Shares of AIM-listed Internet-of-Things technology firm Telit Communications (LSE: TCM) rose by nearly 5% in early trade on Monday, despite the company unveiling a pre-tax loss of $56.8m for 2017.
The Telit share price has fallen by 55% over the last year, in the wake of a scandal involving US fraud allegations against former chief executive Oozi Cats and various other problems.
Replacement chief executive Yosi Fait has since faced a number of of issues, including project hold-ups and delays with the certification of new products. Profit margins were also hit by a faster-than-expected shift to lower margin LTE (4G) mobile technology.
Although sales remained stable at $374.5m in 2017, lower profit margins and higher costs pushed the group to an adjusted pre-tax loss of $17.8m, excluding restructuring costs.
Mr Fait has promised “double-digit growth” and “a better financial performance” for 2018 so I’ve been taking a look to see if this high-tech turnaround a good bet for the future.
Margin pressure?
One of the biggest contributors to expenses last year was a massive increase in research and development spending, which rose from $38.3m to $66.9m. The company says that this was due to the cost of extra staff and an increase in certification costs.
Management is working to reduce R&D costs and expects to close a number of locations over the coming years. For 2018, Telit is targeting a $10m reduction in cash expenses, plus “stabilisation” of gross profit margins and double-digit sales growth.
This suggests to me that gross profit margins aren’t likely to rise. Any improvement in operating profitability will have to come from lower costs and higher volumes. I don’t know how achievable this is. In today’s results, Telit warned of lower margins on 4G technology in the US, and of growing Chinese competition in Europe.
I’m not convinced
Broker forecasts suggest Telit will report an adjusted net profit of $13.1m for 2018, with adjusted earnings of 10 cents per share.
This puts the stock on a forecast P/E of 21 for 2018. Personally, I’m not convinced by this growth story. I’d sell the shares at this level and invest elsewhere in the tech sector.
Being #2 is still profitable
Investing in market-leading companies is often a good strategy. But in some cases, being number two is enough to deliver scale and profitability.
One example of this is FTSE 250 firm ZPG (LSE: ZPG). Formerly known as Zoopla, this firm’s main business is its property website. But to compensate for the fact that it will probably always rank second to Rightmove, it is expanding sideways into other related areas.
The firm’s assets now include price comparison website USwitch and property valuation business Hometrack. This growth strategy has pushed operating profit up by an average of 42% per year since 2011. Although profit growth has slowed in recent years, it’s worth noting that operating profit rose by 8% to £53.7m in 2017.
I’d buy at this level
Analysts expect ZPG’s adjusted earnings to rise by 17% to 17.8p per share this year. The group’s dividend is expected to rise by 21% to 6.9p. This puts the stock on a forecast P/E of 19.5, with a 2% yield.
Although this may not seem cheap, I believe this firm’s proven growth potential and profitability is likely to result in further gains for shareholders. I’d continue buying at current levels.
