Luceco (LON:LUCE): 100-bagger potential
In last week’s article, I introduced a 100-Baggers screen. Similar to my Buffett and Munger screen from the previous week, the results perhaps contain far more misses than hits. This is the nature of Quality Investing, which is analytically very difficult. With perhaps just 4% of listed companies having a sustainable competitive advantage over the long term, and far fewer than that having the ability to profitably scale, the odds make it a challenging task to find these types of stocks.
However, the learning from Buffett and Munger shows that if you can identify a company with a genuine moat, scale to expand sales, and don’t overpay, the long-term returns are great. The 100-baggers study demonstrates that, if you add operational leverage to the mix, the combination of rapid earnings growth and a multiple re-rating makes the returns phenomenal. This framework of Runway (the ability to scale), Moat (Sustainable Competitive Advantage), Operational Leverage and Low Multiple (Cheap) therefore provides a good way of assessing how likely a company is to generate high returns in the future.
One of the major concerns of readers of my last article is that these methods may not work in the UK markets. After all, most major stock market studies, such as Thomas Phelps’ 100-baggers, are US-based. The US tends to have more technology and healthcare stocks, where IP or network effects provide strong moats. However, these are not the only type of moats and only focussing on these may miss out on great companies in other spheres. In the comments on last week's article, timarr pointed out a study by Lindsell Train that shows that UK companies have delivered these exceptional returns in the past:
There are 12 companies in the current FTSE 100 and FTSE 250 which have at some stage delivered a 100-fold return to their investors – from a low to a peak. Let’s list them. From the FTSE 100: Ashtead, Antofagasta, DCC (up 525 times!), Next, Randgold Resources and Sage. From the FTSE 250: Cairn Energy, Capita, Daejan Holdings, Domino’s Pizza, JD Sports and Tullow Oil.
Lindsell Train also found that another 12 companies had increased between 50-100 times and 65 companies increased between 20-50 times. And a further 82 have gone up at least 10-fold at some point since the mid-1980s. That makes 171 companies or half of the FTSE350 that would count as big winners.
If that still isn’t convincing, those who prefer other markets can easily adapt the screen to more fertile hunting grounds since with Stockopedia it is straightforward to add more regions. [It is just better for me to demonstrate the principles using a UK-based screen, where all readers are likely to be able to access the StockReports of the screen results.]
Over the next few weeks, I will pick interesting UK companies from the Buffet and Munger and 100-Baggers screens, and analyse them using the Runway, Moat, Operational Leverage and Low Multiple framework to assess their potential to be large winners. This week I start with a company I know well: Luceco (LON:LUCE) .
Luceco
Luceco manufactures power products such as LED Lighting, wiring accessories and portable power. Investors will probably recognise many of their products which are sold through DIY stores:
They are UK market leaders in Portable Power and number two in Wiring Accessories:
This doesn’t sound like a particularly exciting place to search for multi-bagging potential. However, as Thomas Phelp’s, 100-baggers study showed, mundane businesses can still deliver great results.
Luceco has been listed since the end of 2016 but has a much longer history as a company. It can trace this history back to the creation of the British General wiring accessories brand in 1941. The CEO, John Hornby has led the group since 2005 having originally joined Luceco in 1997. He was part of the original management buyout of Luceco from a listed plc in 2000 and led the secondary buyout with a private equity firm in 2005. The CFO, Matt Webb, has been in the position since 2018, having previously been an FD of a US business. The longevity of management means that the company is unlikely to implement a significant change of strategy any time soon. However, their current strategy of growth, innovation and sustainability is largely what investors would want from a long-term investment.
Runway
One of the key factors in finding companies that are able to multi-bag is assessing their ability to scale. Being among the largest players in the UK market for Wiring Accessories and Power Products which are relatively mature market segments, may act as a headwind for Luceco. However, AMA Research lists 21 competitors of Luceco in Wiring Accessories. So, this is a relatively fragmented market with plenty of scope to increase sales by increasing market share for a company able to deliver operationally. Indeed, the company’s revenue has grown over 4x in the last decade:
This growth has been through organic growth and acquisition. They acquired Kingfisher Lighting in 2017 and DW Windsor in 2021 which added £14m and £24m to their revenue, respectively. However, acquisitions have been made using reinvested cash flow and debt, leaving the share count unchanged since listing:
The company also has the ability to grow into complementary areas. They acquired SyncEV in March 2022 adding to their scale in this faster-growing market segment:
As well as green energy markets, the company sees other long-term market growth drivers, such as repeated regulatory changes in the wiring market and the impact of an ageing UK housing stock. In addition, the consumer demand for higher-end functionality and the need for simpler installation should drive up product value over time. 80% of their sales are currently in the UK. While some of their designs will be specific to the UK electrical market, the opportunity to sell into other territories remains an additional opportunity.
Overall, I think the runway here is good. After all, with the right conditions 100 baggers often only need to increase sales by 10x and this seems possible within the current and adjacent end-markets. The slow growth of their core markets limits their ability to grow to some extent. However, these markets are fragmented and there is plenty of opportunity to grow by increasing market share and through acquisition. The company has a strong track record of being successful at this.
Moat
The company had a Gross Profit Margin of 37% in 2021. This is a decent number for a manufacturer of physical products but is not exceptional. However, this does show a reasonable level of consistency and has been trending up slightly over time, suggesting that they are moving increasingly to higher margin categories, such as EV charging:
The Stockopedia Quality Rank is only 65, mainly because of the low Piotroski F-Score reflecting the weak trends in recent trading. However, apart from a blip in 2018, when UK consumer-facing retail was unexpectedly weak, their Return on Equity has remained well above their cost of capital, and has also tended to trend upwards over time:
This suggests the presence of a moat for the business. I can see three ways in which this manifests itself:
- The first is in their brand value. While not all their brands are well-known amongst consumers, for professional installers a trusted brand is vitally important since the product value is often only a small amount of the total cost to a customer, but a big hassle for an installer if it goes wrong.
- Secondly, they are a design-led company with all products designed in-house. 50% of their revenue comes from products that were designed in the last 3 years suggesting that their pace of innovation is strong.
- Finally, more than 50% of their products are manufactured in-house (mainly in China) and the rest through long-term trusted OEMs. Their in-house manufacturing enables them to have end-to-end control over the design and manufacturing process, which leads to higher-quality products.
These are not moats that are insurmountable, however. A competitor with a large marketing budget could develop better brand awareness or could hire design or manufacturing engineers to compete more effectively on product quality. Still, a historical competitive advantage gives Luceco a head start, and as long as they maintain their momentum of innovation and growth, this should provide a fair but not strong competitive advantage.
Given that Net Income is the numerator of Return on Equity, weak end markets will see both figures decline. This shouldn’t necessarily be taken as an indication that competitive advantage is waning. However, if the Return on Equity starts to drop for several years in strong end markets, this should act as a warning sign that their competitive advantage is being eroded and cause any quality investors to re-evaluate the company.
Operational Leverage
One of the drivers of significant returns to equity holders is operational leverage. In last week’s article, I introduced the idea that low net margin combined with high gross margin could drive very significant earnings growth since admin costs may be relatively fixed. Luceco has a TTM net margin of around 8% due to the weaker recent trading performance. The company targets 15% and had been achieving this over the last two years:
A return to target will have a very positive impact on earnings. However, the long-term picture of SG&A as a proportion of revenue is a little mixed:
They had an average of around 20% prior to listing. On listing this rose to around 26%, due to higher PLC costs and the impact of the Kingfisher Lighting acquisition in 2017. Recently this has been trending down again, although is likely to rise slightly with lower revenue forecast for 2022 and 2023. This suggests that any organic growth may provide some operational leverage going forward but is relatively weak overall. In addition, the current short-term revenue hit due to customer de-stocking may see this operational gearing work in reverse for some time.
Low Multiple
With a forward Price Earnings Ratio of less than 10, Luceco is undoubtedly cheaply-rated:
However, those earnings forecasts have a worrying trend:
The combination of cost inflation taking time to pass through to customers, plus destocking by a major customer who over-ordered in response to high demand as the world opened up again post-COVID, has led to a weakening outlook. The EPS forecasts for both 2022 and 2023 have halved during 2022. However, this weaker outlook has been reflected in the share price, which has fallen 75% year-to-date. From the point of view of an investor considering an investment today what matters is the future. Their Q3 results were in line with expectations. However, they guided for Q4 to be weak on continued customer destocking. Given this trend and the weak economic backdrop, 2023 must be approached with a high degree of uncertainty. However, if these do represent the trough for earnings, the valuation leaves a lot of upside potential during any recovery and subsequent re-rating.
Their Value Rank is strong at 84 but not exceptional, due to a higher-than-average Price to Book Value. However, this is to be expected when looking at companies that have consistently high Returns on Equity. Given that Shareholders' Equity and Book Value are different names for the same thing (the difference between Total Assets and Total Liabilities), then it is to be expected that P/TBV and ROE are positively correlated.
At the H1 balance sheet date, Luceco had £53.9m of covenant net debt. This is in the middle of their target range of 1-2xEBITDA. The recent increase has been due to the SyncEV acquisition and holding higher inventory to mitigate any supply chain issues. With supply chains now normalising, they expect to reduce this by around £10m in H2. The presence of debt adds an additional element of gearing on top of any operational leverage. However, it also adds additional risk, and when debt-adjusted the rating is less compelling. It may also limit the size of any future acquisitions that can be made in the short term.
Conclusion
Luceco appears to be a good company with a large runway for growth and a reasonable moat, although one that could be breached by a determined and well-financed competitor. So far it has shown only a small amount of operational leverage which will limit how quickly EPS can grow in response to any future revenue growth. On the plus side, since listing, acquisitive growth has been financed by internal cash flow and debt, meaning that EPS will grow with earnings. On the downside, the current debt level means that major debt-funded acquisitions may not be possible in the immediate future. However, the low multiple provides a significant upside if the management manages to deliver revenue growth in line with past trends. History has shown the company may well be re-rated upwards if earnings growth returns, and that the combination of the two, if they appear, will generate very good returns to holders. However, this is unlikely to be a 100-bagger due to the lack of real operational gearing over the very long term.
The downtrend in analysts’ consensus may give some investors pause for thought, and the momentum Rank is only 12. The recent Q3 trading statement was in line with management expectations but the Q4 guidance was lower. So there is no guarantee that the 2023 estimates won’t face further downward revision. However, for investors who are willing to look through this short-term outlook, there is a lot to like about the company, even if it is unlikely to ever hit that magic 100x.
Next week I will apply the Runway, Moat, Operational Leverage and Low Multiple framework to assess the potential of another company from my recent Quality Investing screens.
[Disclosure: Mark owns shares in Luceco (LON:LUCE) ]
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41 comments
Yes it will definitely go up to 500p like it did before so even 5x in a few years won't be bad compared to the FTSE100 tracker.
If you look at the Screwfix and Toolstation catalogues, Luceco dominate the EV charger categories and if you deep dive you will notice their #2 competitor is loss making (Companies House), so Luceco can perhaps kill them off with any price war.
The PE of Luceco does not reflect the 30m households will have EV chargers in a decade, plus they are getting into solar inverters if you watch the last earnings call video.
Dear Mark,
You have claimed on this thread that the long term return of the stock market is ten percent per annum.
This is radically higher than any study that I have come across and I asked you over a month ago of you could substantiate this claim to date you have not.
A stock pitch based on facts that are incorrect is of little use to anyone can you update please ?
Mark todays update from Zotefoams suggests that you need to revisit your analysis of what the word quality actually means, a capital intensive monopoly with pricing power is a quality business for a long term investor Luceco has lost investors money from the off and your opinion of the business should reflect that reality
I find it hard to get excited by any filter for x100 potential that includes Unilever LOL !
Dear Mark,
Going through the comments on your Luceco pitch and your replies you make a claim that the long term return of the stock market has been 10% real ( ie after inflation I think you mean) please can you substantiate this as the long term studies that one reads have equity returns around seven percent.
The second claim is that you claim Luceco has returned 25% annually to shareholders yet the company was floated at 130p in October 2016 so no shareholder in the public arena has had a positive experience at the current sub 90p share price.
Apologies, I meant 10% nominal. Accounting figures are, of course, nominal so this should be the comparable return for estimating WACC. I stand by my assertion that a realistic WACC for a small cap is probably around 15% and 20% for a microcap, based on what shareholders typically want to return, given the extra risks they are taking vs being a passive investor.
The only reason we are talking about WACC is that the ROE of any incremental investments a company makes should be above WACC for that investment to generate Shareholder Value. Luceco's ROE has averaged 25% since listing, and Zotefoam's ROE has averaged 9% over the last decade. This doesn't mean that their incremental investments are certain to be of the same quality. But it does give an indication of how good at capital allocation a company's management has been in the past and, therefore, the likelihood of them generating Shareholder Value in the future.
Again, Shareholder Value and historical Shareholder Returns are completely different concepts and shouldn't be confused. The only link is perhaps the Buffett and Munger observation that, over the long term, Shareholder Returns tend to converge to the Shareholder Value added. Hence their strong preference for companies that have high and stable Returns on Equity.
Where do you get the figure ten percent nominal return for the stock market from ?
The historic return as measured by the gilt equity study is around 7%
You might want to question the Luceco ROE in the light of the actual shareholder return to date as one is a conceptual and one is reality and their divergence should be a cause of concern to any current Luceco shareholder.
Have all the commentators deriding the idea that Luceco should hundred-bag missed the conclusion where Mark states “this is unlikely to be a 100-bagger”? Give the guy a break!
Instead it’s a beaten-up cyclical small cap with potential for some decent gains in due course, which is Mark’s final word.
At least it makes it easy to identify who didn't bother reading to the end of the article!
I use what might be called a "100 bagger strategy" for some of my portfolio but I had not previously considered Luceco in this context. My impression is that 100 bagger companies have a winning formula which they can apply to achieve consistent growth over a long period, whilst adapting to external factors as needed. Luceco's results have been quite variable and its share price is down significantly since listing in 2016 so I can't see any evidence that this company has a developed a winning strategy, although perhaps it has not been listed long enough for that to become apparent.
Hi peterthegreat,
While I think it would be nice to just have a smooth and rapid revenue growth, I don't think that is how investing life really looks like. In the 100 baggers study, Phelps found that almost all of the companies that did 100x had pretty sickening drawdowns on the way. (This is why he proposes the "coffee can" approach.) These were periods of market turbulence but also when the growth stalled for a period and the market wrongly thought this marked the peak of their performance. Again, I don't think Luceco's moat is strong enough or there is sufficient operational gearing for it to do 100x, however, it does have some attractive long-term qualities that may be being ignored during the current period of economic turbulence.
Mark
The directors don't seem to think Luceco (LON:LUCE) have 100 bagger potential!
Dear Mark,
The other passing thought is that. Buying shares in EPE Special opportunities is a much cheaper way to own Luceco they are the 22% shareholder in Luceco and you get a few other businesses such as Whittards of Chelsea thrown in for nothing
This is interesting, thanks for sharing. I do like it when you get an investment trust trading at a big discount (they always should trade at some discount to reflect the management charges and listing costs, but often these get too big). This is even better when you think the underlying assets are also undervalued. I'll take a look into it more.
Brilliant writeup mark - very useful to have postings like this.
I remember doing well out of XPP - and this company seems somehwhat simular so i have added to my watchlist on this basis as the sales growth does look decent. The poor bottom line numbers recently can probably be explained by the normal reasons. I always think its harder to get opertational gearing working the right way in companies like this when you are gowring to quick. So uptick in sales at time of supply chain issues and high inflation cant be easy.
with regard to Tombhollidays comments about the moat being potentialy weak - that is an important consideration .Without knowing anything about the company i would say the sales growth speaks for itself (albeit it could perhaps mostly be bought in) - the standout to me is the mention of all design work being done in house and most sales being with regard to products developed in the last 3 years - i like the thought of that . To me these 2 factors combined wouldnt make me worry about the moat - unless someone in the know comes along and says their products are either cheap tat. I know with xp power they design their own stuff too and it takes time for sales to take off for the new product launches - so if its like xpp some of the hard work could already be in the system waiting for growth to materialise perhaps ? - i know xpp managed to 10 bag between 2010 and 2020 approx
There is the danger with any company buying in sales by acquisition that the core business might not be as good under the hood as it appears if constant acquisitions mke lfl comparisons hard - also they need to make businesses they are buying work. factor in the debt and it probably is a leap in faith - but they do appear to have returned decent profit each year apart from 2018 - so even if figures have gone into reverse we are at least talking about coompany that is still making profits despite things perhaps not have gone as well as hoped for?
Hi rmillaree,
It is a good point that often the best companies are the ones that create a product that sells as-is for a decade or more in increasing volume, with little need to change. However, this often requires patent protection or a very strong brand built up over decades. It is clear that Luceco doesn't have this kind of moat. However, even the best brands have to adapt e.g apple still brings out a new iPhone most years, or a drug company re-invests its profits to try to find the next blockbuster drug.
I would be worried if Luceco hadn't grown revenue in this period. I think adding new complimentary products is part of their attempts to grow revenue and margins, rather than a need to completely revamp their product line every few years.
In terms of acquisitions, I largely agree with you. Most acquisitions destroy shareholder value and I am naturally wary of roll-ups. However, there is no denying that roll-ups that are done well - usually buying cash-generative businesses without issuing equity and not overpaying - are one of the types of companies that can generate very high returns for shareholders.
Mark
Cannot quite see Lucecco becoming a £13bn business (the market cap it would need to reach to become a 100 bagger). Would certainly need to massively expand its product range and do an awful lot of acquisitions to get anywhere close.
Signify, formerly known as Philips Lighting, which was spun off from Philips in 2016, has a market cap of €4 bn. It would be some feat for Luceco and its brand to have anywhere near the value of Philips in the lighting space.
Dear Mark,
I hope that you do well with Luceco but to me the moat looks shallow. Paul Scott interviewed Zotefoams last month and i suggest that you look at that. The moat is a unique manufacturing process producing foam with unique properties. The customer list includes the likes of Boeing, Unilever and now Nike, it suggests a small company offering a compelling product. Over the last 18 years HPP Foams have grown from sales of £40000 to £40 million last year and circa 50m for the current year a compelling compound rate of growth I suggest. The company has just invested fifty million expanding capacity by sixty percent. The original volume foam business which was the business in 2004 makes up less than half the profits and will be less than half the turnover within three years.
The latest opportunity in ReZorce, a single polymer 100% recyclable alternative to Tetrapak cartons means the company is entering an even bigger market than Nike running shoes and doing somwith a patented unique product solution.
The shares were over seven pounds at the end of 2018 following the signing of the Nike exclusive agreement a year earlier at £3.20 with the capacity built and in production I suggest that Paul Scott has made a timely call
Welcome your take
Hi Tombholliday,
I've looked at Zotefoams in the past. I like the client list but I think it is the diametric opposite of a quality company. The reason is that it is so capital-intensive. My Buffett & Munger and 100-baggers screen look for companies with high and stable ROEs. Zotefoams ROE is stable but because it is so low.
Their ROE has almost certainly been below their cost of capital for the last decade:
This means that all the growth in revenue they have generated in the last decade has destroyed shareholder value. Instead of raising cash from the market by issuing shares plus reinvesting most of their internal cash flow at such low rates they should have been winding the business down and returning any excess capital to shareholders. ROE figures consistently this low over the full cycle suggest that the company has had zero moat over this period.
There is an argument that they have been investing ahead of growth and that shareholders will now see returns. However, when a company fails to deliver for a decade, I think it is far more likely that this is a fundamentally poor business with no moat. When you add in that you are paying a high multiple for the business too, it looks like the epitome of an anti-Buffett -and-Munger stock.
Just my opinion, but one I think is backed up by the long-term ROE figures.
Sorry about that!
Mark
Dear Mark,
Quality is not defined solely by one financial metric and you probably should study the history of the business, before pronouncing. It was a commodity foam business with no HPP sales pre 2004. It has managed that cyclical commodity business for eighteen years while developing a much bigger much higher margin business that has grown from 40000 to fifty million - a compound growth of over twenty five percent per annum for eighteen years. It has used the profits first from aerospace, then automotive to break into pharmaceutical insulation then into general food manufacturing insulation - T- Fit and now into ReZorce which potentially disrupts the vast Tetra Pak carton market. The comparative business here is Amazon which grew from book retailing to everything retailing and then into web services happy to lose money ( from its maturer market segments such as books) on its newer ventures confident that in turn they would become dominant and then profitable. I am not sure I understand your claim that the business has not delivered a return for a decade the shares were a 140p in February 2012 they are 320 today they were fifty pence odd in 2008. None too shabby though the highs of over seven pounds in 2018 make one regretful. I do not think that you can say that the business has not delivered for shareholders. To follow on and say that it is a fundamentally poor business with no moat suggests that you have not even bothered to pick up the accounts or even chat with your colleague Paul Scott to educate yourself. Everybody is entitled to their own opinion but I would ask that you know something about a business before pontificating. Luceco can be bought at a substantial discount through EPE special opportunities you omitted this from your report poor homework frankly.
hope this is helpful you might want to switch your holding of Luceco across likewise you should sit down and familiarise yourself with Zotefoams any business that has compounded at 25%+ over eighteen years merits a little study rather than a superficial throwaway comment such as you have posted.
I know the company reasonably well, having analysed the component businesses in the past. I have a certain amount of sympathy for the sum of the parts valuation. HPP has certainly been the star of the show:
However, this doesn't escape the fact that while HPP has been growing, the return on equity has been declining:
This means that either the capital required to grow HPP is not really generating great returns (or they are having to put lots of capital into Polyolefin Foams just to stand still and they really should have been shutting down this commodity business).
Despite the potential, MEL has yet to generate any real revenue and has consistently lost money over the last 5 years.
When I say that Zotefoams hasn't generated any Shareholder Value, you have to understand that Shareholder Value is different to Shareholder Returns. Shareholder value is defined as deploying incremental capital to generate returns higher than their cost of capital. Shareholder Return is simply share price appreciation plus dividends. Given the low dividends (because the business has been so capital-intensive) the shareholder returns have been driven by the price increases.
You might say, well who cares? It is Shareholder Returns than make me money. However, the absolutely central idea of Buffett and Munger investing is that Shareholder Returns are almost completely driven by Shareholder Value creation, over the long term. So a company that has seen high Shareholder Returns but no increase in Shareholder Value (Buffett would call them busy fools) is much more likely to mean revert than continue on its upward trajectory.
These articles are very much about finding and demonstrating the principles of Quality Investing and looking for stocks that may fit this mould. Despite some good qualities, Luceco probably isn't a Buffett and Munger stock. Its moat isn't quite strong enough and it lacks sufficient operational gearing.
However, I am almost certain Zotefoams isn't a Buffett and Munger stock. It is a combination of a bad business (Polyolefin), a good but very capital-intensive business (HPP) and a blue-sky business (MEL).
I am not averse to investing in capital-intensive businesses or boring businesses that also contain blue-sky potential. However, I do so knowing that they are not likely to be Buffett and Munger quality compounders so I insist that when I do so I pay a very low multiple.
It is worth adding that Mckinsey's book Valuation is a really good read on all these concepts of Shareholder Value and Return on Capital. It is quite long and dense, so probably more of a skim read than a cover-to-cover read.
https://www.amazon.co.uk/Valua...
It has had lots of versions over the years, but the concepts are the same so it is easy to pick up a second-hand copy of an older version for a few quid rather than paying up for the latest one.
Dear Mark,
I might get a copy but to me the danger of relying on one model of valuation only to make your investment decision on is demonstrated by your Luceco selection since float you have fallen from 130 to sub 90p yet Zotefoams over the same period has risen from 250p to 320 odd ZTF are expected to report a doubling of earnings this year and this is not the case with Luceco
Welcome your response
Dear Mark,
This is interesting but perhaps not real world, your five years of declining Roe are the five years of capital expenditure to expand capacity following the Nike exclusive agreement at the end of 2018 whilst being built it obviously cannot contribute now that it has been built it is and the return from this investment will emerge over the next few years so the jury is out. Polyolefin foams have been managed, this business is cyclical and it has diminished from being a 100% of the business to less than half and will probably be less than a fifth within five years, clearly if Zotefoams had not developed higher margin better quality businesses since 2004 then the business would have long since disappeared from the quoted stage. The question you pose about shareholder value has not been answered within the timescale that you are looking at, the better question is will it be? On the plus side you can see the quality of the customers and the progressive scaling up of the markets that they are entering. If you look at shoes for example you can see that Nike completely dominates the podium for marathons and has done so for a number of years all the athletes on the podium are wearing Nike. Yet The foam is in less than one percent of the trainers sold by Nike. It is less easy to get the statistics for pharma clean rooms but my impression is that they have since 2009 become increasingly dominant here, likewise the move into dairy is still early stage. They are a significant supplier to Boeing less so to Airbus but they are a significant supplier to the space rockets which suggests again a product offering that is compelling. Mucell if it stopped developing new markets as a royalty model would immediately be contributing to the bottom line I hesitate to call that blue sky. Is it worth management attempting to crack the liquid paperboard market which is currently a composite product of plastic film aluminium and virgin wood pulp and reinvesting in this truly vast market as an investor with a sensible timescale the answer has to be yes. On your criteria Zotefoams are demonstrating a moat of real integrity - Luceco clearly not - the question as an investor looking forward is do you back management to successfully and profitably break into these markets or do you invest on a short term timescale in mature low growth businesses?
You might look across at James Cropper there the Technical fibre business carries Colourform and the paper business being family dominated the business is investing for the long term and similar to Zotefoams successfully evolving from a cyclical commodity business, coloured paper, to something that is at the forefront of Green hydrogen and again has the likes of Boeing and the makers of the F35 fighter on their customer list.
Both businesses have successfully reinvented themselves with management taking long term decisions that are the right ones for all stakeholders. If both had followed your advice both would have likely expired or be much diminished. Their is not much value in a Cumbrian paper mill other than as a brownfield housing site and the same could be said for twelve acres of Croydon producing foam for packaging. The sum of the parts valuation for Zotefoams as you say looks attractive for long term investors the diminishing significance of volume foam and the maturing of the HPP markets over the next decade combined with the possibility of a single polymer recyclable packaging solution is compelling. The only blue sky here relates to possible shareholder returns as these investments mature
Thanks Mark, Warrant Star and tomb holiday for a great discussion. Very enlightening hearing the different perspectives. David
To be fair it was you who asked Mark to comment on Zotefoams. He wouldn't otherwise have mentioned it :)
Please can you elaborate on how you have come to the conclusion that Zotefoam's ROE has been below its cost of capital for the last decade? In particular how do you know what it's cost of capital has been?
The subject could be a (very long and very boring) article on its own. However, the simplest way of looking at the cost of capital is what return would a shareholder demand to hold the equity. Well. the stock market has returned c10% real over the long term. So I think that is the minimum shareholders should be using. In reality, no one holds an illiquid, high-risk, small cap stock for 10% a year so perhaps 15-20% should be more reasonable. Conversely, if buying a regulated utility you'd probably accept less.
This is then complicated by debt. At the current market cap about a quarter of the Zotefoam EV is debt. And they pay maybe 5-7% interest on this so weighting the cost of capital you get a lower figure. But debt increases risk and therefore the returns you'd want to hold the equity. Thankfully, by using Return on Equity this mostly comes out in the wash.
So it is all finger-in-the-air but I think 15% is the minimum I'd accept for holding either Zotefoams, Luceco or any similar small cap, and higher for microcaps.
Again, these are mere examples, this isn't the Luceco vs Zotefoams show, but if you accept the 15% as the sort of minimum return a shareholder would want from their equity then Zotefoam's 9% average over the last decade is below this figure, whereas Luceco's 25% average since listing is above.
Mark, Thank you for your reply. It seems that the way to find the cost of capital is to estimate it or to find out what the implied figure is by some means or another. My take on this is that it is not worth the effort required to arrive at a figure for the cost of capital which I could not rely upon. Instead, I would just look for companies which have a ROE which is in the top third of their industry. I could then assume that this ROE would be above the cost of capital.
Yes, that would be a very good method. Although, with the caveat that you will need to look over a number of years and also pay attention to trend, ROE being particularly prone to mean reversion.
Where do you get your figure of stock market returns of ten percent real from, the Barclays Gilt equity study suggests something nearer seven percent taking the last 120 odd years as the reported history
You will be forever disappointed if you think 15% is the minimum return on an investment ! Luceco was priced at 235p in 2017 today it’s 87p so I guess you are missing the minus sign on that claimed 25% per annum return for shareholders !
This is not the Luceco , Zotefoam show but Zotefoams was 280 odd in early 2017 so you seem a little one sided to be claiming a better outcome from investing in Luceco and the stupidity of relying on one financial metric is clear - you have made a little money in one and lost three quarters or more in the other!
Get Real
Do I understand from this that your investment pre dates the October 2016 floatation at 130p or did you omit the -Sign on your claimed 25% return
I created my own 100 baggers screen a while ago and one of those it has picked up is Cerilion #CER which has already 10 bagged since ipo.
Hi Mark, Very balanced succinct article with detailed information to read about the stock's background, history with the financial details not too complicated to understand.. Great to see the reasoning for Stocko's ranking which I didn't pay much attention when I go through a particular stock.. Great read, will keep these points for my stock analysis.
I enjoyed reading this Mark, thank you. As a long term holder looking at a significant loss I'm tempted to average down and be patient.
Excellent analysis. I am really enjoying this series.
Paul Scott did a report on 22 October, and I commented about de-stocking, also a good comment by Gringo below mine. His last sentence is perhaps revealing.
I think I would be uncomfortable buying Luceco (LON:LUCE) at the moment because I have learned the hard way not to fight the market - see my chart. But I think the time will come when the share price will recover. One for the watch list I think.
Everyone sees charts in their own way..... I disagree, I think there's a buying opportunity with a price target around 235p.
Hi Mark great article, I've been a holder of LUCE over many years now, luckily I took some profit near the highs and have recently upped my stake again.
Any thoughts on the impact of shipping rates, just how much do they currently spend, rates have fallen drastically (Baltic shipping rates) so they will benefit but by how much ? Also if you have held for many years you will know they made a right mess over hedging copper, I wonder how that side of the business is going.
I don't think that I've seen Luceco break out their costs in this detail but they did say this during the H1 results:
We have seen helpful movements in freight, commodity and currency rates over recent months. As a result, my estimate of the cumulative impact of input cost inflation on our annual cost base has reduced from £25.0m at the end of last year to £21.5m now. This estimate includes the likely cost of overhead inflation in 2023 as labour cost increases become increasingly impactful.
So it seems that these effects are waning apart from on the labour costs side. I suspect they have learnt from their hedging mistakes. I think it is indicative that the current CFO joined in 2018 after things went wrong.
When the upside is potentially large but the outlook and trend are going the wrong way then investors can certainly be patient, since missing out on the first 30-50% move won't make a big difference over the very long term.
Not my style though. I prefer to buy a small amount and then add as the trend keeps going down as long as I still believe in the long-term fundamentals of the business. All horses for courses.