QUALIPORT
Electrocomponents: 35 Years Of Rising Dividends

By Maynard Paton (TMFMayn)
July 3, 2002

Although recently ejected from the FTSE 100, Electrocomponents (LSE: ECM) is a company worthy of investigation. The company has a long, distinguished history, having increased its dividend payment every year since 1967. With a dominant industry position in the UK, plus plenty of scope for growth overseas, is Electrocomponents Qualiport material?

The business

Worth £1.5b, Electrocomponents is a distributor of a wide range of electrical, electronic and industrial components to over 1.5m customers in 26 countries. The group's principal sales methods are paper catalogues, CD-Roms and the Internet.

Electrocomponents floated in 1967, but began life as Radiospares in 1937 and later traded as RS. The company effectively created the high-service distribution market in the UK after deciding to focus on customers that demanded speed, availability, convenience and reliability, rather than just a cheap price.

The attitude to service has helped Electrocomponents forge a significant competitive advantage and dominant industry position in the UK. During the 1990s, Electrocomponents built on the UK success to establish itself in various foreign markets. The most significant move abroad was the £240m purchase of US distributor Allied Electronics in 1999. Relative to its standing in the UK, Electrocomponents presently has 12% of the European market, 4% of the North American market and 1% of the Japanese market.

Importantly, Electocomponents isn't involved in the more competitive (and less financially rewarding) wholesale distribution sector involving, for instance, supplying parts to major computer manufacturers (c.f. Eurodis Electron (LSE: ELH)). Instead, Electocomponents' customers tend to be small buyers, the average order being just £80.

The financials

Here's the five-year record of Electrocomponents:

Year to March 31st           1998    1999    2000    2001    2002

Turnover (£m)                 662     677     764     855     760
Operating profit (£m)         112     106     119     131     109
Pre-tax profit (£m)           118     112     115     117     106

Earnings per share (p)       18.9    17.8    19.0    20.6    17.3
Dividend per share (p)        9.0    10.5    12.0    13.8    15.9

(all figures adjusted for goodwill)

Unsurprisingly, given the types of products distributed, the latest annual results highlighted a rather dismal performance. Excluding discontinued operations, turnover fell 8% to £760m and operating profits dropped 17% to £109m. Points to note from the recent figures were operating margins remaining at a reasonable 14% level and net debt of only £53m.

The 2002 figures continued a rather flat period for Electrocomponents. However, the longer-term record is quite brighter. Since 1989, underlying sales have grown at around 11% per annum, operating profits have improved at roughly 7% per annum and earnings per share have increased nearly 6% per annum. Remarkably, the dividend has jumped an average 15% per annum over the past 13 years. It's worth noting that these past performances encompass the early 1990s recession, during which time Electrocomponents reported two rather grim sets of annual figures.

Cash flow and return on equity

Electrocomponents has attractive cash flow characteristics:

Year to March 31st           1998    1999    2000    2001    2002

Operating profit (£m)         112     106     119     131     109

Change in working            
  capital (£m)                (29)     (4)    (17)    (14)     31

Depreciation (£m)             (19)    (20)    (20)    (20)    (20)
Net capital expenditure (£m)  (28)    (18)    (16)    (22)    (42)

Over the past five years, just 6% of operating profits have been absorbed into additional working capital.

Given the nature of Electrocomponents' business, it's reassuring that stock, debtor and creditor days have generally remained consistent over time. However, the increase in time to shift stock during 2002 is quite notable.

Year to March 31st           1998    1999     2000    2001    2002

Stock days                    130     137     137     136     147
Debtor days                    63      65      63      62      65
Creditor days                  67      68      66      63      62

Electrocomponents doesn't have a great dependence on fixed assets. Although the figures for 2001 were used, this study showed the company had the ninth lowest reliance on tangible assets within the FTSE 100. Adjusting the study for the depressed 2002 figures, Electrocomponents remains in the top 25. Annual capital expenditure is generally 27% greater than the depreciation charge.

The financial analysis gets a bit tricky when considering incremental return on equity. As 2002 earnings were below those produced in 1997, prospective investors have to take quite a long-term stance on this matter.

Over the past ten years, earnings have improved by £44m while cumulative earnings of approximately £330m were retained for expansion. The resulting incremental return on equity comes to 13.3%. For the record, the return on average equity employed during 2002 was 15.4%. These middling-to-good performances suggest Electrocomponents can produce really impressive returns on equity during the good years (e.g. 1993-98) that make up for those generated in the poor years (e.g. 1998-2002).

Valuation and summary

Taking the conservative view that all capital expenditure is 'maintenance spend', Electrocomponents generated 16.9p per share of free cash during 2002. At 355p per share, the shares offer a historic free cash flow yield of 4.8%. On this measure, they're no obvious bargain.

However, it's worth noting that Electrocomponents distributed the majority of its free cash as a 15.9p per share dividend last year. Although Electrocomponents' shares thus offer a historic dividend yield of 4.5% (the highest the shares have yielded for over ten years), there's a danger that the currently low level of dividend cover could hinder the illustrious past rate of dividend growth. Within the latest results (published in May), Electrocomponents gave a somewhat cautious outlook for their short-term prospects.

A final point to consider is a recent change in the boardroom. Following a year-long stint as Chief Operating Office, Ian Mason has only been Chief Executive since July 2001. Bob Lawson, who was Chief Executive between 1991 and 2001, is currently non-executive Chairman.

Overall, Electrocomponents appears to be quite a decent business. Any company that has raised its dividend every year for 35 years must have something going for it! Although Electrocomponents' recent performance has not been inspiring, there are many underlying attractions to the long-term investor. However, without any obvious value in the shares, plus an unproven Chief Executive at the helm, watching from the sidelines appears the best bet at present.

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