The utility sector is one of the market’s most disliked industries at the moment. Razor thin margins, consumer distrust and potential political interference are all factors contributing to weak investor sentiment.
However, there’s one company that has managed to shrug off these concerns and attract a high valuation thanks to its impressive growth.
Customer focus
Smart Metering Systems (LSE: SMS) connects, owns and operates metering systems for gas/electricity suppliers. Over the past six years, as the demand for smart meters has grown, revenue has exploded by more than 300% and reported net profit has increased by 590%.
It looks as if these impressive rates of growth carried on throughout 2017. According to the company’s year-end trading update, published this morning, total annualised recurring revenue for the period to 31 December grew 38%, and the overall number of assets under management by the firm increased by approximately 62% to 2.03m. For the gas division, meter recurring revenue grew by 15%, while recurring data revenue increased by a similar amount. Electricity meter recurring revenue nearly tripled during the period, and data revenue for this division rose 56% for the year to 31 December.
Following this robust performance, management is expecting the company to report full-year earnings in line with current City expectations. Analysts have pencilled in Earnings per share growth of 10% for 2017 to 19.2p followed by an increase of 17.6% for 2018 to 22.6p.
Unfortunately, the one downside of SMS’s explosive growth is that the shares have attracted a relatively high valuation of 38.2 times forward earnings. Still, while this is high, I believe that it is a suitable multiple for a business that is growing recurring revenue at a rate of more than 30% per annum and assets under management at a rate of more than 60%. As SMS continues to grow, I believe that it won’t be long before this valuation is out of date.
Dividend champion
Another grand champion I’m positive on the outlook for is IG Design (LSE: IGR). Over the past three years, shares in IG have surged by more than 400% as the company has grown net profit at a staggering 122% per annum on average. City analysts don’t expect this trend to end any time soon with growth of more than 50% pencilled in for fiscal 2018 followed by net profit growth of 14% for 2019. Earnings per share are expected to expand by a total of 55% during this period.
Formerly known as International Greetings, IG is a designer, manufacturer and distributor of items such as gift packaging and greetings cards. This is a relatively low-margin business, but the firm’s increasing scale is allowing it to achieve returns not available to smaller peers. For example, over the past five years, return on capital employed — a measure of how much profit a company is generating for every £1 invested — has increased from 7.6% to 15.5%. Improving economics have driven free cashflow growth, and thanks to its improving financial position, IG has been able to grow its dividend from 1p per share and 2015 to an estimated 5.5p for fiscal 2018.
Despite this impressive profit and dividend growth, shares in IG look relatively cheap compared to those of SMS. The stock trades at a forward P/E of 17.9 and yields 1.5%.
