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We probe management in an exclusive interview following troublesome trading update
Thursday 15 Jun 2017 Author: Daniel Coatsworth

Concrete levelling specialist Somero Enterprises (SOM:AIM) is the second best performing stock on the AIM market over the past five years, rising by 1,430% in value according to data from SharePad.

Shareholders have been happy people for a long time… until now.

A disappointing trading update on 5 June has set the tone for a potential profit warning later this year, in our opinion. Trading has been pedestrian in its core North American territory and growth has been harder to achieve in one of its hottest prospects, being China.

The company remains hopeful it will meet earnings forecasts for the year. We are nervous, having interviewed management following the trading update.

What should investors do?

Investors must now decide whether to take profit and sit on the side lines should trading not improve near-term. The alternative is to stay invested and use any share price weakness to buy more shares at a cheaper price, with an eye on the longer-term picture.

We’re not fans of trying to time the market. If you believe a company has good long-term prospects, the best strategy is to stay invested and stomach any setbacks assuming they are
only temporary.

You only need to think about selling your shares if the setbacks point to something more serious which can’t be fixed quickly.

We believe Somero shareholders should not panic sell, but caveat that it could be a choppy few months ahead for the share price.

Survived many pains before

The business is 30 years old, makes 50% gross margins and has been through plenty of good and bad market conditions. We take comfort in its superb track record of generating value for shareholders. Its average lease-adjusted return on capital employed is 18.5% over the past decade. Anything above 15% is a high quality firm, in our opinion.

Somero has no debt and is cash rich which means it can keep reinvesting money back in the business for product innovation and to boost sales and marketing capacity. Such qualities are rare at the junior end of the stock market.

What's behind the recent bad news?

The company believes the North American problems are temporary and chief executive Jack Cooney says he is perplexed as to why trading in China is ‘slow’. He says management will spend more time in the country to find out what’s holding back the expected growth.

China is still a small part of Somero’s business, whereas North America provides just over 70% of group earnings.

For the latter territory, the company has blamed bad weather for delaying projects and political uncertainty for holding back earnings growth during the first half of 2017. These are both temporary issues, in our opinion, and not reason to think its business model is weakening.

Cooney says Somero’s concrete levelling equipment is only needed once a property development project is mobilised, so its kit isn’t ordered if the construction workers can’t do their job because of bad weather.

‘Heavy rain has been going on for months in North America and it is still raining very heavily in Florida,’ he comments. ‘We don’t think our earnings forecasts will have to be downgraded as customers say they have a backlog of work through to 2018.’

Stop-start landscape

As for political uncertainty, property owners and developers paused projects around the time of the November 2016 US election and work has been stop-start ever since, according to chief financial officer John Yuncza.

‘The pace of work is up and down. It is hard to tell on a month by month basis,’ adds Cooney. ‘Everybody in the (US) construction industry is seeing one month up, one month down. The result is flatness. We can’t say if conditions have improved until there has been at least two consecutive “up” months.’

Understanding its Chinese position

In China, there is greater competition for basic equipment to level a layer of concrete on the floor. We’re encouraged by Somero saying earlier in June that it has enjoyed ‘early traction’ with its entry-level kit.

Importantly, Somero has a market advantage by also offering equipment for more sophisticated jobs where the client has certain specifications. Chinese rivals don’t have this type of equipment, claims Somero’s CEO.

‘The Chinese guys aren’t laser specialists like us. They don’t know how to lay down concrete; they are just equipment manufacturers. We’re experts and we have 24 hour support if a customer needs help. We also have a translation system which can talk in 65 different languages. We can have a certified engineer on the phone to anyone in the world within 10 minutes,’ says Cooney.

This service capability gives Somero an important edge. Speed is vital when you’re dealing with concrete as it sets in an hour and is very expensive to move once set. Therefore problems need to be fixed quickly.

Success in other places

The company remains upbeat about its prospects and is introducing new innovative products to cross-sell to existing clients and use as a way to reel in new clients. European growth is going well, so too Australia, India and Korea, says Cooney.

The shares fell 8.3% to 285p following the recent trading update but have since recovered to 292p. The stock now trades on 13.5 times FinnCap’s forecast 27.4c (21.7p) earnings per share in 2017. Existing shareholders should sit tight.

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