Fool's Eye View

[ March 2, 2000 ]

On Site At Latchways

Sales Potential

The historic sales growth has been largely attributed to the implementation of European legislation in 1995, requiring anyone working where there is a potential fall, to have the appropriate safety equipment in place. Although having said that, Rex Orton did describe a turnaround in the company, with David Hearson bringing his extensive marketing skills to a company that "had a brilliant product, but doing it's hardest not to tell anyone".

David Hearson explained that, rather than a sudden immediate surge of sales when the legislation was implemented, that there had been a "gradual acceptance" from customers towards to the legislation. I got the impression that there were still numerous companies not complying with the legislation, especially in Europe. According to David Hearson, there is a "huge opportunity" in bringing the level of compliance within Europe up to the UK standard. And that just concerned the horizontal system market.

The outlook for the vertical system was very positive. The potential described for the systems to be used in likes of telecommunication masts, currently an area largely untouched by Latchways, appeared considerable. I think David Hearson rather understated the prospects for vertical systems, just remarking "We're quite bullish".

Installers

Latchways sells its equipment onto a network of installers, who then sell on their installation skills to the end-users. It was very encouraging to hear Latchways taking a very proactive approach over their installers' productivity. Tough sales targets are set by Latchways, with immediate enquiries being made should sales be seen not to be measuring up. Given that the individual installers are all independent, and are never completely reliant on the fall arrest industry to make their money, the demanding sales approach from Latchways was all the more impressive.

One potential for trouble is poorly installed systems. I was slightly surprised at the number of installers that have been dropped due to poor workmanship in the UK alone -- six or seven in the last few years. Although some monitoring is done by other installers, when systems undergo their annual maintenance, by and large responsibility for the initial installation lies squarely at the door of the original installer.

There is, to a certain extent, an element of trust that installers will implement the equipment correctly. The installation training that Latchways provides, and the attitude towards maintaining the quality of implementations, has meant a clear record in terms of failures. "We see no reason why we shouldn't continue with an unblemished record", David Hearson declared.

Competition

So, if there is still plenty of sales growth out there to be had, were competitors also lining up for a piece of the action? Well, as I had imagined from the rather extraordinary margins that Latchways possess, the fall arrest industry is hardly a cut-throat one. In terms of their horizontal systems, in which Latchways make the bulk of their profits, the company has only one significant competitor -- Capital Safety.

A former subsidiary of BTP (LSE: BTP), Capital are an all-round of safety equipment provider, generating around 10% of their business from fall arrest equipment. A few anecdotal stories of Capital's products and technical "assistance", gave me the impression of Latchways' current overwhelming superiority in the industry.

And of any new entrants? Latchways mostly fear the smaller players, but expenditure appears to be a major barrier for any industry tiddler. Rex Orton described a visit to one such minnow that had developed a system they liked: "Their fundamental problem is that they don't have the resources to turn themselves into a bigger company. To make the step change into becoming a Latchways is such an enormous investment." Good to hear.

Working Capital

As the earlier table showed, working capital has never been a Latchways strong point. The large divergence between accounting profits and cash profits has always given me a worry or two. My original investment theory was that, if Latchways had a stranglehold on its industry, and that demand was there for the products, then sorting out the underlying finances should be a relatively straightforward job. In other words, the business fundamentals outweighed the doubts over the operating cash flow profile.

In hindsight, this reasoning proved correct. Rex Orton described the "historic poor practices" that he had mentioned to me in his earlier e-mail. In previous years, the company had found themselves running out of components. In an effort to remedy this, and to save money via volume purchasing, large amounts of stock were then brought in. But now, the company went to the other extreme, this time having too much stock.

Rex Orton is getting to grips with the task of reducing stock levels. By trying to agree with the suppliers that they will have ongoing Latchways business should they "share the inventory pain", a reduction in the overall inventory turn is expected next year.

Rex Orton added comfortingly: "I'm relaxed about the stock, because it is all metal chunks. It will all go. And what I buy in quantities now, I know I use quantities of. The bigger numbers will disappear as we go along." Let me tell you, the words "It will all go" is very good news. And more good news came in the form of debtors. After reporting a distinct lack of bad debts over the years, my worries over large amounts of cash being tied up in the debtor ledger were somewhat soothed also.

Summary

Rex Orton summarised working at Latchways: "We have 'can-do' shop workers. We enjoy what we do, and for really the first time, I enjoy coming to work. It's great to be working at a company that is going somewhere."

For me, visiting Latchways was great. Both David Hearson and Rex Orton, to whom I extend my thanks, spent an inordinate amount of their time answering my questions. Certainly the whole experience was extremely interesting, insightful and valuable.

Now, if I can put my Qualiport hat on for a second... In those features, you will know that I am always on the lookout for companies with durable competitive advantages and avenues for material sales growth. I believe Latchways has both of those characteristics in spades. Their competitors are few and far between, and seem to be well behind in terms of their products, capabilities and marketing. A new ground-breaking competitor isn't expected any time soon.

The company appears to have no reliance on any supplier, and also has a very diverse and widespread customer base. Indeed, over half of current sales are overseas. Then there is the fact that the future level of safety equipment fittings, to comply with the legislation, isn't going to be dictated by any deterioration in the economy. With the Finance Director on the case with the level of working capital as well, Latchways, in my opinion, looks a solid investment proposition.

Part 1
Part 2

Related Links
• Latchways discussion board
• Full interview transcript
• Latchways website