Should you buy Electrocomponents plc after earnings soar?

Earnings at Electrocomponents plc (LON:ECM) soar by 50%, so are the shares good value?

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I’m a believer in the value of the ‘picks and shovels’ companies that supply goods to industry, as they have the promise to do well whoever wins the end-user race. Here are two I’ve been looking at today.

A stunning improvement

Shares in electrical distributor Electrocomponents (LSE: ECM) had risen by 62% for the 12 months up until Thursday, and they’re flying a further 15% higher so far today at 423p after the release of first-half results.

Companies report all sorts of adjusted figures, and the key ones for Electrocomponents seem to be underlying headline results. Those show a 44.6% rise in pre-tax profit, with earnings per share getting a 56.9% boost — and that appears to be conservatively adjusted too, as statutory reported pre-tax profit rose by 85.3% with EPS up 143%.

Total revenue was up by 12.7% to £706m with assistance from exchange rate movements, with underlying revenue up 2.1%. And £61.9m in headline free cash flow helped get net debt down by 16.9% to £140.9m.

But the shares are now on a fairly high P/E of around 25 based on full-year forecasts, so what lies behind this latest earnings growth and is it sustainable for the long term? We’ll need plenty more of the same to justify such a valuation, and chief executive Lindsley Ruth suggest that’s what we’re going to get.

Mr Ruth said he’s “extremely pleased by the progress we are making [via the firm’s Performance Improvement Plan] to put the customer back at the heart of this business, increase accountability and operate for less.” But he added that “while we have taken a major step forward, we are only just at the beginning of this journey and still a long way from best in class” and said he expects a further step change in the firm’s performance.

It sounds like there should be more to come.

A big faller

I’ve also been taking a look at plastics and packaging supplier Essentra Group (LSE: ESNT), whose shares took a nosedive on 9 June after a profit warning. We heard that the firm’s previous year-end prediction of “continuing our track record of balanced profitable growth in 2016” had been canned, with full-year revenue now expected to be flat and operating profit set to fall.

That was borne out by first-half results in July, which showed revenue largely unchanged (but down 7% on a like-for-like basis) and adjusted operating profit and EPS both down 18%. Chief executive Colin Day reiterated that the firm’s Filter Products and Health & Personal Care business was suffering, but insisted that the company “remains fundamentally strong, with global leading market positions in end-markets with positive growth characteristics, and attractive levels of profitability and cash generation.

Mr Day also reckoned that Essentra’s troubles were temporary and that the second half would be stronger, so has the market’s punishment of the share price been overdone?

Over the past few years we’ve seen Essentra shares valued at growth P/E levels of high teens to low 20s, and that was fine while we had double-digit EPS growth every year — and when the wheels come of the growth wagon, we usually see a share price crash.

We’re looking at forward P/E multiples of only around 11.4 now, with dividends set to yield 4.2%. If the problems really are short term and Essentra can get back on its growth trajectory, that valuation could be too low.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Essentra. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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