Zytronic plc – Financial Statements and Competition
Touch screens are now accepted by all as a daily fact of life and very few of us walk around without one in our pocket at all times. There is another side to the industry, however, with touch technology becoming increasingly feasible in commercial settings. That’s where Zytronic step in with their innovative range of customisable touch screens built for every purpose imaginable. The company has been successful to date, but can they keep pace in the high-tech industry that they operate in?
Screen Summary
- A forward PER of 12.5x is reasonable, not particularly cheap but certainly wouldn’t be considered expensive either.
- The PB ratio of 2.47x is less so, however, and would generally be taken as expensive.
- Operating margins, at 17.3% most recently, are excellent.
- As are returns on capital, which currently stand at 16.9%.
Company Background
An interactive mirror at Kite GB, the opticians.
Zytronic manufactures touch technology products from its base of operations in Blaydon upon Tyne. The touch screens are used for all kinds of things but tend to be used for commercial purposes such as information kiosks, ATMs, gaming machines and military and medical applications. Many of us have probably unwittingly used the products at some point and it seems fairly clear that their utility and relevance is high and will remain so for some time.
Zytronic originally listed in 2000 just as the tech bubble began to burst. For a business that was then only earning £4.5m in revenue and £200k in profits, it floated at an absurd price that promptly came crashing back to reality through 2001 and 2002. It wasn’t the most promising start to listed life for the shares yet the underlying business itself was (and still appears to be) sound.
Financial Statements
Revenue has grown steadily since flotation, with only a few years seeing downturns in sales. The downturns are to be expected given the low order book visibility that Paul Scott discussed with the management team here. This will likely be an ongoing issue for the business but intelligent investors should be able to take advantage of any share price weakness due to a short term fall in sales. The company also earns excellent gross margins (just under 40% at the latest interim reporting date) which gives the business more room for error in its cost management. These high gross margins are expected of a business with a valuable proprietary product and highlight the efficacy of the single site manufacturing facility in Blaydon upon Tyne.
Profitability has also been excellent with operating margins coming in at around 17% on average over the last 5 years. Again, this is sensitive to short term decreases in revenue as we saw in 2013, when operating margins fell to 11.2% on a fall in revenue. The business has not recorded a loss since 2003 though which gives me comfort that the management team have budgeted well, delivered on their plans and not made too many mistakes.
The balance sheet here is superb in my opinion. There was enough cash at the end of March to settle both long and short term liabilities with plenty left over to still pay dividends and then some. Some people may complain about cash sat on the balance sheet due to it not earning a decent return. The concerns are sometimes valid but I would say that the cash is a positive point here. Because of it, I am comfortable that the dividend is sustainable for some time, I am confident that the business will be ready to take advantage of opportunities without the risk of dilution and if, as Peter Lynch recommended, we were to deduct the cash per share from the share price for our valuation work, then it could be obscuring a bargain too!
Competitive Position
The touch screen industry, like any tech industry, is one that is easy to imagine as highly competitive and fast moving. We are all well aware of the difficulty that companies in similar industries have had with maintaining any kind of competitive advantage. Take Dell, a company that for many years was able to produce desktop PCs at a cost far below that of its competitors and which enjoyed a large market share as a result. Many took this low production cost to be a sign of a competitive advantage yet, over time, the moat eroded leaving Dell in the state of gradual decline we still see today.
So what assurance can we gain that Zytronic has an ability to sustain its earnings into the future? First of all, on a broad note, the specific nature of Zytronic’s products must be considered. Zytronic produces mostly for commercial purposes and this in itself mitigates some of the risk normally expected of a high-tech manufacturer. Producing reliable screens that are designed to last as long as possible for a mine or hospital seems far less likely to be subject to the whims of consumer demand than producing smartphone screens, for example. On the other side of this, there is not the potential for the same scale as a smartphone screen producer but that isn’t really an issue if we are realistic in our valuation work and disciplined with our purchase price.
Coca-Cola Freestyle beverage dispenser.
Beyond the nature of the industry’s products as a whole, what does Zytronic itself have to offer? The key factor that stands out to me is the level of customisation available to Zytronic’s customers. Clients can choose from a whole host of modifications such as the size, thickness and curvature of the screen in addition to selecting between rugged industrial models, vandal resistant screens and single or multi-touch interfaces. From the work I have done so far, the level of customisation offered by Zytronic stands out from competitors and provides an advantage to Zytronic who are more likely to win a bespoke contract such as the Coca-Cola Freestyle beverage dispenser as a result.
Unfortunately, I don’t see why this advantage would not be fairly easy (if a little time consuming) to replicate. There are barriers to entry in the way of the investment required for a comparable production facility but if there were sufficient demand for bespoke touch screens, I would be concerned that a competitor or new entrant would be able to enter the market with a similar offering.
That said, Zytronic have been recognised as having excellent quality products and a fantastic design team through their winning of the ‘Design Team of the Year’ award at the British Engineering Excellence Awards 2013 and the ‘Electron d’0r’, awarded by ElectroniqueS in 2013. To support this further, the technical director, Dr Andrew Morrison, claims that all technology is engineered in house. This aids the great degree of customisation that Zytronic offers its customers and presents a real obstacle for potential market entrants. Again, I doubt this is an advantage that can stave off competition indefinitely but we can say that in addition to a facility that allows the production of bespoke products, significant research and development will have to be undertaken to match Zytronic’s offering.
Competition
This review is by no means exhaustive, but I have had a little look to get an idea of what competition is out there and whether or not they represent direct threats to Zytronic’s business.
A large name that turns up on a few searches is Hope Industrial Systems, Inc. This is a well-established business with a large and highly impressive customer list that spans a broad range of industries. The difference here is that the focus is on generic touch screens and stands with very few options for customisation beyond a range of standardised sizes. Further, the company seems to concentrate on industrial applications and it is therefore unlikely to represent a threat in the gaming and signage spaces that Zytronic is present in.
Another US company that may represent a threat is New Vision Display, Inc. The company has much broader interests though and also produces LCD displays, TFT diplays and screen protectors as well as the customisable touch screens. The touch screens do not have quite the same degree of customisation as offered by Zytronic however and, again, seem more limited in their potential applications. They do not, for example, appear to have the ability to compete in the signage and gaming spaces.
The NASDAQ listed company Planar is up next. This is larger than Zytronic with a market capitalisation of about $137m and they represent good competition for Zytronic in the signage market. The company not only produces touch screens but also the display technology itself and they have won a number of awards for this. Potentially, for those looking to create interactive consumer features and signs, a company such as Planar which can supply both bespoke touch screens and displays is more attractive than one who specialises in just one aspect of the ultimate product. Perhaps of note is that Planar is currently priced at around 20x historical earnings. While above Zytronic’s rating of 15x, I feel that Planar probably justifies the premium to Zytronic’s multiple.
Elo Touch Solutions, Inc. claim to be the inventors of the touch screen and were founded in 1971. The product list seems to be quite a good match for Zytronic and they have an impressive portfolio of case studies to go with it. The key difference is that Elo diversify across a range of touch screen technologies – while they produce the projective capacitive screens that Zytronic make, they also produce others such as acoustic and infrared touch screens. While they certainly match the touch screen pedigree that Zytronic boasts, they still don’t offer quite the same degree of customisation that Zytronic do.
Finally, over in the UK, we have a medium sized Cambridge based company called Visualplanet. Their flagship product is called Touchfoil which can turn any non-metallic surface into a touch screen and, due to its large maximum size of over 100”, is perfectly suited to signage or interactive consumer features. Zytronic have recently introduced their own ZYFILM however, which performs a similar function though does not appear to be offered in quite such a large size. The company has been in business since 2003 and does not appear to be competing in the industrial touch screen space, but the flexibility of its core offering may well prove highly successful in other areas.
Concluding Thoughts
I feel quite positive when learning about this company. It appears that they’ve found a profitable little niche and have done a great job of developing and bringing to market a world class product. Zytronic appear to offer a far greater degree of customisation than any obvious competitor I’ve been able to find and this probably gives them an advantage for the time being. If you want a 50” curved, vandal resistant multi-touch screen with your company colours around the frame then there don’t seem to be that many other options currently available to you other than Zytronic.
As tough as touch screens get.
I am sceptical of how long that can last however and I think it would be prudent to expect some external pressure in the future. Touch screens are now a part of daily life and if it becomes far more commonplace to see interactive signage or gaming tables then the trend will not be missed and it won’t be too long until someone else enters the market.
As far as an investment decision goes, I think that the company is well run, is in a strong financial position and is likely to have a bright future. That said, I would prefer the company to be a little bit cheaper and while it isn’t expensive per se, I don’t really think there is much margin of safety built into the current price level. Even once you have stripped out the cash from the market capitalisation I think it is hard to justify a purchase based on prudent discounted cash flows. I will be keeping an eye on this one though and holding out for the next profit warning and (hopefully) the drop in price that comes with it!
Hope you enjoyed the article, if so then please share it with your network and feel free to leave any comments or questions below – I am always particularly interested to hear opposing points of view!
At the time of writing I do not hold a position in Zytronic plc – LON:ZYT
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.
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17 comments
I agree it is difficult to go head over heels on this one given the flat revenue profile. I also think it is aggressive to adjust market cap for cash, whenever I have done this before it has proved the wrong approach for one reason or another.
Also take a look at XP Power, good return on capital and margins.
Thanks to everyone for a studied sensible discussion on ZYT. It has confirmed my view as a buy,but shall wait for a lower price.
Paul, perhaps the CEO meant that the customer's unit may be designed to incorporate the ZYT product and there's then a kind of starting price at the time of the first order with it then being fairly easy for the customer to know what price variations ought to be for subsequent orders. I'd imagine that the real selling job with ZYT's major customers comes at the design stage of new units they are planning to put on the market, such as the Coca-Cola dispenser that Tom includes as an illustration (and that accounted for about 4% of ZYT's unit sales last year). It's at that stage, I believe, that costs and margins (and exchange rates) and competition would matter rather more in terms of whether ZYT would succeed or fail in locking up business to provide the turnover for future years.
Paul and Tom,
Yes, I knew ZYT were covered for their margins on current orders, given the two factors of a 12-month forex coverage policy and their short order lead time. It was the longer-term aspects that interest me more since as a small UK company exporting 94% of its production and with 50% of its turnover reportedly coming from only three customers, I feel there could be real market vulnerabilities there with a strong pound combined with limited order visibility. I understand very well the niche nature of their products and also understand that their factory in Blaydon is operating at well below full capacity so, yes, if they get it right and take a clear market lead, then they ought to do very well. It's perhaps the stalling of their growth over the last three or four years in a market reportedly growing very fast that makes me cautious. Anyway, we shall see!
Tom, many thanks for opening this discussion.
Hi Jane,
Re the longer term impact of exchange rates, I'm wracking my brain to think of what was said when I discussed this with the CEO. I'm sure he said that demand wasn't very price-sensitive. So ZYT quote the price they need, to achieve their target margins, and the customer accepts it.
So the obvious next question I asked was why in that case, they don't really whack up prices, and take greater advantage of inelastic demand? He said well you can't really do that, because the customer knows what the right price should be, and so it harms relationships if ZYT try to take the p, so they don't.
It seems that if the customer specifies a Zytronic screen, then that's what they want, and providing the quote is reasonable, then it is accepted. That at least seems to provide some protection for ZYT against longer term exchange rate movements. And of course we don't know what longer term exchange rates will do. Who's to say that there may not be a sterling crisis at some point in the future, making UK exports more competitive?
Personally I treat exchange rate movements as swings & roundabouts, and as long as the company has in place some hedging arrangements, but above all some pricing power, then it should hopefully all come out in the wash, long term.
Regards, Paul.
Tom, one very important factor you need to consider is that Zytronic exports 95% of its turnover, half of that (9.2m pounds in FY14) being to the EMEA region and that their production is entirely in UK. This presumably creates a vulnerability to exchange rate movements which could affect both revenues and margins in the case of an appreciation of the pound sterling, as has happened this year (yes, I know they hedge 12 months in advance; I'm looking beyond that), and an exposure to the European economy in general. There has been a much smaller favourable movement of sterling against the US$. I wonder whether the setting-up of in-region sales operations in USA and East Asia is a response to lessen that dependence on Europe. Besides that, this reliance on exports is perhaps going to mean that Zytronic is likely to be competing essentially with local manufacturers in their home markets, something that ought to require perhaps heavy investment in R&D to keep ahead of the game and/or investment in Europe through the acquisition of a competitor. They have some cash on the balance sheet and, yes, that gives some comfort to investors but not so, I'd suggest, if there is perhaps a strategic business disadvantage which they ought to be thinking of plugging by investing that cash to better use.
Hi Jane,
I've quizzed the CEO & FD of Zytronic (LON:ZYT) about exchange rate vulnerability several times, given its importance, as you correctly say they export nearly all their production. He was amazingly relaxed about it. The reason is that they are a bespoke manufacturer, and they factor in exchange rate considerations into each project. So they will either hedge, or build in additional margin, to suit.
Also, the cycle from getting the order, to delivery, is quite short, so they just agree a price for each order which gives them the margin they need.
What struck me most from talking to him, is that there is very little competitive pressure. This is why ZYT make such good operating margins. They can (and do) charge a premium price, for premium (bespoke) products. The only risk is if they don't win enough orders to keep their factories busy, which happens from time to time.
I think it's a lovely niche business, with a lot of potential, but you're right to ask "where is the growth?". Next time I speak to management (usually every 6 months) I'll really press them on this point.
Regards, Paul.
Hi Jane,
I was going to reply re the FX rates but Paul has got there first and I've not really much more to add on the matter! To be honest, I was actually going to admit that that was a weakness I hadn't considered all that much but Paul's explanation of how they can build FX variance into each order makes sense.
Re the growth - I agree that it has not really been present of late, although the longer term growth rate in revenue is quite impressive. From 2000 to 2014 it grew at a compounded rate of just over 20%, for example.
When I talk about growth here though (and perhaps Paul is referring to the same thing?), it is more the opportunities for growth I am thinking about. Take the first picture from the article for instance, the Kite GB touch screen mirror. I read an article about just that mirror which you can find here if you're interested to read it:
http://www.screenmediamag.com/screenmedianews/4467...
Now posting pictures of myself trying on glasses to social media is not something I would do (and if I did, I doubt anyone would respond) but that is definitely something that a lot of people would do, if the option was there. A lot of people really love the idea of a futuristic, interactive mirror that can enhance their shopping experience and I think it is only a matter of time (who knows how long!) until features like that are common in shops.
And why stop at glasses? Imagine a clothes shop where you can go in, stand in front of the mirror and do a similar thing? Or even where you can swipe the touch mirror and different clothes will appear to be on your body without the need to get changed? A company called Holition is already doing the 'augmented retail' experience if you doubt that by the way.
And those are just two ideas for the fashion world - its not too hard to dream up many others. So I'm not saying that Zytronic are definitely going to grow, or even that they will definitely be a part of any increased trend in interactive touch screen features all over the place, but the opportunity is certainly there and all it takes is for one of these ideas (say the mirror) to really take off and appear all over the place for Zytronic to have the chance to increase sales volumes quite significantly.
Anyway, you do raise a valid point and the absence of that growth currently is what has led to me to be more cautious with my DCF model and to factor in a few less positive scenarios too.
Have a good day!
Tom
"If you can find me another company in an interesting growth area, on a cash-neutral fwd PER of 10, which makes an operating margin of 17%, and pays a 4% divi yield, then pls send me a private email with more details!"
Record (REC) might be a candidate. Ticks the margin and yield boxes. PER might be about 10-11 on an EV basis. 'Interesting growth area' debatable - growth predicated on institutional investors trying to mitigate greater currency fluctuations within their portfolios. Not been great demand for such services during QE, but starting to pick up a bit of late.
Difficult to find other candidates as you say.
This is a share I have held in the past and hold a small quantity of now. Jane is right about the relative (lack) of growth, but flat screens are a 14%/annum growth market. Zytronic specialise in industrial/rugged public screens but for whatever reason their sales are not growing at anything like that rate. One day their time may come! Ian
"There are three ways to ruin yourself -- gambling, women, and
technology. Gambling is the fastest. Women are the most
pleasurable. Technology is the most certain."
Georges Pompidou
Tom and Paul,
Where is the growth you both talk about?
Revenues and profits and EPS have not grown in three or four years.
Is this another one of those shares which seems to strike a chord in our minds, that from our experiences of using vending machines and the like we unconsciously extrapolate the potential for this company and see growth where in fact there has been none (but where there ought to have been)?
Or is it something self-limiting in the choice of market sector, that is that the very fact of offering extensive (but perhaps costly?) customisation perhaps attracts the "bespoke" type of low-volume customer? Would ZYT be competitive with large-volume opportunities?
Is the investing opportunity in ZYT not instead the chance of it being taken over to serve as the (European?) manufacturing base for some larger group willing to invest in order to go seriously for the volume market?
Good piece of work Tom, thanks. It's a good example of my kind of stock, although it is a bit smaller than I usually go for, I have made an exception in this case given the attractive valuation and business characteristics.
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Hi Tom, great post! I'm currently a holder of ZYT, you raise some interesting points re the competitive landscape and pricing power.
Superb article - thank you! I note that Zytronic have recently opened new offices in Japan and Taiwan, as well as extending sales presence in South America, which suggests confidence and growth opportunities.
Hi Tom,
Really good article, thanks.
Although I am perplexed as to why you think the shares are not cheap enough, when they look strikingly cheap to me, especially once cash is stripped out!
A forward PER of 12.5, for a company where about 20% of the mkt cap is net cash (essentially surplus cash), would reduce down to a cash neutral PER of around 10, which is remarkably cheap in the current market for a company which is generating very impressive operating margins, hence has pricing power.
If you can find me another company in an interesting growth area, on a cash-neutral fwd PER of 10, which makes an operating margin of 17%, and pays a 4% divi yield, then pls send me a private email with more details!
Regards, Paul.
P.S. That said, as discussed before, there is the ever-present risk of a gap in the order book opening up, and a profit warning occurring, that's an unavoidable risk for this type of company which produces bespoke items to order, and has little short term visibility.
However, this could change, and that dangles the tantalising possibility of a re-rating. If say the company wins some long-term big contracts, which is possible given the increasing popularity of large touch screens, then it could see the double benefit of increased earnings estimates, and a higher PER. In the right circumstances I could see this re-rating to a PER of 15-20, and on potentially much higher earnings, that means there is at least the possibility (I don't know how likely or not) of a rise to say 600-700p, which is why I'm in this share.
Hi Paul,
Thanks for the feedback – I suspect the difference in opinion here comes down to a difference in valuation methodology. On a multiple basis, especially ignoring cash, I agree that the business looks really cheap, and if I were buying for a broader diversified portfolio the shares would certainly tick all the relevant boxes. I have, for example, added the shares to a paper portfolio I'm currently running (though I don't own any myself).
I suppose I'm writing the article from the perspective of considering the share as a standalone investment though – ie, would I put 10% of my portfolio into this share at the current price level? For this type of analysis, I always prefer to put together a DCF model and value the company at a range of growth rates dependent on a number of potential scenarios. If we assume that growth continues in a similar manner, then my analysis does suggest that the shares are undervalued.
If you assume a slower growth rate in FCF or even a small decline however, then the analysis does not support the idea. So it's not really that I think the shares are overvalued, just that I think there is room in the valuation for a fair bit of downside and therefore I wouldn't quite have the margin of safety I'd want if I were buying today.
Guy Spier talks about margin of safety in an interview I watched a while ago, and said something to the effect of: 'when you're doing your valuation work, if you're only looking at a double it's probably too close.' I think he was actually quoting someone himself (possibly Mohnish Pabrai) but I forget the precise details. I'm barely looking at a double in the optimistic scenarios I think and when giving some weighting to more pessimistic scenarios then it's not even that close to a double.
I'm not going to lie though, that was a tough decision to make for me (and I still feel a bit uncomfortable with it) and it comes off the back of a renewed drive of being strict with my purchase prices. It's a border line case but the analysis said no so it's a no from me for now. I run the risk of missing out on this one but I think there is enough evidence to suggest that in the long run adhering to those kind of rules will improve my performance. I do like the company though and will continue to learn about it and may yet become convinced that the growth case outweighs a more bearish case by a sufficient margin.
Oh, and you cover a far broader universe of stocks than me so I assume you challenge me to find a stock with the mentioned characteristics knowing full well there aren't (m)any! I can't think of one off hand that meets those criteria anyway so you've really got me doubting myself… Maybe I've been too prudent in my analysis, any thoughts?
Tom