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Why this small-cap looks set to lift off

After trading sideways around the 125p level since September, the shares of technical fluid power products distributor Flowtech Fluidpower (LSE: FLO) are out of the gate this morning, up 7.5% at around 138p.

Strong results

The catalyst for this seems to be the strong results revealed today – full-year for 2016 and Q1 for 2017.

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This year has started well for Flowtech, with revenue up almost 32% compared to the equivalent period last year, and net debt down 59% after raising funds in a placing. Net borrowings stand at around 0.9 times the level of last year’s operating profit. The firm drives growth both organically and through its vibrant acquisition programme and the first-quarter results reflect that.

Chief executive Sean Fennon explains that the firm maintained gross margins in its Flowtechnology division in the face of rising input prices due to the company’s flexible pricing approach. Meanwhile, he also finds the firm’s performance encouraging in its other two divisions – Power Motion Control and Process.

During 2016, revenue grew 20%, operating profit lifted 12%, and earning per share ticked up 3.2%. That was topped off with a 5% hike in the dividend. It looks like growth in Q1 builds on those solid foundations.

Consolidating the sector

I find distribution firms interesting as potential investments because they enable us to ride the fortunes of entire industries without getting too entangled in the daily cut and thrust of dealing with the users of products. Final-customer-facing businesses, such as contracting firms, tend to lead a complicated, problem-filled existence that makes earning a buck from operations difficult. Distribution firms such as Flowtech, on the other hand, potentially deal with a smaller list of challenges, the main one being fluctuating demand.

According to chairman Malcom Diamond, Flowtech aims to consolidate the UK and European fluid power sector, which is fragmented. That strikes me as a strategy that could drive strong operational progress as long as the general economy holds up because the firm’s operations are inherently cyclical and sensitive to changes of fortunes in the industry.

Is this an inflexion point?

Last month, Flowtech raised a gross £10m in a placing to help fund ongoing growth objectives and I think the company looks well-placed to generate higher earnings when it deploys the money into more acquisitions. Mr Diamond has said “it is clear that the group is now entering an exciting stage of its development”, and it does seem to me the business and the shares have arrived at an inflexion point.

At a share price of 138p, Flowtech trades with a forward price-to-earnings (P/E) ratio of almost nine for 2018 and the forward dividend yield runs at 4.4%. City analysts following the firm expect earnings to grow 38% this year and 12% during 2018, and to cover the dividend payout almost 2.6 times. The valuation remains modest and I think Flowtech looks attractive right now.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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