. However, with the disruption from the bankruptcy of a bus manufacturer customer and new bus registrations in the UK market continuing to be substantially down year-on-year, this will not now be the case.
This is potentially Wrightbus, which went into administration in September 2019.
The report is not all bad news:
By contrast, the Group’s core Systems division, with the majority of its revenues generated outside the UK, has made solid progress throughout the year and its results are expected to be ahead of the Board’s expectations. In particular, Synectics has made substantial progress in its target market sectors of Transport & Infrastructure and High Security and continues to achieve excellent results from its Gaming surveillance activities in the Far East and North America.
Security: A Tough Business
A look back at some of the previous Synectics releases show that this is not an easy business to be in, especially if you are around this size. Synectics profit warning are common and appear quite frequently. The reasons for them are common and themes repeat themselves many times, for example:
- Contract slippage
- Sector downturn affecting spending
- Reduction in public spending
- Key customer concentration
Their headline figures from Stockopedia don’t make great reading:
Admittedly more could have happened to explain this. On the face of it this looks like a business where it is very difficult to grow revenues, and/or profits. The systems side of the business shows far greater operating margins. A recent average of 7% operating margin compared to 3% for the integration – although the latter may have more promise as these revenues can be recurring.
We could say that the economy has dealt Synectics a bit of a bum hand, but stewardship here appears to play it safe. As mentioned, the number of shares has stayed constant. Existing shareholders could easily have suffered a dilution at a higher share price as the company sought cash to grow via acquisitions. This does not seem to have happened here.
So while net profits after tax have been fairly modest over the years (see table above) there has not been a great deal of extra spending. Thus, the group has stayed out of debt. Net cash at the last annual accounts was £8.1m which represents a significant percentage of the market cap. In addition, the company enjoys the use of a freehold building which it paid off in the current year.
Capital expenditures have been low, with the company taking the decision to capitalise only a small portion of research and development costs. We have seen dividends paid, but at a very low rate respective to cash flow. As we can also imagine the solvency tests are good. The current ratio is 1.82, and great strides have been taken with respect to receivables, with the average collection period shortening dramatically. With few other liabilities aside from the usual the position is not bad, and there is no immediate danger. Facilities were around £9.5m in overdraft and loan facilities, and these were not used.
Is the Synectics profit warning a buying chance?
In all, out of the three profit warnings covered today, this one is probably the ‘best’ one, in my own opinion. Arguably this will always be on the cheap side to buy. The relatively low order book (£24m at the last annual report) does not give a very clear look into future revenues. But it does appear that there are many competitors battling it out, many of similar size. There also will be more profit warnings in the future. The firm is quite dependent on spending by different sectors and governments. This is likely to result in choppy trading.
But it could be the case that at this level these issues are already priced in. It depends what how much weight you put on the future earnings potential. A third of the market cap is in cash, and Stockopedia predicts net profits for 2020 to be £4.03m. There have been bullish sounds about other parts of its business. The problems have been on the sector with smaller turnover and profits. It is also the case that management have been good so far and have shown good stewardship with regard to cash. As such, the dividend looks safe. A decent yield may underpin the share price.
It is true that revenues are flat, and there does not seem to be a catalyst for this to improve any time soon. But this doesn’t mean there will not be one.
One difficulty is that there are very few shares in issue and there is not a lot of activity. Liquidity could be an issue for larger amounts. Aside from that, I think there is more to like than dislike. 4/5.