The Motley Fool

Why I’m still avoiding this FTSE 250 company despite its market-share gains

Today’s half-year results report from international electrical and electronics components distributor Electrocomponents (LSE: ECM) has whacked the shares down almost 12%, as I write.

I ventured into the dank and cobwebby basement this morning at Motley Fool towers to rummage around the archives. After blowing off the dust, I discovered my previous article on the company was published at the beginning of February. Back then, I was cautious on the stock believing the valuation had raced ahead of itself and the business was vulnerable to cyclical shocks to the downside.

Profits down

It has to be said the shares have zig-zagged up a bit since February and now stand at around 624p, and that’s after today’s setback. The price compares to around 567p when the previous article came out last winter.

So, what are investors worried about in the firm’s news release today? Revenue rose by 7.3% in the six months to 30 September compared to the equivalent period the year before.

We can strip out the effects of currency movements and additional trading days that the company engaged in by looking at the like-for-like figure, which lifted by 4.5%. The directors said in the report its industrial sales “more than offset” a weaker performance from electronics. 

So far, so steady. But things didn’t go well for the firm with profits. And I’m going to look at the ‘best case’ figures, which I reckon are the adjusted ones. Indeed, the unadjusted figures show bigger declines. Operating profit came in an adjusted 1.5% higher, but the like-for-like figure dropped 2.1%. The operating profit margin slipped back by 0.6% and 0.8% when considering like-for-likes.

Meanwhile, adjusted free cash flow plunged just over 59% and net debt shot up almost 59% to nearly £221m. The balance sheet reveals to us that the increase in net debt is primarily due to more borrowings rather than falling cash levels.

Asset write-downs

Part of the outcome with profits occurred because Electrocomponents was caught up in British Steel Limited’s compulsory liquidation on 22 May. British Steel owed the firm money for goods it had already received and, sadly, the situation has led to £10.4m of assets being written down. Such setbacks are one of the risks and harsh potential realities of being in most businesses, from the smallest sole-trader to the biggest international conglomerate.

But the company is also ploughing capital back into its operations in order to remain competitive. There’s a transition programme, for example, moving operations from catalogue-led sales to digital sales, which is sucking funds into new IT systems.

However, some of the margin attrition is down to “product mix,” which I reckon is something to keep an eye on. Shrinking profits could be an early signal of tough trading ahead in a market where price-slashing and lower-margin goods are needed to stimulate sales.

Yet the directors slapped more than 11% on the interim dividend, suggesting confidence in the outlook and their expectation of “continued growth and outperformance over the medium term.” But I remain cautious on the stock for now.

There’s a ‘double agent’ hiding in the FTSE…

We recommend you buy it!

You can now read our new stock presentation.

It contains details of a UK-listed company our Motley Fool UK analysts are extremely enthusiastic about.

They think it’s offering an incredible opportunity to grow your wealth over the long term – at its current price – regardless of what happens in the wider market.

That’s why they’re referring to it as the FTSE’s ‘double agent’.

Because they believe it’s working both with the market… And against it.

To find out why we think you should add it to your portfolio today…

Click here to read our presentation.

Kevin Godbold has no position in any share 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.