Somero Enterprises Preliminary Analysis

As a unique business, Somero Enterprises Inc appears, at first glance, to be a rare example of a small AIM listed company with something of a competitive advantage!  Profitable, with excellent margins and returns on capital, the business is even trading relatively cheaply on a multiple basis.  While incorporated in the US, they have operations in many locations worldwide and are currently experiencing convincing growth in both revenues and profits.

Screen Summary

• A PE of 11.2x and a PCF of 11.5x indicate that the firm may be trading cheaply relative to its earnings.
• An ROC of 39.4%, ROE of 53.2% and operating margins of 21.2% are all indicative of a high quality business with potential for pricing power.
• A PB of 4.2x is high, but there may be evidence to suggest the existence of significant internally generated intangibles.  Further analysis may or may not confirm this.
• Revenue has grown steadily over the past few years, as has net income since the firm has recovered from the recession of 2008.

Company Background

Somero develops and manufactures laser guided machinery used in horizontal concrete placement; products which allow the placement of large areas of concrete flooring quickly and to a high standard.  All of their products are protected by patents and really do what they say on the tin - head over to the Somero website for some videos of the machinery in action.  In addition to making the products themselves, they run training courses to teach customers how to use the products to their full effect to produce quality concrete flooring that meets high US floor flatness standards.  The idea is that, through this training and customer support, they can establish long lasting relationships to ensure that future referrals, and therefore sales, persist.

Somero's Market Position

It is claimed, in the 2014 year end accounts, that Somero Laser Screed equipment holds a 99% market share in the non-residential, horizontal concrete flooring industry in over 92 countries.  This is quite the claim and I can't comment for now whether this is true or not, but if so then this could be a text book example of a business with a strong competitive advantage.  If that many construction workers are trained on, and require the standards set by, Somero's equipment, then it will be difficult for another company to compete in the short run due to high switching costs.

It is important to note that this does not make the business model bulletproof, however.  As seen in the recent recession, the fate of this business is tied to construction activity in the wider economy and, should construction slow again, losses will likely materialise quickly as they did before.

Current Operations

Operations are predominantly in the US, but are present to various extents more or less worldwide.  Most interestingly, the second largest source of revenue is from China, where concrete consumption is approximately 30 times greater than in the US at present.  This represents a real opportunity for Somero, and they are currently in the process of seizing it by constructing the Somero Concrete College, due to be completed in Q4 2015.  If Somero are able to train large numbers of Chinese workers on their equipment and to their standards, I think that they have an excellent chance of becoming synonymous with quality concrete flooring in China.  This growth opportunity alone has good potential and the idea of setting up a college to train workers on your equipment, which they will then depend on, is a brilliant way to capitalise on it.

Given that the company designs and produces all of its own equipment, it seems reasonable that they would require continual investment to fund research and development.  It is stated in the 2014 accounts that policy is to invest 2% of revenue each year in product development, and as a result of this new products are introduced every year.  It is great to see the business recognise that, despite current strength, continual effort is required to stay ahead of the game and I believe that this pursuit of improvement can only aid in strengthening the business's competitive position over time.

Concluding Thoughts

A final consideration is management's bold target to double 2013 revenue by 2018, with 2014 revenue of $59.3m being well ahead of schedule.  If the company is able to meet this target, then a CAGR of 14.9% in revenue is implied until 2018.  Given the excellent operating margins currently seen, the growth rate in profits would likely be higher still...certainly worth further investigation in my opinion.

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At the time of writing I do not hold a position in Somero Enterprises – LON:SOM

It is important to note that all opinions expressed in this piece are the opinion of the author only and do not, in any way, constitute investment advice.  Any individual seeking to make investments of any kind should conduct thorough proprietary research so as to fully understand the risks they are taking.