Technical fluid specialist Flowtech Fluidpower (LON:FLO) issued a profit warning today citing tough market conditions. The shares dipped over 25% at one stage before recovering and finding some stability:
Looking back at previous updates, this should have been covered before: there was a large profit warning in 2018 which caused a huge tumble in price from around 175p to below 125p. Since then the shares have staged a bit of a recovery but the company seems to have flirted with a profit warning throughout 2019, hinting at a possibility which has caused some volatility in price.
The share price did recover post-election but today’s warning means it has given up all those gains. Interestingly enough the 100p region could be significant in the bigger picture: the share price has bounced off several times from this area in the few years it has been listed, and the price always moves away from this area once breached. Whether this may happen this time around remains to be seen.
What’s gone wrong at Flowtech Fluidpower?
The bad news is delivered in a trading update which covers the year to 31 December 2019.
Market conditions in the second half of 2019, in particular the final quarter, have been challenging; data from the British Fluid Power Association shows a decline in distribution channel revenues of 7% and 13% for October and November respectively, and a decline in revenue of in excess of 10% in October for the manufacturers within the sector.
Against this backdrop, the Group experienced organic revenue decline of c.10% in Q4; as a result Group revenue is expected to be c.£112.4m which represents overall organic revenue reduction of c.1.5% (H1 growth of c.3% and H2 decline of c.6%) for FY19. The Board now expects to report underlying profit before tax* of not less than £9.0 million.
There is a broker note out today (available on Research Tree), the old estimate was for £11.4m, so this is a fair sized miss. The trading update also warns on profits for the next year:
Expectations for FY20 have been reviewed by the Board and whilst it is confident that investments made in 2019 will lead to market outperformance, current conditions are such that achieving organic growth may prove difficult, in particular in the first half of FY20. It is therefore possible that the positive impact of the cost saving initiatives which have now been formulated, and which will shortly be implemented, will be offset, at least in part, by market conditions remaining challenging.
The broker note also downgrades profits (adjusted EBITDA FY20 £13.3m down to £11.0m, FY21 £13.9m to £11.7m.
Flowtech Fluidpower: Lubricating the wheels of industry
Flowtech are a relatively new listing, coming to the market in 2014. They specialise as one might guess in the supply of hydraulic and pneumatic systems to industry. Split across three segments (Flowtechnology, Power Motion Control and Process), the group heavily weights its operations to the UK (which generates approximately 80% of revenues) and Europe (which accounts for most of the rest).
From this we can already deduce that recent political instability (Brexit) may be a legitimate reason for delays to consumption (unlike City Pub Group, which warned yesterday).
The IPO raised £37m which was used to pay off debt. Since then, debts have increased again which has necessitated material stock issued (>10%) in the past two years. But at the same time, revenues have grown sharply:
Much of this growth can be put down to acquisition: since flotation the company has acquired no less than 14 businesses, mainly smaller businesses where the owner is seeking to retire. This is not too dissimilar a model to other companies who specialise in their fields such as SDI or Judges Scientific. And as we can see from the numbers above, the integration of the businesses appears to have gone smoothly, although margins seem to have fallen (the 2014 result from Stockpedia appears to be an error with the decimal point).
One important factor is that the business seems to have gone ex-growth: broker forecasts do not imply any further acquisitions, and as we can see from the profit warning today, organic revenues are on the decline. But let us still call it what it is: the company has a good record of profitability.
We can then move on to other aspects. As we may expect with an acquisitive company, there are plenty of intangible assets on the balance sheet: over half of its £134m in total assets are either goodwill or intangible. However, tangible asset value is still positive. Current ratio is over 1.4: although much of the current assets are tied into inventory or accounts receivables. With the latter balance of almost £25m it is clear the lead time to payment is long.
At the last financial statements, net debt was up to around £20m. We can see from the trading statement that this figure has dropped to £16.6m largely thanks to an unwinding of their working capital positions. And this was required: their revolving credit facility was drawn to the maximum (£16m). 2021 sees the renewal of these facilities, which may be on more favourable terms.
The situation seems OK for now: capital expenditures are not large (averaging a quarter of cash-flow), and the debt was reduced. It can be said that it may be the case that working capital position unwinding cannot continue but in a need for cash there still appears to be some options left; the situation does not seem critical.
Are Flowtech Fluidpower shares good value?
The price of the shares have dropped a lot: halving in the space of around 2 years. There is also plenty of volatility to contend with, and the company has effectively given a warning that 2020 and perhaps even 2021 will be poorer years and the brokers have forecasted only slow growth.
The dividend yield here looks great at the moment (6%+) and has been progressively increasing since going public. This also has been affordable as well: it has been covered by free cash flow. Whether this is should be sustained is another matter: dividends cost the company £3.56m in the last year, and if there are rough seas ahead it may be more sensible to pay down debt to avoid getting into a bad situation.
This may be a tough call to make. On valuation grounds there is little wrong, and there may be a case for saying it is a tad underpriced if one can accept the next couple of years may be barren. Perhaps more industry knowledge is required to make an assessment of whether their acquired brands are strong in their field. I don’t have a real strong opinion either way. 3/5.