Focusrite: A Quality Compounder

7th Dec '22 by Mark Simpson

11 comments 2086 reads

Summary

A quality company that has compounded sales and income at high rates over the last decade with a return on equity significantly above its cost of capital.
Recently, higher costs and a strong post-pandemic comparative means that EPS forecasts are for slight declines for this year and next.
However, there is little sign that the company has gone ex-growth over the medium to long term.
The short-term outlook, plus the possible presence of a forced seller, has driven the price down to a level where it may represent good value for the long-term investor.

Profile

Focusrite (LON:TUNE) is an AIM-listed supply of hardware and software to the audio industry. It began in 1985 as a supplier to professional studios. The current Chairman, Phil Dudderidge, acquired the company in 1989 with the aim of expanding the business to serve commercial and hobbyist musicians as well. He has succeeded by growing the business, not just organically, but by acquisition. The pace of inorganic growth has accelerated in recent years, with four companies added since 2019. However, importantly for shareholders, this has been achieved with no dilution:

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Today the company focuses on two areas: Content Creation and Sound Reproduction

Content Creation

Focusrite provides hardware and software for music, streaming and podcasting content creators. There has been a trend in the music industry for content that would once be recorded in a studio to be done at home. The company provides both types of equipment, but the line has been increasingly blurred. On top of this, the trend for podcast content continues to grow, and listeners increasingly expect podcast audio to be high quality. Focusrite's equipment enables podcast hosts to create this with minimal effort. Covid provided a boon for the content creation side of the business as musicians could only produce content themselves as studios closed and live events ceased.

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They trade under the Focusrite, Focusrite Pro, and Novation brands in this sector. They also have a software offering called Ampify which they bundle with their hardware.

Sound Reproduction

This division includes Synthesisers from Sequential, Amplifiers from their latest acquisition Linea Research, speakers from Martin audio, and studio monitors from ADAM Audio, such as these:

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In contrast, sales in sound reproduction were severely hit by Covid. This is unsurprising, as the…

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ACounsell

7th Dec '22

The market doesn't appear to believe they either have a moat or can replicate historical growth rates going forward. Stock price is down 45% YTD and 54% from its all time high back in August 2021. I held but sold in July having bought at the beginning of 2022 taking a hefty loss of 24% in the process but things have got worse since then! IMO it would be a brave investor to buy into this share at the moment given the upcoming pressures on consumer expenditure and rising interest rates for what is expected to be a growth stock.

Viz

8th Dec '22

Isn't that a sign of when Buffett would be buying?

codefluence

I'm a happy amateur customer, in my view their products offer good value for the money they cost. The brand has had a very good reputation for many years. Still pricey for my investment style and current uncertainty but definitely on my radar.

rwh3ue

Paul Scott covered the results in the SCVR today if anyone hasn't noticed.

BnB

Mark. Now we've had the trading update, what are your further thoughts, if you don't mind me asking?

DanTE

17th Dec '22

Do you know why it got so expensive during the pandemic, doubling in price?

Rusty2

Just my thoughts. Possibly because of lockdowns, people were stuck at home, so ordered home studio gear. I noticed a lot of new albums came out in 2021, some artists released 2 or 3 albums, because they could not play live.

Also non musicians were buying Hifi more and streaming music at home.

If you look, the profits leap in 2021.

G4M was similar.

Mark Simpson

18th Dec '22

Sorry for the late reply; lots going on at the moment, and as a non-holding looking at the Focusrite (LON:TUNE) results was lower on my list.

In short, I don't see anything in these results that invalidates the thesis. Revenue was a slight beat, perhaps helped by acquisition, and EPS maybe a slight miss depending on how you decide to make the adjustments, particularly around the amortisation of acquired intangibles.

However, they have done incredibly well to hold the exceptional gains in revenue from their boom period in 2021. Gear4music Holdings (LON:G4M) faced the same boom conditions, and their EPS has fallen off a cliff. Plus they are more expensive, especially once you account for their debt.

Gear4music Holdings (LON:G4M) appears to be a much poorer quality business with a much weaker moat that faced an exceptional period, and investors got carried away assuming it was the new normal. You can argue that investors in Focusrite (LON:TUNE) were also irrationally exuberant, but at least they were buying a business that has a strong moat, even if they were potentially overpaying.

In terms of the short-term outlook for the business, it does indeed look like there will not be strong growth again for a while, given the headwinds. However, the question is would Buffett care about a weak short-term outlook? I doubt he would. He would care more about if their moat had been eroded or had their runway significantly lessened. And here, recent results look more promising for the company.

That said, I don't hold the stock. The 19xP/E is just a little rich for me for any stock. Particularly in a market where decent companies are available to buy at single-digit P/Es. These sorts of stocks rarely trade cheaply, however. A quick look at Treatt (LON:TET) shows that it is a quality company with a very similar medium-term outlook to Focusrite (LON:TUNE) after an exceptional 2021. Yet Focusrite (LON:TUNE) looks a better company on almost every metric, and Treatt (LON:TET) has a forward P/E of 28. Perhaps my unwillingness to pay up for such a business is a bias that I should work hard to overcome.

Thanks for sharing your thoughts Mark. My concern, inevitable near term slowdown aside, is whether the business will sustain this much higher income long term. And indeed push on with growth from the higher level. Management claim to be confident of sustainable organic growth from here but time will tell.

19th Dec '22

Perhaps my unwillingness to pay up for such a business is a bias that I should work hard to overcome

I own a good selection of high quality US industrials where the p/e is normally in the mid-20s - not to mention the even pricier Halma and Spirax - and they have been very good performers and a very unstressful hold over a considerable period. All depends on your investing style of course but I’m a believer in looking for the highest quality in the most attractive markets and ignoring short term noise (like recessions!).

20th Dec '22

Another acquisition today, taking the group into audio software for the first time. Earnings enhancing in the current year too.
https://www.londonstockexchang...

Focusrite: a quality compounder

Summary

Profile

Content Creation

Sound Reproduction

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About the Author

Mark Simpson

11 comments

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