Interesting Growth Company - Zytronic (ZYT)

12th Dec '12 by Paul Scott

9 comments 9545 reads

Invitations to meet company management often hit my inbox these days, as more brokers and PR companies recognise the useful role I can play as a conduit between the City and private investors, a role I'm very happy to play for quality companies only! I've held shares in Zytronic (LON:ZYT) before (but not currently), so was pleased to meet their CEO and FD today at Buchanan's offices, for a results presentation and lunch. Many thanks to Buchanan for their excellent hospitality! As an aside I must also mention my astonishment when at the end of the meeting, whilst I was chatting to Zytronic's FD, another attendee at the meeting chucked two ten pound notes across the table at me, and just said, "for your running fund!", smiled and disappeared. I was so taken aback, I didn't properly thank him! So if you're reading this, thank you so much for your generosity, and I have paid it across to the charity on your behalf through JustGiving.

What do Zytronic do?

They are a specialist manufacturer of rugged, larger, touch screens, typically for ATMs, vending machines, betting terminals at casinos, etc. About two thirds of their touch screens are 15-20" (across the diagonal), with the trend being towards larger sizes still. They are based in the North East of England, and manufacture everything themselves in clean rooms in 3 factories.

318p (at CoB 11 Dec 2012) * 14.9m shares in issue = £47.4m Mkt Cap

Their results issued today for y/e 30 Sep 2012 can be found here.

I'm very pleased to see that the results presentation given at the meeting today is also on their website here. That's very shareholder-friendly, hence gets a big thumbs up from me.

Looking briefly at their results, turnover was flat at £20.4m, but operating profit rose a respectable amount from £3.7m to £4.3m, due to high achieved gross margins. Margins are expected to continue rising, and the company is targeting an increase from mid-30%'s to low-40%'s. You can do the maths, but that makes it look to me as if it probably won't be long before profits pass the £5m p.a. level.

EPS moved up a useful 21% to 22.2p. So at the current share price of 318p that works…

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fek47

25th Mar '13

Thank you Paul for an excellent analysis of Zytronic (LON:ZYT).

With the shares having crept down 30p or so in the past couple of months, my view is that they current represent pretty good value at ~291p, so I've taken the plunge just now and bought some in my SIPP.

Francis

Paul Scott

10th May '13

Quick update - unfortunately Zytronic (LON:ZYT) have warned on profits today, and it sounds like a fairly big miss.
The key part of the RNS says;

"...despite there still being an encouraging pipeline of opportunities, the conversion rate to orders is much slower than the Board anticipated, and as a consequence the result for the year will be very significantly behind market expectations, with year to date profitability more than halved." (my bolding)

Given that their year-end is Sep 2013, then today on 10 May they are in month 8, so almost two thirds of the way through the year.

They did 21.9p EPS for the full year in 2012, so if we say they're probably heading for around half that for this year, then it looks like say 10-11p EPS might be where things are heading?

So how should we value it? Who knows? The big question is whether this year is likely to be a one-off glitch, or whether the business is facing a much tougher competitive environment. If it's the former, then we could look through this profits warning, and justify a price of (say) 200p+, based on earnings rebounding next year. If it's the latter, then we might apply quite a low multiple (say 7 or 8 times) to this year's earnings, and come out with a sub-100p share price.

On the more positive side, the profits warning today also mentioned that;

"The company continues to be cash generative and is in a strong financial position with cash of £4.6 million and borrowings of £1.8 million as at 31 March 2013 and is still in a position of having several very interesting projects with the potential to materially improve future performance."

If I can find time, I'll try to speak with the company next week. Also we can all keep an eye out for an updated broker note from N+1 Singer.

My commisserations to shareholders in Zytronic. Very unfortunate, although you're in good company - I see that shrewdies Hargreave Hale own 12%.

Regards, Paul.

Ultimate_behemoth

Thanks for the update Paul, I agree it is a difficult one to value now given the break in eps growth.

Personally I have taken the opportunity to open a small position, given their track record I'm hoping this is a one off opportunity to pick them up at a cheap price. Time will tell.

Hi Ultimate_behemoth (good name by the way!)

I was tempted today, but usually find that it's best to hold fire after a profits warning, and see where the price settles. Therefore I'm probably going to wait & see.

I'd throw caution to the wind & buy regardless if they get into the 100-120p range. But it might not go that low, depends whether existing holders are minded to give them the benefit of the doubt, or whether there's a stampede for the exit.

As the warning happened intra-day today, and the decline continued unabated to the close, it looks to me like there is a further fall likely next week.
Depends what info the broker & PR people put out next week in support of the price, and how credible it is.
It usually pays to bide your time after a big profits warning though.

Regards, Paul.

djpreston

11th May '13

Very true Paul (re biding your time), especially in a poor liquidity situation where there are some large holders, like Hargreave Hale.

As you know, if they want to reduce to a lower level exposure or even sell out then the price is going to be held back, depressed or crushed. Even if they just decide to reduce over time them any bounce back will be muted due to the overhang from stale bulls.

Shame to see the warning (no position though), a good company with competent management but was always way about vulnerability if a "project" was delayed, as so many are when times are tough.

I'm a big fan of companies from the North East. for much the same reasons you highlighted in the OP. Doesn't mean you dint get the odd stinker in terms of management, Tanfield anyone?

Just need my beloved Sunderland to stay up now.

Cheers from very sunny (too hot) Florida.

D

Mark Simpson

As the warning happened intra-day today, and the decline continued unabated to the close, it looks to me like there is a further fall likely next week.

I don't get why companies think that an intra-friday profits warning does them any favours - you get a big drop on the day anyway followed by a further drop on monday as those who didn't spot the release at the time digest the news over the weekend and then sell anyway but at a disadvantageous price. 8 months into the year then 11.29am Friday can't be the first time they thought 'hey this year might be a miss we better tell the market'. This behavoir then makes investors doubt the competence of the management which is going to do you no favours when they price this additional uncertainty into your share price.

Re: Valuation it really comes down to what is the new normal - as you say if it's 10p EPS and a no-growth P/E + 10p/share cash then you are looking at 80p fair value and still a fair way down from here. However if it is just a blip then fair value could be much higher. Given the uncertainty then without clarification you have to treat it like a base case valuation plus an option on the upside. However given that the management either don't have very good visibility or control over the business or are not good at communicating with shareholders I struggle to place much value on that option. Hence it would have to go sub-100p for me to even consider buying unless we get clear evidence that this is just a blip not the new normal.

Cheers,

Danger (thankfully no position)

12th May '13

Hi Danger,

Some really good points in there, have a thumbs up!
You make a very good point about intra-day profits warnings. I think there is a very strong argument for the regulations to be changed so that all profits warnings must be released at 7 a.m. only, other than in very exceptional circumstances, otherwise it's not a level playing field at all, because most investors don't sit glued to a screen, and even if they have an alert set up, might be too busy to read or respond to it.

I happened to notice the ZYT warning within about 30 seconds of it being issued, as it's on my monitor, and I do sit at my screen most of the day. I read it & thought, ooh this is bad, and immediately thought to myself that this is likely to knock a third to half off the share price. I don't usually short things, but I thought to myself when the price had only come off a few pence, this would be a very good short at 260p.

As you say, there will probably be other shareholders who have only seen & digested the news over the weekend, so probably more selling on Monday. Depends whether existing holders still buy the story, and hoover up the sells, which is possible, in which case I would expect the shares to stabilise around 150p. Or if they don't, or worse a large holder decides to bail out, then we could get to your sub-100p level in the next few days.

I'm keeping my powder dry on this one, but what a pity to see such a lovely growth track record shattered. Just shows, it's all educated guesswork really. None of us really know what growth companies are likely to achieve. It also reminds me that companies without recurring revenues are really not very attractive investments, as trading can fall out of bed any time they have a poor period for order intake. I'm gradually moving my focus more to companies that have recurring revenues, as the chances of a profits warning are so much less.

Thanks Paul,

I'm not convinced regulation is the way to go myself - I think it would probably be unenforceable and further discourage accurate timely disclosure because companies would start to care more about meeting the letter of the regulation than good communication. I don't have any issue with market participants that are quicker or (legally) better informed than others, it's the companies' managements that are questionable here.

What maybe needs to be made clear to company managements is that an important mid-trading Friday announcement of any kind without good reason (e.g. in response to market price movement) says that:

1. The management care more about short term speculators than long term investors who will support the company or provide equity finance at a reasonable price.

2. They are poor at taking necessary actions in a timely manner. We all put off things we don't want to do but if you do this regularly when running a business sooner or later it will cost that business cash.

3. They don't really understand or care about their status as a listed company and by extension the owners of their company.

I doubt many companies intentionally have these attitudes but they do need to realise the impression that such behavior gives and how it encourages speculators and discourages long-term supportive shareholders. Which is diametrically opposite to the share register that most managements want.

It would be an interesting academic study to see if there is a correlation between the timing of price sensitive announcements and future equity returns.

Cheers,

Danger

22nd May '13

Hi,

Here's an update on Zytronic (LON:ZYT).

The company issued interims to 31 Mar 2013 yesterday (21 May 2013). The figures were as expected - i.e. pretty awful, as had been pre-announced by the company for a long time - remember that the most recent profits warning was not for H1, but for H2. They always said H1 was expected to be slow, due to delays in order intake.

The fact that H2 is also expected to be slow does concern me, as delays shouldn't cause a whole year's profits to be severely reduced.

Other notable things from the results (in my opinion), and from my telephone conversation with management yesterday;

Sales down 20% - OK this can be explained by delays in orders. They talked me through the various projects in quite a lot of detail, and it is clear that Zytronic still has a good pipeline of projects, but their order visibility is only 4-6 weeks. So I think investors will just have to accept that the business is more volatile & hence accident-prone than they had perhaps previously realised. So I think this impacts on what PER the business should be priced at. I think a PER of 12 is probably about right for the time being.

Gross margin also down, from 36.4% to 26%. This concerns me more - as it seems to suggest pricing power is disappearing. When I spoke to them, management firmly rebutted this. They said that the margin fall is due to inefficiencies in production, caused by the lumpy nature of sales - i.e. there have been higher labour costs, etc, which has brought down the gross margin. They reiterated their previous guidance that they are targeting getting the gross margin not only back up into the high 30s, but into the low 40s in the future. So if they succeed, that's pretty good news.

What will future EPS be? We just don't know. The latest forecast is for only 8.5p this year, although reading between the lines, I would hope to see them beat that, maybe 10-12p hopefully this year? If it's below 8.5p then that would be a disaster. The house broker has estimated only 10.6p for next year, in a new forecast. So again that would only justify a share price of around 130p in my view.

The interim dividend was actually increased by 6%, so that's good news in the short term, as it demonstrates confidence in the outlook, and ZYT has a strong balance sheet, so can afford it.

Overall management said they are "disappointed, but not despondent", and are full of upbeat commentary about the future prospects for the business. So you would hope that recovery is likely. I'm just not happy to pay up-front for a recovery that hasn't begun yet.

There are some large screen interactive projects with Coca-Cola in the pipeline that sound good, and also gaming tables, where new products from ZYT could boost sales. They have long-term client relationships, and a strong competitive market position, and mgt emphasised they have not lost any projects to competitors, which I think is important.

Overall then, I like the company, think management are honest & competent, but at the moment I'm not ready to buy at 180p. I'd be a buyer below 150p only, in order to ger the balance of risk/reward right for me personally. But we're in a bull market, so there's no saying what the share price will do.

One final point, I did mention to the CEO & FD that I thought an intra-day profits warning at 11:30am was most unhelpful, as many private investors will not be at a screen, so asked them if they wouldn't mind issuing trading statements in future at 7am so it's a level playing field for all investors to get the information at the same time, and have time to digest it. They took the point.

I also hope that we can get them to present to PIs at one of the meet the management forums, such as Mello or Equity Development, and others - all of which are very useful events for us to attend.

Interesting growth company - Zytronic (ZYT)

What do Zytronic do?

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Paul Scott

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