Alongside tech, one of the few major industries that the LSE lacks significant exposure to is car makers. But domestic investors willing to dig around a bit will find at least two fast-growing firms that cater to the auto industry. They may be even better picks than the car producers themselves.
The founder knows best
The first I’ve got my eye on is AB Dynamics (LSE: ABDP). The £171m market-cap firm is the leading global designer and manufacturer of testing equipment for the industry. It works with each of the top 25 car makers, their suppliers and government bodies that oversee them.
The firm designs equipment that covers everything from testing the mechanical systems of a car to high-tech robot drivers and software that tests how well driver assistance systems function.
Thanks to this ever-expanding range of testing equipment on offer, deepening relationships with long-term customers in Europe, and a concerted sales push into massive new markets like China, AB Dynamic’s revenue is growing rapidly. In the year to August 2017, sales were up 20% to £24.6m while an increased focus on high-tech, high-margin equipment pushed adjusted operating profits up 26.2% to £5.9m.
Over the long term, the company appears well placed to take advantage of increased levels of vehicle ownership in emerging markets, the rising technicality of traditional cars, and the intense competition between car makers and tech firms to design driverless and electric vehicles.
And management is investing to meet rising demand for its services with a brand new £8.4m design and manufacturing facility completed at its headquarters and continued high levels of reinvestment in internal R&D teams. But management isn’t betting the farm as its net cash position of £9.6m provides a very nice rainy day fund for when the auto industry inevitably experiences its next downturn.
AB Dynamic’s shares aren’t cheap at 25 times forward earnings, but I believe its founder-led board has built a sector-beating company that will reward investors for many, many years to come.
When in doubt, call a consultant
Another auto-related stock on my radar is consultancy Ricardo (LSE: RCDO). It provides services to a wide range of industries, but in 2017 saw 56% of its orders come from its automotive and high performance vehicles segments.
And with these segments attracting a bevy of new contracts from global auto manufacturers, Ricardo is booming. Half-year results released this morning saw revenue growth accelerating by 9% to £182.6m. The group’s order book also grew 24% to £302m, which bodes well for the medium term as it includes plenty of multi-year contracts.
Although Ricardo isn’t as profitable as AB Dynamics, with underlying operating margins for the period coming in at 9.5%, the group does have the benefit of being more diversified with major customers in the rail, energy and defence sectors. This trend should only continue as management uses acquisitions to expand into new sectors related to its core engineering expertise.
With its shares sanely priced at 16 times forward earnings, a well-covered 2% dividend yield, sustainable net debt of only £31.5m and a bulging order book, I think now could be a great time to pick up a long-term winner at an attractive point.
While I have a long investing horizon and have no problem holding cyclical stocks through the business cycle, more risk-averse investors may prefer the record of one stock idea from the Motley Fool’s Head of Investing that has increased sales every single year since going public in 1997.
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Ian Pierce has no position in any of the 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.