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QUALIPORT
By
Carburton Street, London -- Today's Qualiport will review Druck Holdings (LSE: DRK). Although it's a bit of a tiddler, Druck exhibits many of the characteristics that prudent long-term investors seek. And at the current share price of 179p, the company's valuation is very appealing too. Under pressure
Druck is a world leader in the design, development and manufacture of pressure sensors. Uses for the company's sensors include monitoring river levels for flooding, recording fuel and tyre pressures on racing cars, controlling liquid natural gas delivery systems and regulating carbon dioxide bubbles during soft drink production. However, it's the aerospace industry that is Druck's largest single market. The company's Air Data Test Set devices, used to calibrate various cockpit instruments, are sold to both commercial and defence aircraft manufacturers. Druck's pressure devices are used extensively in the oil and petrochemical industries too. Overall, with accuracy and employee safety the paramount issues for customers, there's little doubt that Druck's expertise and reputation gives the company a decent competitive moat. Indeed, Druck's products are said to have global market shares of anything between 30% and 60%. Druck's industry position is undoubtedly underpinned by its Chairman, John Salmon, and its Director of Advance Technology, Michael Bertioli. Salmon and Bertioli co-founded the company in 1972 after building a pressure sensor five times more accurate than anything available at that time. Between them, Salmon and Bertioli own 51% of Druck. The financials Here's Druck's five-year financial record.Year to March 31st 1997 1998 1999 2000 2001
Turnover (£m) 54.5 58.8 68.3 70.3 76.1
Operating Profit (£m) 10.0 11.6 13.4 13.8 14.1
Pre-tax Profit (£m) 9.7 11.3 13.3 13.8 14.6
Earnings per share (p) 9.4 11.3 12.9 13.9 14.3
Dividend per share (p) 1.7 2.0 2.2 2.4 2.6
The table above fails to do justice to Druck's long-term financial record. After the company's formation in 1972, Druck has since managed to increase sales, pre-tax profits and earnings per share (EPS) every year!
Since 1992, sales growth has compounded at 13.4% per annum, pre-tax profit growth at 15.2% per annum and EPS growth at 14.6% per annum. However, the rate of growth has slowed somewhat in recent years, albeit to still respectable levels. Since 1997, annual growth of 8.7%, 10.7% and 11.0% has been registered in sales, pre-tax profits and EPS respectively.
While acquisitions helped to boost turnover and profits in 1997, there are two more notable points from the above profit record. Firstly, operating margins have consistently hovered around the very enticing 18% level. Even during a relative low point for the company, the recessionary year of 1992, an operating margin of 17.3% was still reported. And secondly, there have been no exceptional items dogging the accounts in recent years either.
Cash flow
Druck's cash flow record does not provide too many questions.
Year to March 31st 1997 1998 1999 2000 2001 Operating Profit (£m) 10.0 11.6 13.4 13.8 14.1 Change in Working capital (£m) (4.1) (3.7) (1.7) (1.0) 0.0Even though profits have been improving, the amount of cash absorbed into working capital has steadily diminished over recent years. While this trend cannot continue forever, it's a very good sign of the company's focus on cash management.
Depreciation (£m) 2.0 2.2 2.3 2.5 2.7 Capital expenditure (£m) (2.7) (3.7) (3.5) (2.8) (2.9)
It's also worth noting Druck's annual capital expenditure (capex) consistently overshooting the depreciation charge. While the year to March 2001 only saw a small differential (capex was 8% higher than depreciation), the past five years have shown cash expenditure on fixed assets averaging 134% of the stated depreciation charge. Although it's impossible to distinguish between Druck's maintenance and expansionary capex, it's a reasonable bet that last year's overall capex figure was unsustainably low.
Return on equity
Unfortunately, Druck's incremental return on equity performance is not particularly outstanding. While the traditional return on equity calculations highlight a sound performance, the low incremental return suggests a deterioration in recent reinvestment achievements.
Year to March 31st 1997 1998 1999 2000 2001 Earnings (£m) 6.1 7.3 8.3 9.0 9.3 Shareholders Funds* (£m) 36.0 41.6 49.2 56.3 64.5 Return on average equity (%) 18.3 18.8 18.4 17.1 15.4 Incremental return 11.3 on equity (97-01) (%) (* -- adjusted for goodwill)There are two reasons for the good, but not exceptional, performance:
* Druck spent £9m on acquisitions during 1996. At the time, the purchases brought in annual earnings of just £0.6m. How the acquisitions performed afterwards is unclear, but it's certain the group's subsequent return on equity performances suffered generally.
* Druck's financial position has changed from having £6m net debt in 1997 to having net cash of £12m in 2001. While eliminating debt is commendable, bolstering the company's bank balance is not conducive to improving equity returns.
Valuation
At 179p per share, Druck is valued at £114m. In terms of producing a historic "operational" free cash flow calculation, two adjustments are needed:
* Replacing the company's depreciation charge with a more realistic capex figure. Multiplying the latest depreciation charge (of £2.71m) by the five-year average capex "premium" (134%) gives £3.63m, and;
* Stripping out the company's not insignificant £11.9m net cash pile (worth 18.3p per share) and associated interest receivable.
So, with operating profits of £14.11m, and the company's typical tax rate of 35%, we could say free cash flow of £8.57m (13.15p per share) was generated for the year to March 2001.
If we subtract the value of the company's cash pile from the current share price, investors are effectively receiving 13.15p of "operational" free cash per share for an outlay of 160.7p per share. In other words, investors are receiving a very attractive free cash flow yield of 8.2%.
Summary
Druck is very similar to the two specialist engineers that presently reside on the Qualiport's watch list: Renishaw (LSE: RSW) and Halma (LSE: HLMA). All three companies have dominant global positions in various engineering markets, a characteristic that leads to high margins and steady and consistent growth records. For an outsider at least, there's not much to choose between the companies in terms of relative industry standings.
All three companies have long-standing managers too. However, while the management of Halma and Renishaw have spent the last thirty years increasing their annual operating profits to £50m and £27m respectively, the same period has witnessed Druck improve operating profits to just £14m. While "growth" is not the full story of any investment, do Druck's management have the same ambition as their opposite numbers at Halma and Renishaw? Maybe growth in Druck's sensor market is much more restricted?
Furthermore, in comparison to Halma and Renishaw, Druck's financials are the least attractive, especially in the acquisition department. Certainly when considering the incremental return on equity performances, Druck's (somewhat deteriorating of late) 11% figure is overshadowed by Halma's consistent 16% return and Renishaw's robust 22% performance.
Druck is a steady, solid business and its shares are presently trading at attractive levels. Should the Qualiport buy Druck? Well, given the "big bold bet" nature of the portfolio, I'd say not. In short, I'd far rather wait for Halma or Renishaw to become attractively priced, than buy into my least favourite of the three engineers. That said, for the long-term investor whose diversified portfolio isn't adverse to the odd smallcap, Druck is well worth some serious investigation.