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The installation of David Hearson in the boardroom during 1995 and the introduction of recent safety legislation have given the top line at Latchways a healthy boost. Sales growth has compounded annually at an average 40% since 1996. Pre-tax profits have compounded annually at an average of 45% over the same period. All this has been without recourse to any acquisitions. It's all pure organic growth -- lovely!
Working Capital and Return On Equity
Thankfully, some "historically poor practices" with the management of stock appear to have been addressed. On the face of it, Latchways hasn't been a cash fountain over the years, but the company's most recent annual performance is definitely a step in the right direction.
The company's equity base has swelled from £720,000 to £4.15m over the past four years, aided partly by the £1m raised at the company's flotation in late 1997. The enlarged equity base has helped post-tax earnings to surge from £440,000 to £2m over the same period, equating to an incremental return on equity of 45%. This achievement is of course, very impressive, more so given that it's been accomplished with minimal debt.
With plenty of cash in the bank, it's time for another Qualiport proposal -- Latchways (LSE: LTC). As is my wont, it's another tiddler. At a share price of 482p, the company is valued at just £51m.
As some readers may already be aware, I have to own up to the fact that I'm already a personal holder of the shares. I've also had the pleasure of visiting and interviewing the company's management in February. This feature will mainly pick out the salient Qualiport points from this more comprehensive site visit report.
The Business of Safety
Latchways is the name in fall arrest safety equipment. In a nutshell, fall arrest equipment continuously protects those at height from falling to their deaths. For instance, if you're climbing up to the top of a crane, or venturing up to the top of the Sydney Harbour Bridge, as tourists are now able to do, you will need to be securely attached to a safety system. And so enter Latchways, aided especially by increasing worldwide legislation that now stipulates mandatory use of fall arrest equipment above certain heights.
The equipment can be used on any type of construction, and can be installed on new and old buildings alike. But Latchways just designs and subsequently assembles the equipment. Manufacturing is outsourced, and the systems are actually put into place by a network of approved third-party installers.
As I mentioned when reviewing Halma (LSE: HLMA), safety systems bring an investor dilemma. Fall arrest equipment is pretty much a "must have" product for those companies with employees working at dangerous heights. The flipside is that sales of the equipment tend to be a one-off. As David Hearson, the Managing Director of Latchways, explained: "You don't tend to get a repeat purchase on the same system. But what you do get hopefully are more systems on the same site".
The Financials
The business of fall arrest systems doesn't sound too sexy. But the overall financial history of Latchways should arouse most investors.
To 31st March 1996 1997 1998 1999 2000
Sales (£m) 2.25 3.66 4.57 6.67 8.66
Operating profit 0.58 1.18 1.69 2.23 2.84
Profit before tax
and exceptionals (£m) 0.62 1.21 1.75 2.30 2.78
Earnings per share
before exceptionals (p) 4.85 9.35 12.82 15.44 18.85
Operating margin (%) 25.8 32.1 36.9 34.0 32.8
Another notable operating feature is the company's margins. Gross margins are typically above 60%, while operating margins are consistently above the 30% mark. Those fat margins largely stem from Latchways' dominance in its niche industry. The company has a market share of about 80% in its traditional "horizontal" system market, and has vied with only one significant competitor in the past -- Capital Safety, a subsidiary of BTP (LSE: BTP).
Another great feature of the company's record is that its market leadership isn't underpinned by the need for additional staff to constantly help rack up increased revenue. Sales per employee have more than doubled since 1996.
To 31st March 1996 1997 1998 1999 2000
Sales (£m) 2.25 3.66 4.57 6.67 8.66
Employee numbers 23 23 25 32 38
Sales per employee (£k) 98 159 183 208 228
The company's financial history isn't without fault. Working capital and the resulting cash flows have been a problem in the past. Compare the total change in stocks, debtors and creditors to operating profits for the past few years. Indeed, in 1999, half of the reported operating profit was sucked into an fast-expanding debtor ledger.
To 31st March 1996 1997 1998 1999 2000
(£k) (£k) (£k) (£k) (£k)
Operating profit 580 1,178 1,688 2,265 2,842
Change in stocks (50) 42 (190) (626) 263
Change in debtors (299) (147) (584) (1,168) (506)
Change in creditors 107 (8) 27 451 627
Total change (242) (113) (747) (1,343) 384
In terms of return on equity, high margins and a low appetite for capital expenditure combine to give Latchways some very enticing figures.
To 31st March 1996 1997 1998 1999 2000
Earnings (£m) 0.44 0.84 0.96 1.55 2.00
Average shareholders'
equity (£m) 0.57 1.28 1.46 2.64 3.59
Return on average
equity (%) 77.4 65.7 65.4 58.6 55.6
Incremental return
on equity (1996-2000) (%) 45.4
Valuation and Summary
Here's how I summed up Latchways from my visit to the company:
"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."
My view's hasn't really changed since. Granted, I suspect competitors are gradually realising the attractive returns to be had from this particular industry, but Latchways isn't going to lose its fall arrest "franchise" for a few years yet. My only doubt over the Latchways business is its inevitably niche marketplace which, when served, could leave the company (and its shares) with nowhere to go.
In terms of nearer-term sales growth, David Hearson told me of a "huge opportunity" in helping to bring the level of fall arrest compliance in Europe to the UK standard. Currently, revenues from UK are three times higher than those generated on the Continent. Other corporate opportunities include the installation of safety equipment in telecommunication masts, an area where Latchways has just started to scratch the surface. The company's recent AGM statement declared that "after a traditionally dull start to the year, orders have picked up strongly in June and July".
Unsurprisingly, the record and prospects of Latchways have been recognised by stock market. Brokers have pencilled in earnings per share (EPS) of 20.8p for the year to March 2001, with EPS of 26.3p for the year after. At a share price of 482p, the forecasts place Latchways on a prospective price to earnings (P/E) ratio of 23. No obvious bargain at the moment.
From this preliminary view, Latchways looks an attractive proposition for the Qualiport. In short, a dominant player in a niche industry, exhibiting a very impressive financial history, with significant future sales potential. Should the shares ever fall back to a more attractive valuation, the Qualiport could be falling for Latchways.
Where Next?
• Visit the Latchways discussion board | website
• Go on site at Latchways and read the full interview with the company management