Today, I’m looking at two small-cap technology groups that are expanding through a mix of acquisitions and market share growth.
Strong underlying gains
When a company is going through a major period of change, adjusted accounts showing only continuing operations can be very useful for investors. These numbers provide a snapshot of progress that strips out all the ‘noise’.
Today’s 2017 accounts from TT Electronics (LSE: TTG) are a good example. This £350m electronic component manufacturer sold its transportation division last year in order to focus on its higher margin product lines such as current sensing, circuit protection and signal conditioning.
TT’s figures for underlying performance show sales from continuing operations rose by 8% to £360m last year, while operating profits measured on the same basis rose by 18% to £24.3m. Adjusted earnings per share were a whopping 40% higher, at 10.9p.
When profits rise faster than sales, this usually indicates rising profit margins. That certainly seems to be happening here. The group’s operating margin from continuing ops rose from 6.2% to 6.8% last year. Return on invested capital, one of the company’s preferred measures of profit, rose from 9.2% to 10.6%.
More change coming
Last year’s disposal left the company flush with cash, and this hasn’t been left idle for long. In February, TT announced it had made a successful offer to acquire specialist electronics maker Stadium Group for a cash payment of £45.8m, plus net debt of £11.8m.
Today’s accounts show net funds of £47m, suggesting that the acquisition will leave the firm with a modest net debt position. That doesn’t concern me, given the group’s stable profits and the potential for cost savings when Stadium’s operations are integrated.
Analysts’ forecasts for 2018 put the stock on a P/E of 18, but I expect these estimates to rise when the Stadium acquisition completes and TT’s management provides updated guidance. I’d rate TT Electronics as a long-term buy at current levels.
A stealth growth stock
One company you may not have heard of is Cohort (LSE: CHRT). The group owns a selection of engineering, software and consultancy businesses which operate mainly in the defence sector.
Areas in which the group operates include cyber security, electronic warfare, communications and surveillance. The logic behind Cohort’s expansion seems to be that the companies it buys will enjoy cross-selling opportunities and access to new markets as part of a larger group.
I can see the case for this, although the evidence so far is somewhat mixed. The group’s operating profit margin has fallen from 11.8% in 2013 to just 0.9% last year. Return on capital employed has slumped from 14% to 1.2% over the same period.
A turning point?
In fairness, I think these isolated numbers probably mask a more attractive picture. The group’s acquisitive growth has been funded without issuing a lot of new shares, and while maintaining a net cash balance.
However, there’s no doubt that progress will be required to justify a higher share price. Analysts expect the group’s adjusted earnings to rise by 6% to 29.1p per share this year. That puts the stock on a forecast P/E of 12.7. There’s also a prospective yield of 2.2%.
This valuation seems about right to me, but if you view this as a long-term growth story, then the shares could be worth considering.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Cohort. 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.