The Ricardo share price (LON:RCDO) fell over 15% today in early trading as its interim results contained a bleak warning for the full year, with the second half set to be hit heavily by the coronavirus.
This week has not been a good week for firms wishing to bring out a profit warning. The markets have been in brutal mood, and the FTSE 100 has fallen from close to the 7,700 level to approaching the 7,000 mark. This undoes the boost many investors have seen since the General Election of December 2019.
Ricardo are a new firm to me. They have a long and distinguished history, being founded by Sir Harry Ricardo in 1915. They describe themselves as ‘a global engineering, technical, environmental and strategic consultancy business’ as well as ‘manufacturing low-volume, high-quality, and high performance’ products. A look at their annual report shows that they have plenty of fingers in plenty of pies, with business all over the world.
They have been listed a very long time – since 1986, in fact. The Ricardo share price had a massive run-up in the dot.com bubble but share price performance has been middling for investors until the last few years when profits and the share price have grown steadily.
What’s gone wrong at Ricardo?
The bad news comes in the interim results. The headline figures are good – profits up 5%, and the order book up 6%. As we go down, we find out this is not so great. Most of the growth has been driven by acquisitions, and the organic like-for-likes read very poorly. The order book is down some 29% in organic terms.
The real sting in the tale is the CEO comments. Ricardo CEO Dave Shemmans added to these results:
As we start the second half of the year, we have seen increased headwinds in the automotive sector which we anticipate will lead to suppressed order intake in our US, EMEA and China Automotive businesses. The Coronavirus outbreak at the start of H2 has already had an operationally disruptive impact on our Automotive and Rail operations in China and we anticipate continuing disruption to client engagement, project delivery and business development in the coming months in mainland China and surrounding countries. Based on the issues highlighted above we are anticipating material impact to our forecast second half profits and thus full year.”
Frustratingly there are no numbers. We have to go to a research note (available on Research Tree) for more information, and it does look pretty grim. Liberum note that H2 has a 60% weighting, and therefore the PBT estimate is cut by 25%. A gander at the annual report also reveals that Automotive is a large segment – accounting for almost a quarter of order values.
Given this news it could be seen as quite a success that the share price did not fall any further.
Ricardo: A diversified group
There are a lot of moving parts to Ricardo’s business, making it harder to analyse. The question ‘what do they do’ is not easy to answer quickly. 70% of their revenues are made from their Technical Consulting segment. This has a whole host of different large projects on the go in a wide variety of sectors, from large rail projects to highways and power plants. The rest of the revenues derive from the Performance Products segment. This is more in line with the original Sir Harry business, which manufactures engines and other parts for high performance vehicles and defence.
Given the trend for large projects which may be subject to delay, you would think this may be a business which regularly warns on profits. Or comes with small margins. Companies like Tekmar recently gave out a profit warning, and contractors have also had a poor time of it – Keller, Van Elle or Kier to name a few.
But Ricardo has not suffered as much. Recent investors may disagree as the share price had declined from over 1000p in mid 2018. It is also fair to say that the share price today is no higher than it was 5 years ago despite a large increase in revenues. And its margins are way above those of the contractors – almost 10% in both of its divisions. We may also surmise that by staying ‘upstream’ of the work Ricardo gets paid without any of the hassle of unforeseen circumstances affecting their revenues.
Ricardo – growing by acquisitions only
The top-line figures shown by Stockopedia may explain the share price performance over the last few years:
Revenues have grown, but the net profit figure for 2019 remained almost the same as it was in 2014. Profits for this period peaked in 2017, when the share price also was riding high.
We can see from Crunchbase that Ricardo have been riding the acquisition trail in recent years. Many of these companies are of the consulting variety, specialising in one of the markets mentioned earlier. Its latest acquisition was one in Australia, Transport Engineering. This was subsequently rebranded as Ricardo Rail.
These haven’t come that cheaply – Ricardo Rail’s headline price was £21.7m. This recent spurt of growth has taken its toll on the balance sheet. Intangible assets make up almost one third of the total assets. More pronounced is the debt position. In 2015, Ricardo reported net cash of £14.3m, but at the interim results this figure was a net debt of £73.8m, a large increase.
This should not present too many additional worries. The extremely benign borrowing environment has made it quite advantageous for good companies such as Ricardo to borrow cash. The current rate of borrowing (according to the last annual report) was 1.4-2.2% + LIBOR, and the total facility was for £150m at least, which gives ample headroom.
There is no question of this profit warning posing any threat to immediate solvency. The company converts its cash flow to profitability well, and its current assets were much bigger than its current liabilities. The receivables balance seems very high – over double that of TClarke (LON:CTO) with the two companies having similar levels of turnover. Perhaps with consulting there is less need to be paid in advance.
Is the Ricardo share price good value?
Understanding all of Ricardo’s businesses may prove pretty difficult, although from past figures it does seem clear that they perform an important role in large projects. More importantly for shareholders they are also carried out at a decent margin. Given their geographical spread it may be safe to say that their services will be in demand from at least one place.
One of the bugbears is that growth in revenues seems to have only come from acquisitions; without them revenues would have declined. With increasing headwinds and over £100m of its £150m facility committed this path appears to be nearing its end.
The real worry is the coronavirus. This seems to be the catalyst that drove the automotive industry in China over the cliff: numbers showing very sharp falls. The virus may clear up soon, but what isn’t so clear is how long it will take for sentiment to turn. On the flipside, with its varied businesses there may be opportunities for Ricardo in the aftermath. The virus may be a watershed moment and may lead to things being done differently in future.
On to valuation. One benefit of using debt for acquisitions is that shareholders have seen no dilutions of their stakes. But that is not to say in future an issue of equity could come, either to shore up the balance sheet or for further acquisitions. At this moment in time, I still think the coronavirus is a temporary factor which will eventually clear up (although that opinion may still change depending on news flow). And the business itself is a solid enough one.
Despite this I feel the valuation implied by the Ricardo share price is just about right at this moment and upside and downside is in balance. 3/5.