Regulatory-driven growth at ventilation products firm Volution (FAN) is not reflected in the current valuation as the company completes the largest acquisition in its history.

The £38m purchase of New Zealand peer Simx increases its exposure beyond UK markets from around 43% to more than 48%, and is expected to be immediately earnings enhancing.

Volution’s ventilation business represents nearly 90% of group sales. It designs, assembles and markets ventilation fans, systems and ducting for domestic and commercial buildings. It has leading market positions in the UK, Scandinavia, Germany and now New Zealand.

The remainder of group sales come from the Torin-Sifan business which supplies motors and fans for the global heating, ventilation and air conditioning industries.

Demand for ventilation products is being driven by tighter regulations on air quality. Principally operating as a designer, supplier and assembler rather than an asset-intensive manufacturer of products, Volution generates strong margins and cash flow.

It has a good track record of reinvesting cash into bolt-on acquisitions in what remains a highly fragmented market. Volution has previously estimated the seven acquisitions made between 2012 and 2016 generated average returns on capital of 24%.

M&A HELPS BOOST GROWTH

Acquisitions have helped supplement organic growth of between 3% and 5%. The company aims to enhance the margin performance of acquired businesses by boosting selling prices, redesigning products to reduce the cost of assembly, improving procurement and switching to in-house components.

This latest deal is not cheap at an enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) ratio of more than 10-times. Yet it provides exposure to a relatively strong economy and its integration should be smoothed by Simx’s status as a long-standing customer of Volution.

The group as a whole trades on a price-to-earnings (PE) ratio of 12.2-times for the financial year to 31 July 2019, compared with an average forward PE of 18.3-times for a Liberum-compiled list of its peer group.

So why is Volution trading at a discount? Margins are under a bit of pressure, falling from 19.4% to 18.5% in the six months to 31 January 2018, thanks to the loss of some higher return work in the UK and the initially more modest profitability of acquired businesses.

First half cash flow performance was disappointing. This reflects increased working capital demands as the company looks to maintain customer service in the UK during the completion of a consolidation of its facilities in Slough and Reading.

These factors look short-term in nature to us and do not justify the current gap between Volution’s valuation and that of its peers. (TS)

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