Somero: Good portents from Ashteads Q3s, and only on a PE of 10x growing topline 40%

Somero Enterprises     SOM.L    113p       Mkt Cap  £65m

Having seen the strong numbers published by plant / equipment rental business Ashtead yesterday, I thought I would update with a few thoughts on Somero Enterprises. Somero is an AIM listed (£65m mkt cap), US Headquartered, designer / manufacturer of laser guided screed (concrete) machines. These are used to make really flat floors for warehouses and out of town retail space. 

https://www.youtube.com/watch?v=rn587OSkTgU
(a quick youtube video of their machines in action)

Operations
Operations are predominantly in the US, which accounted for 53% of sales, with 17% from EMEA and 30% from ROW (China, S America, Korea). The structural drivers here are the demand for more automated picking from warehouses. Automated warehouses need v flat floors. Some customers like Prologis & CostCo have on occasion specified that the building contractor use Somero's laser guided machines. Its clear the company is top of the pack in its field. Also China sales have been growing v fast and a Shanghai office has recently been opened.

On top of that there is a cyclical element, which is huge (ie was great 2005 to 2007 but absolutely terrible for Somero in 2008-2010). No point in sugar coating this, if the non residential construction cycle is for you, great, if not, watch out. The company is currently in an upcycle with sales growth of 40% in 2013 and another 40% H1 14 vs H1 13. Growth is mainly from its large line machines and spares. Geographically strongest growth is in the US and China but the Group is also seeing improved sales in EMEA.
Longer term management is targeting a doubling of 2013 sales by 2018. Realistically this is only a guess as it's a highly cyclical company.

Barriers to entry ?
There's a bit of IP in designing the machines. I read the company has a 99% mkt share in laser guided screed machines. Not sure if I believe this. The company does aim to introduce one new model each year and recent In all Somero spends c2-3% sales on Engineering but in 2013 this only amounted to $900k, so it wouldn't be insurmountable for a competitor to spend say $5m over a couple of years getting up to speed.
The company does have a direct sales force with experienced sales people, in both N America and in a small number of offices around the globe eg Shanghai, UK, 

Operational Leverage
In short: Bags of it…A picture is worth a thousand words.

Source: Annual reports, VegPatch forecasts (hopefully you can see the table better in 2 sections)

Gross margins are impacted by sales of larger, higher margin machines which tend to dry up in a down cycle. Following the economic downturn revenues GMs fell. GMs declined from 55% to 47% fell between 2008-10. The company's response was to cut costs. G&A fell by $6m 2008-12 but G&A as % of sales went from 14% to over 30%. Overall EBIT margins fell from nearly 20% to -50% in 2009. However the reverse is true in an upcycle. As non residential construction has picked up margins have massively improved and I think they are likely to go back to 2007 highs.

Balance Sheet
The Balance sheet is net cash, but given what I have showed you about margins I think this is the only sensible position to be in.

Still in an upcycle ?
Yes. The most recent Trading Update on 20th Jan stated:

“Due to particularly strong trading in December, the Board is pleased to announce that it now expects to report EBITDA for the year to 31 December 2014 slightly ahead of market expectations. Demand has continued to be strong across our core existing product range whilst new products have contributed significantly. We have also seen a broad geographic base to our growth, with H2 2014 top line growth driven by sales in North America, China, South East Asia, Latin and South America and Europe.

Based on the continued momentum we have seen across the business in the second half of 2014, the Board expects to deliver further growth in 2015."

Outlook for 2015 and beyond
Banks still easing lending criteria (top chart), while demand for loans is increasing (bottom chart)

source: US Federal Reserve, Feb 2015

So why did you mention Ashtead at the beginning ?
Like Somero, Ashtead (LON:AHT) is highly influenced by the US non residential construction cycle. Its growth has been v strong post the crisis (cyclical) and combined with a competitor in United Rentals who is financially burdened after an acquisition, and a trend more towards rental than ownership (Structural) it has been able to grow very fast. Whats interesting is that Somero has lagged Ashtead (LON:AHT) share price by around 45% since October 2014 (Ashtead share price is the brown line on chart below, Somero's is grey/blue) despite both showing very similar growth dynamics.

Valuation
On my numbers Somero is on 10x PE 2015, which is slightly higher than 9.5x the consensus EPS (I tend to be conservative). I fully understand paying a low multiple for peak EPS but I don't think the US non residential construction cycle is petering out yet. I think we have a another few years to reasonable growth given that private non residential construction activity is still 1/3 below the 2007 and 2008 peak years (I'll admit they were too high though) and fell back to levels in the financial crisis last seen in 2001. So I think there is still pent up demand which will come through as bank lending standards continue to ease. However when I see Ashtead is on 16x April 2016 EPS then I think there both relative and absolute value in Somero. I have bought more today.
VegPatch